Amid record production from Cabot Oil & Gas Corporation (COG) and its competitors, analysts are predicting another winter of near record low gas prices. Phil Flynn, a senior market analyst for Price Futures Group, is calling for prices around $2 unless this winter brings extreme cold, which is far below recent NYMEX prices for October delivery of around $3 per million British thermal units. A compilation of estimates by Bloomberg is more optimistic, predicting an average price around $3.20 per mbtu.
By either estimate, however, Cabot should be able to eke out its margins; according to Cabot CFO Scott Schroeder, Cabot's breakeven is "probably below $2," meaning that even if prices hover around $2 into next year, Cabot has a chance of making a profit from its ever increasing natural gas production. This potential for profit even in a worst-case scenario is one of the strongest reasons for snapping up shares of Cabot while they're still trading low.
Natural Gas Markets, Moves Benefit Cabot
There are several factors keeping natural gas prices depressed. Low demand is leading to record stockpiles, even as increased production is forecast. To meet the increased production, several pipelines are scheduled to come online in the next few months, including pipelines serving the Marcellus Shale, where Cabot is a play leader. Even if these new pipelines force natural gas prices lower, they will also be lowering Cabot's costs, as estimates call for transportation charges to fall to as low as $0.50 per tcf, considerably below recent charges reported by Carrizo Oil & Gas (CRZO) at around $1.40 per tcf.
Producers like Cabot and competitor Chesapeake Energy (CHK) are pushing production from the Marcellus ever higher; data from Goldman Sachs (GS) shows that last year, the Marcellus accounted for 5% of US natural gas output, and will account for as much as 22% of US natural gas output in 2016. Indeed, Cabot is consistently releasing record setting production, reporting an all time high of 752 mmcf during a single 24-hour period in recent weeks and continuing an average above 700 mcf for the last two weeks of August.
Cabot Chairman, President, and CEO Dan O. Dinges attributed the record setting production to "a series of projects and upgrades that improved the pipeline system operating efficiency." Even before the projects Cabot was doing well, as according to Dinges it "owned 14 of the top 20 producing wells [on the Marcellus] in the first half of 2012."
Cabot is learning how to do more with less; it is currently running only four rigs on the Marcellus, but the target pay is in the area of thickest Marcellus, leading to higher payouts on wells completed. To take advantage of this, Cabot is tentatively scheduling five or six rigs for 2013. Cabot is also hinting at the potential of these areas to support 10 well pads, which would increase efficiencies on nearly all measures, from initial mobilizations to spud to rig release to number of wells per rig per year. This, a doubly condensed pad from the 5 well pad the firm recently tested, would further cut Cabot's costs to support a profit even on continued low natural gas prices.
After the Marcellus, Cabot's next most active area is the Eagle Ford, where it holds 80,000 net acres, and the occasionally vertically underlying Pearsall, where it holds 62,500 net acres. Here it is competing heavily not only with Chesapeake, but with EOG Resources (EOG) and Plains Exploration & Production (PXP).
Plains is staking its recent run of success on the Eagle Ford, as it becomes more efficient at unconventional drilling, much like Cabot, and makes the most of its 8 rigs currently on the play. Cabot, by comparison, is running just one rig on the Eagle Ford, and two rigs on the Marmaton. Yet despite its smaller size, Cabot's growth track hints strongly at a buy.
Cabot is currently trading around $46 per share, giving it a price to book of 4.5 and a forward price to earnings of 53.6. For comparison, Chesapeake is trading around $20 per share with a price to book of 0.9 and a forward price to earnings of 10.8. Carrizo is trading around $26 per share, which gives it a price to book of 1.8 and a forward price to earnings of 6.6. EOG is trading around $114 per share, with a price to book of 2.3 and a forward price to earnings of 18.1. Finally, Pioneer is trading around $104 per share, with nearly identical value ratios to EOG; Pioneer also has a price to book of 2.3, and a slightly higher forward price to earnings of 18.2.
This high forward price to earnings is indicative of the low natural gas prices holding revenues down. However, natural gas prices will not remain low forever, and once they rebound Cabot's stock is bound to go up, so what looks like a premium may actually be viewed as a discount. Cabot's production mix is weighted 60% towards natural gas, with the remaining 40% in liquids. Cabot expects to spend 83% of its 2013 capital expenditures, tentatively estimated at between $900 million and $1 billion, on drilling costs.
So what's next for Cabot? In addition to looking at core efficiencies through improved infrastructure and downspacing, the firm recently completed its first zipper fracs, which it found successful, and is looking to focus on further liquids growth from the Eagle Ford and Marmaton.
In the Marcellus, extended laterals and additional stages are not being ruled out, although tangled Pennsylvania regulations prevent Cabot from forced pooling units, making these enhanced production methods more difficult when they would extend under property not held by lease when voluntary pooling is not forthcoming. Still, altogether, Cabot expects its efforts to result in 30% to 50% production growth in 2013, most of which will be at healthy profit margins if Cabot's costs and natural gas price predictions stay in line.
Cabot will release its third quarter earnings report on October 26.