In previous articles, I have calculated and compared costs of oil companies all over the world. Most of those companies also produced significant amounts of gas, as it is hardly possible to get pure oil out of the subsurface. As soon as the pressure of the oil falls below a certain threshold value (called bubble point), gas bubbles will form from the oil. Sometimes this gas is flared, as its sale would not generate enough money to finance the facilities necessary for its processing.
To take both oil and gas into account, the concept of barrel of oil equivalent - boe - was perceived. It enables a comparison of different hydrocarbons based on their energy content. 1 barrel of liquid oil has about the same energy content as 6000 cubic feet of gas at standard conditions (standard cubic feet - scf). As the properties of gas (density,…) strongly depend on the pressure and temperature regime, gas can only be compared at definite conditions. Standard conditions in the oil and gas industry typically refer to 14.7 psia and 60 degree Fahrenheit. That means, 1 boe can either be 1 barrel of liquid oil or 6000 scf of gas at standard conditions or a mixture of both. Nevertheless, with the same thinking it is also possible to convert barrels of liquids into scf equivalent. This principle is mostly applied by upstream companies that have a high share of natural gas in their portfolio and therefore on are called gas companies from now on.
Of course, it is quite tricky to define the threshold that separates 'gas companies' from 'oil companies'. One could assume a threshold of 50% in terms of energy content. Nevertheless, it is questionable, whether this makes sense at all, as liquids earned a significant price premium on energy content-base historically. The main reason for this might be the much easier handling of liquids compared to gas. Let's imagine, one barrel of oil costs $80 and 1,000 scf of gas costs $5. This means, 1 boe consisting of oil would cost $80 and 1 boe of gas would cost $30. An equal split in terms of energy content would lead to a revenue share generated from oil of 72.7%, which makes it hard to think of the company as a gas company.
Eventually, the threshold taken in this article was 25% on energy content base. Depending on the individual price ratio of oil and gas, it could be possible that a gas company receives more income from oil than from gas. In this article, I calculate and discuss production costs of three North American gas producers: Cabot Oil and Gas (NYSE:COG), Chesapeake Energy (NYSE:CHK) and Comstock Resources (NYSE:CRK).
The cost model I use for the calculation of gas production costs is very similar to the one used for the costs of oil productions. Only slight adjustments were necessary. I would like to highlight, that this article will slightly tend to overestimate production costs of gas production (the explanation can be found in any of my previous articles).
Once again, costs are divided into costs that can directly be related to production (cost of sales) and costs that cannot directly be related to output (overhead). However, many companies are also active in downstream and midstream or other economic sectors. Hence, I have divided sales, general and administration expenses (SG&A) by total revenues and multiplied it with the revenue of the E&P division to get SG&A for E&P. I did the same for any similar type of cost (marketing expenses, R&D) and for financial expenses. Depreciation of assets, on the other hand, can be directly linked to gas production.
Costs of sales are divided into 3 sub-categories:
- Exploration costs
- Lifting costs
- Non-income related taxes
Exploration costs are costs related to all attempts to find hydrocarbons. This category includes cost for geological surveys and scientific studies as well as drilling costs.
Lifting costs are the costs associated with the operation of oil and gas wells to bring hydrocarbons to the surface after wells (facilities necessary for the production of oil and gas) have been drilled. This figure includes labor costs, electricity costs and maintenance costs. With a special focus on gas, lifting costs also include handling and transport expenses for gas.
Non-income related taxes: as production of hydrocarbons is such a lucrative business, governments also want to have their share. There exists an abundance of different models how the state can profit from hydrocarbon production (profit sharing, royalties, etc.). This is true for oil and also for gas.
The following figure shows the pattern of the cost model:
All numbers in the tables in this article refer to 1000 scf. It might be, that different companies use different categories for the same type of expenses, but eventually the sum of all costs should be their total cost for producing 1000 scf. If one wants to compare the costs of gas production directly to the costs of oil production in my previous articles, all numbers related to 1000 scf must be multiplied by 6. Those articles can be found as following:
- Majors I
- Majors II
- Independents I
- Independents II
- Independents III
- Oil Sands I
- Oil Sands II
- Tight Oil I
- European Former NOCs
Application on 3 American gas companies
As mentioned above, I have applied the cost model on 3 North American gas companies: Cabot, Chesapeake and Comstock. Cabot's two most important production areas are the Marcellus Shale and the Eagle Ford Shale, which both produce gas from tight reservoirs. The company also operates gas gathering and transmission pipeline systems. Chesapeake is the second largest gas producer in the United States (beaten only by Exxon Mobil (NYSE:XOM)). The enterprise also focuses on unconventional resource plays, among them Barnett, Marcellus and Haynesville. Comstock is the smallest of the three companies here, and its production also focuses on shale gas (Eagleford). The fact that all companies depend on shale gas highlights the importance of that unconventional resource type for North American gas production. All numbers necessary for the calculation were taken from the company's annual reports, which are all stated in US-$.
The results can be found in the table below:
Liquids do not only refer to classical oil, but also to gas condensate and bitumen (produced from oil sands).
Different companies tend to get different prices for their products and the percentage of gas or liquid alone is not sufficient to define the price. This was true for the oil producers and is true for the gas producers. Although Comstock had a higher percentage of gas produced than Chesapeake, it generated much more revenue. On the other hand, Cabot is clearly distinct with the lowest production costs, but also the lowest realized price per 1000 scf equivalent and the highest share of gas produced.
The pre-tax margins of the companies are significantly different. While Cabot and Chesapeake were doing very well (about 25%), Comstock suffered losses with a pre-tax margin of -5%. This is not deadly for Comstock as my methodology includes all costs related to hydrocarbon production and the loss is not existence-threatening for the company, but clearly indicates that Comstock must focus more on cost discipline. Otherwise, the company cannot be profitable at today's price level. Investors see it also this way, as Comstock's stock price was more than $80 in 2009, but fell to a price slightly above $10 in the meantime.
Implications for the gas price
On the other hand, cost discipline is what enabled Cabot and Chesapeake to be highly profitable at today's natural gas price. If someone assumes, that gas prices must go up because they are below the production costs, the numbers in the table prove him wrong. At least two companies in North America can easily survive at the price level of 2013 and earn good money with it.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.