Oil & gas industry still high on investors' radar

Justin Perucki and Eric Chenoweth attended the IPAA Conference in New York April 20-22, meeting with a number of Exploration & Production and oil services companies. Attendance appeared as strong as it has in any of the past four years, with some individual company breakouts exceeding levels of any we've seen in recent years, suggesting high investor interest levels despite the industry's sell-off. We assembled some highlights below:

Mixed views on the natural gas price
In general there was a lot of optimism for natural gas prices heading into 2010, though many expect severe weakness over the next 60-90 days. Bullish views were driven primarily by the dramatic pullback in drilling and completion activity that should allow the steep natural decline curve to bring down supply. Longer-term bullish views were driven by the continued trend of conversion of more and more power generation to natural gas, away from coal. XTO Energy suggested that too much attention is being spent on the size of new discoveries instead of the role accommodative credit markets played in financing aggressive drilling over the past five years. Forced to live well within internal cash flows now, companies can only afford to drill at much reduced levels. Put another way, natural gas supplies can be abundant, but at an appropriate price. The price to develop the new shale plays is thought to be much higher than the current market price; many suggest $6 to $8 per Mcf (cubic foot).

Bearish views suggested that a turnaround in gas prices could be postponed until later in 2010 or possibly 2011. Bears point to high present storage levels, high line pressures curtailing potential currently available production, a large supply of drilled and cased wells awaiting completion, greater LNG (liquefied natural gas) cargos hitting US shores, and a weak economy suppressing industrial demand for gas longer. Nearly everyone seems to agree that the US natural gas industry doesn't work at sub-$4 gas, and prices should eventually rebound once the decline curve rationalises enough supply.

Banks are using a firmer hand when influencing firms' behaviour
In exchange for maintaining borrowing bases, banks are forcing companies to shed assets, expand hedge positions, and issue equity--even at apparently better capitalised firms. Some firms have liquidated longer-dated deep-in-the-money hedges, paid down debt, and re-established hedge positions at a lower price level.

M&A trends still point to greater activity, weaker prices
Companies are largely split into two camps: those seeking greater liquidity, and those considering deploying liquidity. There are a lot of assets for sale, and a lot of leases are set to expire in 2010. Both of these factors are aiding potential bidders’ patience. Better assets and terms are expected before the end of the year as sellers could become more desperate unless a natural gas price rebound materializes. The Helix Energy package is a key one to watch near term in the Gulf of Mexico market.

Majors are hunting for shale assets
Many believe that the majors are looking very intently at the independents and the various shale plays. The intellectual flight following the ConocoPhillips, Burlington Resources acquisition has majors reticent to acquire an entire company, and many would prefer joint ventures or an asset deal. Access to capital and cost of capital advantage make the majors ideal financial partners in these highly capital-intensive, manufacturing-style shale plays.

Haynesville still a dominant conference topic for a second year
Of note, East Texas is less prolific than Louisiana but sports a flatter decline curve. East Texas is still early in this area of the play. Key well to watch: EOG's (Petrohawk is also a 45% working interest partner) Gammage H well in Nacogdoches County, Texas – the western-most well drilled in the play to date. Results expected in 1Q calls. Smaller operators are moving up the learning curve, so expect better drilling results in near future.

New industry advocacy groups being formed to tackle larger political issues
Producers are joining together to educate the public and politicians about the industry and natural gas' key selling points--clean and local. General consensus that IDC tax deduction won't be repealed for independents, but expect some form of higher taxation down the road.

Costs are down big, but still have further to fall
Cost declines are in the ball park of 30%-50% across the country. Marcellus costs have been sticky due to higher activity levels relative to a smaller local services buildup, but are expected to fall through the course of the year as service capacity increases. Frac costs also holding up better and longer, but are expected to fall over 50% in coming quarters. Jack-up day rates in the Gulf of Mexico have reached as low as 1979 levels.

New lease terms very favourable relative to peak
Lower royalties (<15% versus 25%), longer terms (five to 10 years versus three years), and smaller bonuses ($300-$1,500/acre versus $3,000-$25,000/acre) are making leases more attractive for E&P firms. Many desperate sellers (e.g., companies, landmen, and neighbourhood groups) are pressuring the marketplace. Some talk of lease bonuses being amortized versus being paid up-front.