Another take on natural gas put out by Reuters today
regards
Robert Raymond
Rising costs form flipside to higher US natgas prices
By Andrew Kelly
HOUSTON, July 9 (Reuters) - Pervasive bullishness about the long-term outlook for U.S.
natural gas may cause investors to overlook rising costs that could prevent oil and gas
exploration companies from cashing in on higher prices.
Analysts said costs of finding and developing natural gas reserves in North America have
been rising along with prices for the clean-burning fuel, with the result that producers'
profitability has not improved and might even have deteriorated.
"It seems to me that a lot of people have been preaching the bullish message without
realizing the impact on costs and margins," said J.P. Morgan analyst Shannon Nome.
UBS Warburg analyst Bill Featherston said oil and gas exploration and production companies
have had to drill smaller reserve targets to keep up production levels, pushing up their costs
and holding down their financial returns.
"Our analysis tells us that during most of the second half of the 1990s, you needed $2.25 to
$2.50 (per thousand cubic feet of natural gas) to earn back your cost of capital. Now it's
probably $3.25 to $3.50," he said.
Analysts said it is becoming increasingly difficult for the United States to find and produce
the gas that it needs to heat homes and generate electricity.
"We've got to drill deeper, we've got to drill tighter rock, and it costs a lot more to do all that
because we've picked all the low-hanging fruit here in North America," said Nome.
She estimates exploration and production companies will earn a "full-cycle" return of 13
percent after taxes in 2002, the same as the average return for the five years through 2001.
MARGIN SQUEEZE
In a recent report Simmons & Co. analyst Chris Eades calculated that costs for the average
exploration and production company increased by $5.31 per barrel of oil equivalent (boe) over
the last five years while revenues rose by $4.18, leading to an average contraction in profit
margins of $1.13 per barrel.
Eades calculates that margins at Anadarko Petroleum Corp. and Devon Energy Corp. will
have declined by $4.96 and $5.60 per boe respectively between 1998 and 2002.
By contrast margins at XTO Energy Inc. and Ocean Energy Inc. will have increased by $3.97
and $4.75 per boe respectively, according to Eades.
Analysts said that in addition to flat U.S. natural gas production, there are also signs that
Canadian imports will not be sufficient in the future to meet the domestic shortfall.
As long as prices stay above $3.25 per thousand cubic feet, this is expected to open the
door to a steady rise in imports of liquefied natural gas (LNG) which is frozen and shipped in
liquid form across long distances aboard special tankers.
"The gas market will grow into much more of a global market, just like oil is, and that can only
happen via increased LNG imports," said Nome.
In the face of rising finding and development costs, Featherston said he was pleased that oil
and gas companies were showing greater financial discipline than they had in the past, for
example by easing back on production when gas prices dipped to around $2 per thousand
cubic feet at the start of this year.
"They were willing to give up the pursuit of growth in order to preserve returns on invested
capital," he said.
So far this year gas prices have risen 16 percent to $2.98 per thousand cubic feet while
Standard & Poor's index of oil and gas exploration and production stocks <.GSPOILP> is
unchanged and Standard & Poor's 500 index <.SPX> has fallen 15 percent.
Anadarko shares have fallen 16 percent so far this year, while Devon Energy shares are up
24 percent, XTO Energy shares are showing a gain of 10 percent and Ocean Energy shares
have risen 6 percent.
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