Analyst: Heady Acquisition Costs Won't Trigger Gas Drilling Boom
(Copyright © 2004 Energy Intelligence Group, Inc.)
Natural Gas Week Monday, July 5, 2004
High prices paid in recent merger and acquisition (M&A) deals have tilted the scales back in favor of the drillbit as a way of building gas reserves, but that does not necessarily herald a surge in US drilling activity.
In a recent research report, Southwest Securities analyst John Gerdes compared the fully developed finding and development costs of three recent M&A deals against the drillbit finding and development costs of the exploration companies he covers.
Factoring in operating expenses and reserve life indices, Gerdes then calculated the Nymex gas prices that would be needed in each case to generate a 15% pre-tax return on investment.
The result was a price of $4.60/Mcfe for organic reserve additions and prices ranging from just over $5/Mcfe to almost $6/Mcfe for the recent deals in which Kerr-McGee, EnCana and Pioneer acquired Westport, Tom Brown and Evergreen, respectively.
Does this lead Gerdes to conclude that companies will ramp up their drilling activity significantly if acquisitions are no longer a bargain?
"No that's not what I'm saying," Gerdes told Natural Gas Week. "All I'm saying is that the economics favor drilling over buying."
In reality, companies do not have an unlimited inventory of prospects they can simply drill one after the other and reap a healthy return on their investment.
The fact that companies have bid up the cost of purchasing reserves above the price of adding reserves through their own efforts reflects this scarcity of good prospects.
Gerdes calculates that it will take sustained Nymex gas prices of $4.50/Mcf to $5.00/Mcf to support a US gas rig count of around 900 and prices well above $5.00/Mcf to keep the rig count above 1,000.
He expects the gas rig count -- which has held slightly above the 1,000 mark for the last few weeks -- to "drift slowly higher" in the coming months. "It's not going to take off," he said.
In the mean time, the pace of acquisitions is likely to slow down for a while as acquisition-oriented companies such as Apache, Chesapeake and XTO find it difficult to consummate deals at prices that meet their requirements for returns.
Stifel Nicolaus analyst David Tameron said that while a theoretical case can be made for the superior economics of drilling, things will probably play out differently in practice.
"That assumes you have the prospects to drill, which I think is a pretty big assumption," he told Natural Gas Week.
Tameron said the recent wave of merger activity -- much of it focused on the US Rockies -- looked like a scramble on the part of buyers to ensure that they have enough inventory to generate sustained production growth.
"If all of these guys were sitting on prospects that would generate 30% or 40% rates of return, they'd be drilling them, they wouldn't be going out and buying stuff," he said.
Gerdes said the buyers appear to assume that US gas prices will stay well above $5/Mcf over the long term and thus make their acquisitions profitable. He expects their bullish view will likely be vindicated and predicts that prices will stay closer to $6/Mcf.
--Andrew Kelly |
