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Gold/Mining/Energy : Big Dog's Boom Boom Room

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To: Tommaso who wrote (121232)	5/30/2009 1:59:49 PM
From: quehubo	1 Recommendation Read Replies (2) of 206085

Driscol now with Barclays has a piece out this week more or less projecting low ng prices and low drilling activity for years. For me this will be a ten year run by year end. I started primarily investing in natural gas related issues. Today the outlook is much different than it was in 2000-2001. I think the oil side of the business is a safer bet over the next few years. But presently with all the OPEC excess capacity and the global economic weakness it is hard to get excited. Below is a cut from the report. Investment Conclusion The emergence of low-cost non-conventional, and especially shale gas, resources may lead to sharply lower than expected natural gas prices for the next 5-10 years. Shale -- along with other low-cost unconventional gas -- could provide 75-90% of new gas supply over the next several years and set the marginal cost of new supply. The current period bears some similarities to the 1985-2000 period. As strict natural gas regulation began to unwind in the mid-1980s -- partly a result of the steep drop in oil prices -- natural gas supply costs fellsharply. While the drivers of falling supply cost are far different we believe the gas-price and supply risks are similar. For more than a decade after the 1986 collapse of oil and gas prices many industry participants misunderstood the depth of the changes to gas supply cost curves and delivered too much supply to the market on the mistaken belief that high (perhaps unchanged) industry supply costs would lead to a sharp near-term natural gas price recovery. While prices eventually did recover the industry suffered through the "gas (oversupply) bubble" of 1985-1988 which became the "gas sausage" of ~1985-1995. It took 20 years for average wellhead gas prices (in real terms) to return to the levels of the early 1980s. While natural gas prices appeared to move in tandem with oil prices it is worth noting that the oil/natural gas price ratio averaged 10-12X during the decade after the peak gas price was reached. We believe that exploration and production shares now embed expectations of a sharp recovery in natural gas prices to about $7/MMBtu (along with $65/bbl WTI). But, this expectation uses what we believe is the wrong cost of new supply. We believe the average E&P stock has 15- 30% downside if the market comes to believe mid-cycle gas prices are $5-6/MMBtu. To achieve 30% average appreciation we believe the shares would need to price in mid-cycle prices of $8/MMBtu along with $80 oil. We reiterate our 3-Negative sector view and our preference for oil-oriented producers. Summary ?? What is the marginal cost of new natural gas supply? Go-forward costs for already drilled wells fall lowest on the cost curve. Further up the cost curve we will find "drill-bit" ready non-conventional and conventional drilling opportunities and then full-cycle costs for new shale and other unconventional (e.g. "tight gas") opportunities. Full-cycle supply costs for c onventional gas, broadly speaking, make up the highest cost supply category. However, full-cycle supply cost of conventional natural gas are less relevant than in the past as the industry has in some cases forsaken the search for new conventional drilling opportunities. While conventional gas makes up an estimated 60% of total US supply (nearly 1/2 this 60% is associated and offshore gas) it may provide only 10-25% of new supply over the next several years. We believe roughly 65-75% of production additions have come from non-conventional sources over the past 2-3 years. That figure may climb as high as 75-90% in 2009. Thus, the need for conventional drilling may be increasingly displaced by non-conventional production, knocking conventional from the supply curve. We believe that the marginal cost of supply is in the $5-6.50 range. This level is well below 2011 and 2012 forward prices. ?? We believe 800-1000 rigs drilling for gas are required to maintain gas production. This estimate compares to our prior estimate of just over 1,100 rigs. We have raised estimated production additions per rig by ~ 25% to +/-50% vs. 2008. Several factors support the conclusion that per-rig production additions are sharply increasing: (1) the greater share of rigs drilling horizontal wells in gas shales means a greater share of rigs will add +/-40 mmcfpd per year and a smaller portion will add <10 mmcfpd annually; (2) capital spending

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