CG on Energy -- Oil and Gas, Exploration and Production
E&P CAPITAL INTENSITY STABILIZING WITH COMPLETION OF SHIFT TO OIL DEVELOPMENT
Investment summary
Incentivized by the price advantage of crude oil over natural gas/NGLs, the E&P industry
aggressively reallocated capital away from gas-directed activity, and to a lesser degree NGLoriented
drilling, in favor of higher margin oil development. Accordingly, most of our
coverage portfolio expects natural gas production to stagnate or decline in ’13.
With the conclusion of the transition to oil development largely complete and some relief in
oilfield service price pressure, our analysis suggests E&P capital intensity is stabilizing.
Since ’10, the dramatic industry pivot toward liquids development coincided with a 40%+
increase in E&P capital intensity. In F&D cost terms, E&P capital intensity has increased
from ~$22.50/Bbl to ~$32.50/Bbl. Correspondingly, industry capital allocation by product
has roughly inverted from 35% liquids/65% gas to 65% liquids/35% gas since ‘10.
Overall, as a consequence of the Q4/12 earnings cycle, the median target price of our
coverage portfolio was unchanged. See Addendum A for a discussion of individual company
target price changes. Addendum B displays our capital spending outlook, while Addendum C
presents the liquids/gas capital allocation, liquids weighting and growth drivers. Addendum
D presents our production outlook (’13-’15E).
E&P top long/short picks
Our expanded list of favorite BUY-rated names include Anadarko (Wattenberg, Eagle Ford),
Cabot (Marcellus), Carrizo (Eagle Ford, Niobrara), Comstock (Eagle Ford, Permian Basin)
and EOG/SM/Sanchez (Eagle Ford), which offer differential equity value upside in our
opinion. HOLD-rated names include EQT/Range/ Southwestern (gas macro valuation). We
feel SELL-rated Pioneer is over valued on excessive enthusiasm as to Wolfcamp horizontal
prospectivity. Sell-rated SandRidge is over valued on undue enthusiasm as to Mississippian
productivity and under appreciation of their long-term capitalization challenge, in our view.
Sector commodity price reflection – risk/reward
In our view, E&P shares currently reflect NYMEX ~$4.85 gas and ~$78 oil, which are the
commodity prices that deliver a market return on equity capital. Long term, we anticipate
NYMEX ~$5 gas and ~$90 oil prices implying a positive sector risk/reward (~25% upside)
with oil-weighted E&Ps having greater upside than gas-weighted peers.
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