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Sep. 13, 1999 (PETROLEUM FINANCE WEEK, Vol. 7, No. 36 via COMTEX) --
-- But Independents With Strong Balance Sheets Emerge from Downturn in
Significantly Better Shape --
It was not surprising that higher oil and gas prices translated into
much better first half results for independent producers this year.
Total operating income for 22 mid-sized independents (with market
capitalizations ranging from $250 million to $1 billion) jumped 111%
year-to-year on revenues that climbed 53% from their total for 1998's
first half, Petroleum Finance Week's latest Mid-Caps at Mid- Year tally
shows. But the improvements did not occur across the board, nor did
they extend completely to smaller producers who continued to struggle
with heavy debt.
Wall Street oil analysts were not surprised. "Commodity prices improved
dramatically, not just for crude oil but for natural gas," observed
Andrew Lees, who follows independents for A.G. Edwards and Sons Inc. in
Denver. "That helped in the short term. But many of these producers cut
costs significantly last year to survive the downturn. That will help
them in the long run."
"The stocks that have rallied the best are the independents with larger
market caps and stronger balance sheets," noted John J. Myers of Dain
Rauscher Wessels in Austin. "Many of the smaller producers were
over-levered and have lost a lot of their credibility. Their largest
competitors are in a better position to acquire assets or farm-in with
the majors."
"The ones with strong balance sheets are in a better position to take
advantage of opportunities, especially acquisitions," said Robert
Morris of Paine Webber Inc. in New York. "Some independents are selling
properties, but acquisitions currently outnumber divestitures. The
companies that are heavily in debt are using their higher cash flow to
concentrate on reducing their obligations instead of increasing
production."
"Balance sheets and opportunity made the biggest difference,"
maintained Wayne Andrews of Raymond James and Associates Inc. in
Houston. "If a producer has a decent balance sheet, it can come up with
the capital. If it has the prospects and the acreage, it can exploit
the improvement."
Share price improvement is a significant element in the rebound. Myers
noted that between March 31 and Aug. 20, the price for a common share
of Forest Oil Corp. (NYSE: FST) jumped 105.9% from $7.50 to $15.44,
while H.S. Resources Inc. (NYSE: HSE) climbed 83.5% from $8.75 to
$16.06, Chieftain International Inc. (AMEX: CHF) increased 79.1% from
$12.25 to $21.94, Basin Exploration Inc. (NASDAQ: BSNX) rose 69.7% from
$13.88 to $23.56, Cross Timbers Oil Co. (NYSE: XTO) climbed 65.6% from
$7.06 to $11.69, Pogo Producing Co. (NYSE: PPP) increased 62.5% from
$13 to $21.13 and St. Mary Land and Exploration Co. (NASDAQ: MARY) rose
61.4% from $17.38 to $28.06.
"They essentially doubled their lows," said Andrews. "My personal
favorite, Barrett Resources Inc. (NYSE: BRI), passed $1 billion in
market cap after hitting a 52-week low of $15.44. It's around $39 now.
St. Mary Land and Exploration, with about a $300 million market cap, is
another good performer because it has a good balance sheet and lots of
opportunities." But the most significant trend, he told Petroleum
Finance Week, has been the way that selected independents have turned
their higher share prices into acquisition currency. Apache Corp.
(NYSE: APA) is the most dramatic example, with its purchase of
properties from Shell Oil Co., according to Andrews. But he added
that a mid-cap, Tom Brown Inc. (NASDAQ: TMBR), accomplished the same
trick by acquiring Unocal Corp.'s (NYSE: UCL) Rocky Mountain operations
after the Denver independent's stock price staged a solid recovery.
"These companies used a decent share price, instead of additional debt,
to make acquisitions this year," Andrews said.
"Obviously, a stronger share price allows independents to use more
equity to pay for an asset," said Lees. "This is true not only of Tom
Brown and Devon Energy Corp. (AMEX: DVN), but also of Burlington
Resources Inc. (NYSE: BR) and what it's paying for Poco Petroleums Ltd.
(TSE: POC) in Canada and Talisman Energy Inc. (NYSE: TLM) and its
purchase of Rigel Energy (TSE: RGL). On the other hand, properties cost
more because everyone has higher expectations. Prices are based on $18
instead of $10 oil now."
Analysts contacted by Petroleum Finance Week expect the majors to
continue selling domestic upstream operations. B.P. Amoco Plc. (NYSE:
BPA) and Shell have confirmed that they are in negotiations to sell
their Altura Energy joint venture in the Permian Basin. "Clearly,
longer-term, the majors are heading in an international direction,
where returns potentially are higher, and are ready to divest their
domestic properties," declared Myers. "With all the head count
reductions, they no longer have the staff to work these assets, so
they're ready to divest them in exchange for stock in an independent
who can work the properties."
"As a whole, independents are looking to the majors to provide them a
new crop of assets," said Lees. "But it would be wrong to assume that
the properties will be given away. The majors believe in generating
high rates of return. There will be specific deals that will be very
good, while others will involve people paying way too much."
"There's been a big run to the equity markets, with the rebound in
stock prices," said Myers. "A third to half of the larger independents
already have gone there. The question now is whether they'll use their
appreciated equity to buy assets from competitors who haven't rallied
or simply pick up more assets from the majors."
Morris suggested that the biggest near-term question is whether
exploration and production stocks will continue to outperform the
overall market. "The E&P sector continued to advance during August,
while the overall market posted a lackluster performance due to
widespread interest rate fears," he said. "We continue to believe that
the valuations for our coverage group do not reflect the longer-term
commodity price outlook. However, the psychology surrounding commodity
prices may gain the upper hand for the moment."
With West Texas Intermediate crude prices above $22 per barrel and
natural gas prices off strongly after storm activity subsided in the
Atlantic Basin and the storage deficit has shrunk, Morris thinks that
investors may be leery about aggressively expanding positions within
the energy sector. "At the same time, now diminished interest rate
fears have provided life to growth sectors such as technology. We
believe that our coverage group, on average, possesses at least 20%
further up-side over the next 12 months. However, the direction of the
overall market and commodity prices, particularly for crude oil, will
continue to influence E&P stock price improvement in the near term," he
said.
Morris also expects third quarter results for the independents that he
follows to be stronger not just year-to-year but also quarter-
to-quarter. He anticipates that the improvements (nearly 50% higher
than 1998's third quarter and more than 30% higher than 1999's second
quarter) to be driven primarily by higher commodity prices, while
production could be marginally lower than in both previous periods. "I
expect production to be lower in the second half because these
companies still are not spending enough to offset the production
declines," Morris told Petroleum Finance Week. "Many balance sheets
still are heavily levered, which mean that more of the higher cash flow
will be spent to pay down debt."
But the analysts agree that independents probably will continue to
emphasize gas over oil. "From an investor's standpoint, there's still a
preference in owning gas stocks going forward," said Myers. "There's
still a production overhang in oil, and the Organization of Petroleum
Exporting Countries could decide to increase production."
"The group still is focusing more on gas than oil," said Morris. "Even
though crude oil prices rebounded farther, people still see more
favorable long-term fundamentals for gas."
-- Nick Snow in Washington.
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Copyright Phillips Publishing, Inc.
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