US gas companies seen as possible targets as low commodity prices and high capital costs bite - analysis26 October 2006

US natural gas exploration companies, squeezed by high capital spending and low commodity prices, will become targets for cash rich oil companies in the next year, industry executives said.
Many gas companies, keen to profit from high gas prices last year, decided to borrow, spend and drill. But after last year’s unusually warm winter, gas demand dropped and prices with it.
Mark Erickson, chief executive of Gasco Energy, a USD 242m market cap natural gas company focused on the US Rocky Mountains, said "things will get ugly" next summer if there is another warm winter. "There’ll be lots of mergers and acquisitions and restructurings," he said in an interview. "Those gas companies that haven’t hedged, planned far ahead enough or structured capital spending will be toast."
One investor expects gas companies, especially those such as Gasco in the Rocky Mountains, will be forced to sell in the next year. Pressure to sell will come from the greater difficulty in extracting and selling Rockies’ gas, combined with capital intensive projects and continuing low gas prices.
The price of natural gas on the New York Mercantile Exchange increased last week to USD 7.24 per million British thermal units (MMBtu), but many analysts said they believe gas prices may drop again in the coming months because record high storage levels will be enough to meet peak demand this winter.
Gasco’s Erickson said his company had managed for that risk with hedging and that it had structured its capital spending to get the company through the next two winters.
Nonetheless, a second investor expects smaller natural gas companies to start feeling the pressure in the next three to 12 months. Cash-rich oil companies are expected to buy them, he said.
“Most gas companies are still happy: they have Capex already budgeted for 2006 and maybe until the middle of 2007, plus they have cash from hedging. But once that dries up in the next year their bankers could put pressure on those companies to sell, particularly the smaller ones,” the second investor said.
One other factor that will put pressure on the natural gas companies is debt, he added. “Debt for gas companies is a new thing – they didn’t have that last year,” he said. “They will sell when it doesn’t get fun any more,” he said.
One natural gas company already forced into selling is Infinity Energy Resources, whose debt now matches its USD 52m market capitalization. Infinity went from employing one drilling rig, to none, due to severe capital restraints and continued low natural gas prices, said Infinity COO Jim Tuell. "USD 4 gas in Texas is not a good time to be drilling," he said.
Another natural gas company considering its options is Abraxas Petroleum, a USD 152m market cap company with natural gas exploitation and production activities in Texas and Wyoming. CEO Bob Watson said he may sell to private equity investors next spring when normal winter weather will have corrected his share price from current 12-month lows. “I am tired of the public market. It is not fun any more,” he said.
Chesapeake, a consistent acquirer, managed to sell gas at USD 9/MMBtu this year because of hedging, while most sold at USD 4/MMBtu and some producers at the well-head got as little as USD 2/MMBtu, said CEO Aubrey McClendon at a recent industry event. "To me it’s a demand problem,” he said. Ultra Petroleum, which has a gas-rich acreage in Wyoming, told the same event that it was selling gas at just USD 2.50/MMBtu.
Many executives said service companies will need to drop their rates for rigs. Gas companies are putting pressure on those services companies by simply not drilling until gas prices recover sufficiently or shutting in unhedged production during the downturn.
"Gas is going to be below USD 5/MMBtu for a period of time. I think we’re going to see costs coming down. If costs don’t come down the economics will be pushed," said Fred Callon, chief executive at Callon Petroleum, a USD 300m market cap company.

by Mark Andress and Heather West

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