Natural Gas pricing

[dan_s]

My view is that Natural Gas prices will continue to drift higher this summer, primarily due to the heat and threat of an active hurricane season. The unknown of how the BP oil spill and federal moritorium on deepwater drilling will affect the GOM is also supporting the price. A lot of our gas comes from the GOM but most of it from the shelf. Long-term it is hard to be bullish on gas prices. I just don't see anything that gets the price of NG anywhere near the 1/6 of the crude oil price which has been the historic norm.

If you do want some gas in your portfolio, NFX, XEC and PXD look good. S-16 member NFX has a very high percentage of the NG hedged at very good prices.

This was taken from a Wall Street Transcript Online interview.

Raymond Deacon, Senior Research Analyst at Pritchard Capital Partners LLC, has worked as a Senior Sell-Side E&P Analyst over the past 10 years at Bank of Montreal, Broadpoint and RBC/Dain Rauscher. His focus centers around the Appalachia Basin and the Rockies Basins. He covers both large- and small-cap names, and hosts an annual Appalachia Forum. Mr. Deacon holds an MBA degree in finance from NYU and an undergraduate degree from Colgate University. He also has a master's degree from Columbia University and is a Chartered Financial Analyst.

TWST: What's going on in the E And P space, given oil and gas prices?

Mr. Deacon: There has been an enormous shift to oil-oriented drilling. Let me start out and say we've been cautious for sometime on natural gas prices. We are forecasting $4.75 for this year and expect it to recover to $5.50 next year. Our caution on gas is driven by the fact that you enter 2010 with the most significant amount of production hedged of any year. E And Ps had almost 60% of this year's production hedged entering into the year. So that encouraged a lot of people to drill, based on $6 to $7 gas prices. So we haven't seen the drop-off in supply that I had hoped to see. The horizontal gas rig count has stayed close to 500 - actually well above the 2008 peak of 421. So the supply declines on the natural gas side just are not going to be as significant as we thought we'd see. So we remain cautious on gas, with supplies ranging from 100 to 200 years.

So it's hard to come up with any kind of scarcity argument and, if anything, the bottleneck surrounding new pipelines and potentially new gas processing plants could hold up some new supplies. In general, we just see returns for gas-oriented drilling are going to be well below oil in the near term, yet I think that's the consensus. But we have focused people, when we are recommending gas names, on companies that are able to show economics that are very viable below $5 gas. Today that looks like the Marcellus, Fayetteville, Barnett, Horn River, Montney and the Eagle Ford shales. The most recent results out of the Eagle Ford show that it is very consistent across a very large area.

So we like that as a focus area for investors and some of the stocks have done extremely well already. For example, Pioneer Natural Resources (PXD) has been the best-performing large cap - it's up 35% year-to-date, and I think the oil focus in a group that's flat. We don't currently cover Pioneer, but we have been recommending Murphy Oil (MUR) for their exposure to the Eagle Ford shale. This morning they announced that they've doubled their acreage position there, with over 200,000 acres, and they announced their first well in Karnes County. And there they produced well over 1,100 barrels a day of oil. So it should be very economic, given the $45 million well cost in that area.

TWST: Why haven't the gas guys pulled back due to the consistent well pricing?

Mr. Deacon: On a relative basis, the market was up 10% in the first quarter, the E And P sector was flat. On a relative basis, the group has underperformed the market, but we've seen the forward curve for gas go from a peak of 625 down to - currently you're at 476 during the first quarter for the 12-month forward strip. So I think that a lot of people are hanging in there, trying to justify a higher gas price at this point, thinking that the forward curve does not justify drilling economics in many spots - maybe the Marcellus Shale, maybe the Haynesville Shale, maybe Montney and Horn River. But I think that a lot of the activity in the conventional plays will drop significantly. Yesterday Baker Hughes (BHI) said they felt the gas rig count could drop by as many as 200 rigs in the second half.

A 969-gas-rig count in the U.S. is not a bullish number, in our opinion, since it allows producers to grow reserves and production. So I think the thought process would be the rig count will drop, supplies will fall off, and gas will find the floor and move up back over $5. The price today is hovering around $4. The current environment reminds me a little bit of the Rockies back in the late 1990s, when you had all these large players enter the U.S. gas market and do JVs in the shale plays, and that's resulted in a significant increase in activity. You are going to see about a 100-rig increase in Appalachia in 2011, between now and the beginning of 2012 really. So you are going to go from about 98 rigs today to 200 rigs by the end of 2011, and a lot of that is the shale JVs that are being announced.

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