Merrill Lynch expects US, Canadian integrated companies to sell more producing properties

By OGJ editors

HOUSTON, Jan. 6 -- Integrated companies in the US and Canada will sell more producing oil and natural gas properties in 2003 compared with the previous 2 years, possibly triggering increased demand for oil field services and contract drilling, Merrill Lynch forecast.

"We don't envision there being much cross sector M&A (merger and acquisition) activity i.e., integrateds purchasing E&P (exploration and production) companies," analyst John P. Herrlin Jr. of New York wrote in a Jan. 2 research note. He is first vice-president of the Merrill Lynch Global Securities Research & Economics Group.

M&A expectations
"Domestic or international integrateds have tried to minimize dollar recycling in mature producing provinces and now, in our view, don't have the infrastructure or desire to get back into fast-track, small reserve scale projects," Herrlin added.

During 2002, US and Canadian upstream sector consolidation totaled $17.6 billion worth of E&P mergers. Of that, $14.8 billion involved Canadian deals, while US deals totaled $2.8 billion, he said.

"Going forward, we expect there to be more (property transactions), given greater wellhead cash flows, reopened capital markets, and the potential for more available properties from the integrateds," Herrlin said.

E&P cash flow expectations
"Going forward, we see (the) E&Ps we follow increasing capital expenditures about 10% and believe that higher wellhead realizations will inspire (second half 2003 capital expenditure) increases, he said.

He is bullish about the E&P sector, saying it has the potential to offer earnings or cash flow surprises during 2003 because of "constrained natural gas supplies (in North America), and higher oil prices."

"For 2003, we expect US natural gas production to drop 1-2% without strong (second half 2003) spending, and Canadian imports to be down 5%, and for LNG to partially offset the Canadian export declines. With higher oil prices, we don't see much fuel switching from gas to oil happening, and thus believe that the potential for natural gas prices may be above our . . . forecast," Herrlin said.

Merrill Lynch is basing its E&P models upon 2003 price assumptions of $25/bbl for West Texas Intermediate and $3.70/Mcf for natural gas at the Henry Hub.

"We realize that we might be too conservative on natural gas prices, but it's still early in the withdrawal season, and weather patterns are turbulent. On a dollar traded basis, natural gas remains the most volatile commodity around," he said.

E&P stock price volatility
US and Canadian oil company stock prices remain under appreciated by investors, Herrlin said.

"We expect more E&P stock price volatility in 2003 but believe that 2003 will be an up year and view our estimates to be conservative," he said.

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