Sam Fletcher
OGJ Online
HOUSTON, June 29 -- Faltering demand for natural gas will slash US producers' cash flow by 20% over the next year, triggering cancellations of North American drilling projects that will hit the service industry even harder, analysts at Simmons & Co. International said Friday.
The Houston-based investment banking firm lowered its natural gas price projections to $3.50/Mcf from $4/Mcf. "And that brings our earnings expectations (for producers) down by about 20%," said Dan Pickering, a senior analyst.
The service sector will be hit even harder as producers shelve marginal prospects that they would have drilled at a higher market price for gas.
Pickering foresees earnings reductions of 10-15% among the largest international service companies to as much as 50% for some of the North American offshore and land drilling contractors. "That might sound like a big number, but there's a ton of operational leverage in those businesses," he said in a telephone conference call Friday.
"When natural gas prices drop below $3.50/Mcf, some marginal activity starts to drop off, particularly onshore and on the outer continental shelf in the Gulf of Mexico," said W. Mark Meyer, vice-president of E&P research at Simmons & Co.
"For drillers, it's not the base level of demand that sets the price; it's the marginal level of demand. We've been in a very frenzied environment to drill incremental wells in last 12 months," said Pickering. "That has generated a lot of price improvements for service companies. Our guess is, they're gong to have to give some of that back."
Nonetheless, Pickering cautioned, "This is an air pocket, not a meltdown of the energy sector. We've got a North American gas issue, not an overall energy issue. There's big difference between $3/Mcf natural gas and $10/bbl oil."
Simmons analysts said the problem is primarily that some of the traditional large industrial markets for natural gas -- the manufacturers of fertilizers, chemicals, and metals -- have been slow to return to that market after gas price spikes during the winter caused many to curb consumption.
"We have not changed our view that industrial demand is going to rebound," said Pickering. "We haven't changed our view that new natural gas-fired generation later this summer will add incrementally to demand. The point is it is not going to happen quick enough to protect the rising inventory level. So the gas price looks softer."
Rapid replenishment of natural gas inventories in underground storage over the last couple of months "put us past the point of no return on inventories. US gas inventories are now likely to be normal, which is around 3 tcf coming out of the injection season. That will drive prices in the $3-$3.50/Mcf level over the next five to six quarters," said Pickering
"That's still a good price, but below the expectations built into earnings estimates for energy stocks and, most importantly, below the assumptions being carried by E&P companies who were spending money on the margins," he said.
Cash flows for exploration and production companies still are expected to be robust next year, although down from this year's level. As a result, Pickering predicted total spending for North American exploration and development will be "flat to slightly down" next year. Spending by independent producers will likely be lower year-over-year, while spending among the major integrated companies is expected to be "flat to slightly higher." Not much change in international spending is expected, he said.
However, Pickering said, "The supply response in gas is pretty darn quick. Drop much below $3-3.50/Mcf for any period of time and it generates a slowdown in drilling activity. You then bounce back because supply drops so quickly." Nonetheless, he said the industry might see prices below $3/Mcf for some of that time.
Over the next few years, gas prices in a supply-constrained market will likely be even more volatile than in the last decade. "But around a higher mean (of) $3-$4/Mcf," said Pickering.
Meanwhile, the rollback of natural gas prices and earnings has already been "at least partially factored into"industry stock prices, which are down 25% or more from their recent highs, including a 10% drop in last couple of days," said Pickering. "I think we see 10-20% downside potential in E&P and service stocks, he said.
However, he said, "We're not advocating a panic sale of these stocks."
With many companies still showing "pretty strong" balance sheets, Pickering said there's "a strong possibility of further consolidation and acquisitions to keep a floor under that asset value."
Contact Sam Fletcher at [email protected]
