Weathering the economic storm

Don Stowers
Editor OGFJ

Amid all the gloom and doom, there is still reason for optimism if you’re in the oil and gas business. That is, if you’re a well-run company with an experienced management team.

This is what I consistently hear from individuals on both the capital provider side of the business as well as the industry side. Savvy energy companies understand the cyclical nature of our industry and play their cards accordingly.

For example, Tracy Krohn of W&T Offshore (see story, page 24) told us he expects his company to weather the economic storm at least as well as it did Hurricanes Gustav and Ike, both of which tore through the heart of the oil and gas infrastructure in the Gulf of Mexico in September. Much of the company’s production was still shut in as of mid October, but the damage was not nearly as bad as it was three years ago when Katrina and Rita roared through with a massive one-two punch.

Krohn says his 25-year-old company is not overleveraged and does not borrow money to drill. Although W&T has a $500 million credit facility, he prefers to operate out of cash flow. For now, he says he isn’t concerned about tightening credit.

Unfortunately for many companies that prefer to do business this way, commodity prices have plummeted in the past few months. Crude oil prices reached an all-time high of about $147 a barrel in early July. Since that time, prices have declined by more than half, which has stunned the industry. Natural gas prices have also dropped. Lower prices mean that operating from cash flow has become a little harder. As a result, a number of E&P companies are cutting back on their drilling budgets for the remainder of this year and are exercising caution as they look forward to 2009.

Low oil and natural gas prices are their main concern. Drilling offshore and in unconventional gas formations onshore are capital intensive, and the economics have to be there in order to pursue an aggressive drilling program. Most company executives I’ve talked to have adopted a conservative wait-and-see attitude.

As one of them pointed out, “Our business is not to drill for oil or gas. Our business is to make money for our investors.”

For the nation as a whole, falling oil prices translate to lower prices at the pump, which should eventually mean increased demand. It should also stimulate a weak economy. For example, food prices and prices for other goods should decline as shipping costs come down, and people will start to buy more.

A strong economy is good for everyone. You can’t sell goods and services if people don’t have the money to buy.

Energy stocks have also fallen dramatically during the current downturn. Many of them are at their lowest level since the early 1990s.

Although the country is suffering through its worst financial crisis in at least 70 years, successful investors like Warren Buffet and Carl Icahn see plenty of investment opportunities, especially in the energy sector.

“This one is more unique and more worrisome (than previous downturns) because of the banks,” Icahn told Crain’s Investment News.

While he expresses caution about investing now, Icahn talks up the energy and pipeline sector.

“Energy has gotten so killed,” he said. “Some of these energy stocks and pipeline companies are very cheap right now.”

Indeed. Chesapeake Energy stock was selling for as little as $12 a share in mid October. Since that Oklahoma City-based company is the country’s largest natural gas producer, one would think their stock is a little undervalued at that price. Ditto for many other US producers and service and supply firms.

Berkshire Hathaway, Warren Buffet’s holding company, recently bought Constellation Energy for about $5 billion. In early January, shares of Constellation were trading at over $100, and yet its management accepted Buffet’s $26.50 a share offer in October. Why? The company was slammed by the credit crisis and a classic run on the bank with panicked investors dumping shares. Management had two choices – bankruptcy or buyout. They chose the latter.

After the purchase, Buffet injected $1 billion in capital into Constellation, thereby stabilizing it. He now owns a diversified energy company with a portfolio of coal and gas generation plants stretching from coast to coast; Baltimore Gas & Electric, a large and profitable utility; and a successful energy trading operation. Constellation controls 9,000 megawatts of generating capacity.

To Icahn and Buffet, investing in energy is a no-brainer. OGFJ