Oil Drop Makes Drillers Own Worst Enemy; Gas Offers Haven

By Jim Polson and Bradley Olson


U.S. oil producers that saw profits soar on the North American shale boom are feeling the downside of success: falling prices and shrinking cash are threatening to slow development.

At the same time, as crude prices approach four-year lows, natural gas companies are experiencing a reversal of fortune after having been shunned by many investors when a supply glut drove the fuel to a decade-low. Gas producers are now viewed as a safer haven than oil companies.
Whiting Petroleum Corp. (WLL) hit an all-time high in August after striking a deal to become the biggest oil producer in North Dakota, the state with the second-largest output. It has since lost more than $4 billion in value as its shares plunged 38 percent. Meanwhile, Southwestern Energy Co. (SWN), an independent producer whose output is 99 percent gas, has fallen just 13 percent.
“Natural gas is becalmed through this,” Donald Coxe, who manages about $200 million at Coxe Advisors LLC in Chicago, said in an interview. “It is Walden Pond compared to a hurricane in Florida.”

Whiting is one of 26 companies on the S&P Oil & Gas Exploration and Production Select Industry Index that have declined more than 30 percent in the past month. Shale producers had shifted their focus to more profitable oil as gas prices fell. Now a growing glut of crude has deflated the price of the U.S. benchmark by 18 percent in the past three months, as gas futures dropped 7.2 percent.

“We’re running into a wall,” said Scott Hanold, an Austin, Texas-based analyst for RBC Capital Markets LLC. “We’re producing more light, sweet crude than we need.”
West Texas Intermediate touched $80.01 a barrel, the lowest since June 2012, on the New York Mercantile Exchange today. Brent prices, an international benchmark, fell to the lowest price since November 2010.

Continuing to Drill

Exploration and production companies “just drill and produce and all at once say, ‘My God, we’ve oversupplied the market,’” T. Boone Pickens, chairman of Dallas-based BP Capital LLC, said in an Oct. 9 interview. If crude prices stay below $80 a barrel for three months, they “are going to sober up.”

Most companies with strong balance sheets will continue to drill through the downturn as long as prices don’t fall below $80, Scott Sheffield, chairman and CEO of Pioneer Natural Resources Co., said at a forum in Washington yesterday.

Below $70, “you will see a significant curtailment,” he said. “You’ll see job loss, rig loss, job loss extending into service companies.” 

That’s prompting investors to take a fresh look at companies like Southwestern and Fort Worth, Texas-based Range Resources Corp. because they focus on gas, which many forecasters see as having steady or rising prices with the onset of winter.

Low Costs

Southwestern, based in Houston, has also benefited from operating in a lower-cost area, hedging against future prices and from a spending plan that’s kept cash flow positive.

Southwestern has been spending about $2.75 to produce a thousand cubic feet of gas, well below the average price of $4.45 it sees over the next few years, Michael Hancock, a company spokesman, said today in an interview. “Low costs have become our calling card.”

While the break-even price for oil production can be as low as $50 a barrel in some areas, companies that rely most heavily on debt to fund drilling will be the first to cut back, said Manuj Nikhanj, managing director and head of energy research at ITG Investment Research.

Cash Flow

Cash flow is one of the better ways to evaluate which producers will face the greatest pressure to scale back spending if lower prices continue, he said.

Prices at $80 a barrel through 2015 will reduce cash flow per share at major producers by an average of 17 percent, according to an analysis published yesterday by RBC Capital Markets. Among companies with significant U.S. shale drilling operations, Marathon Oil Corp., Encana Corp, Talisman Energy Inc., Whiting and Ultra Petroleum Corp. will see the most pronounced declines, the analysis shows.

Higher Costs

The past six weeks haven’t been kind to Whiting and others that concentrate on the Bakken Shale, where oil fell below $75 a barrel today, just $7 away from the price producers need to break even, according to ITG. Bakken prices are lower in part because of bottlenecks in getting the oil to refiners.
Once among the hottest drilling regions in the world, activity in North Dakota is looking increasingly at risk as a higher-cost area that may be the first to see cutbacks.

Making matters worse for Whiting, almost 80 percent of the company’s output is oil. Other producers that drill more for natural gas have seen less of an impact. Whiting is also one of the least aggressive among peers in using hedging contracts to lock in prices, which cushion the blow on many producers in the coming months. That leaves the company among the most exposed, according to analysis by Bloomberg Intelligence.

In July, Whiting announced plans to acquire Kodiak Oil & Gas Corp. for $3.8 billion in stock, a deal that would create the premier oil supplier in North Dakota. Kodiak has hedged about 67 percent of its production for 2014 and 13 percent for next year. Whiting has hedged 2 percent of its 2015 oil output, according to data compiled by Bloomberg.

Chairman and CEO James Volker has said Whiting can make money on two-thirds of its acreage with an oil price of $70 a barrel. The company declined to comment for this story.

“I’m not trying to deny that there would be some shrinkage in our capital budget, but I could see scenarios where we would be down to $60 a barrel and we’d still be drilling,” Volker said in September.