Energy Matters

Here’s the latest, greatest survey: “What I Did On TS Edouard Day!”

Houston, the energy capital of the world, partially closed today for TS Edouard that made a nearly direct hit on the formidable city with its 25 mph winds and constant, unrelenting downpour of drizzle.

What did Houstonians do on TS Edouard Day?

Options could be as follows. What did you go? (Note: In the spirit of the TPH morning e-notes, the need to use proper punctuation and complete sentences — with both nouns and verbs and articles — is suspended on TS Edouard Day.)

– Went swimming (hey, it was Adult Swim hour all day!)

– Went to the mall (and was glad to see on my BBerry that the FOMC kept the rate at 2% while I was shopping/spending)

– Took the dog for a long walk in the rain (that Dog did not want to go on, since it was raining, for goodness’ sake, and there were nasty puddles of unfiltered water everywhere)

– Dumped shares of Bottled Water Co.; bought shares of The Weather Channel

– Went out for a drive (there was no one on the freeway at 5 p.m., and I had a full tank of gas from the day before!)

– Tried to return all the cash I had taken out at the bank from day before (how does one put money back in an ATM?)

– Went to liquor store for replenishment of hurricane supplies (liquor store was open)

– Tried to pick up dry cleaning (cleaners was closed)

– Moved from beer chest and into freezer all groceries purchased day before

– Wandered around home wondering what may need a new battery

– Removed storm tape from windows; considered buying expensive storm-proof windows, the kind that do the laundry too

– Watered plants

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com  

P.S. Here’s my new hurricane-season prediction: The next storm will have a name, it will have a name that starts with the letter “F” and it will be a girl’s name. Fifty bucks says it’s so.

The FOMC has decided to keep the federal-funds rate at 2% despite the largest one-month jump (0.08%) in inflation since 1981. Rates are usually pushed up to beat inflation down, but the Federal Reserve has disconnected the U.S. economy from normal functioning, while propping up the U.S. mortgage industry, so now the FOMC must respond similarly—dysfunctionally.

Pushing up interest rates now would tip the already-teetering U.S. mortgage profile toward more foreclosures. Meanwhile, the U.S. dollar remains weak, and the federal budget deficit is a half-trillion dollars.

Following is the FOMC’s statement today. Committee member Richard W. Fisher again dissented, preferring to raise the rate, as he has held to through this year.

“The Federal Open Market Committee decided today to keep its target for the federal funds rate at 2 percent. Economic activity expanded in the second quarter, partly reflecting growth in consumer spending and exports. However, labor markets have softened further and financial markets remain under considerable stress.

“Tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth over the next few quarters. Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth. Inflation has been high, spurred by the earlier increases in the prices of energy and some other commodities, and some indicators of inflation expectations have been elevated.

“The Committee expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain. Although downside risks to growth remain, the upside risks to inflation are also of significant concern to the Committee.

“The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh. Voting against was Richard W. Fisher, who preferred an increase in the target for the federal funds rate at this meeting.”

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com  

Think $25,000 an acre is top of the market for the Haynesville play? Don’t stop there.

When looking at Chesapeake Energy Corp.’s deal with Plains Exploration & Production, one may think acreage prices are “topping out,” says Deutsche Bank Securities Inc. research analyst Shannon Nome in her report “From Shale To Shining Shale: A Primer On North American Natural Gas Shale Plays.”

Instead, “we believe Chesapeake’s monetization was simply motivated by a pressing need for cash, and not a statement that $25,000 to $30,000 per acre is a high-water mark for leasehold values; in fact, we see ample room for rising acreage value from here.”

She estimates for the play a base case of $14-million per-well net present value, incorporating an industry-standard 10% discount rate.

“Assuming a drilling density of 80 acres per well, this would imply an amazingly high pretax net present value of $175,000 per acre. On 60-acre spacing, that value theoretically expands to a stunning $233,000 per acre.

“While these values are eye popping, we note that they are pretax and impute a 100% chance of success, and few operators are likely to lease acreage without applying some sort of risk factor.

“As well, even though IRRs (internal rates of return) theoretically break even at a $175,000-per-acre leasehold price, most companies would find the associated F&D (finding and development) costs—$4 per Mcfe, inclusive of the leasehold—to be unacceptable. Nevertheless, these data points—and sensitivities—support our contention that per-acre prices could very well push up toward the $50,000 threshold—unrisked—before F&D costs would move much above $2 per Mcfe and before IRRs would fall much below 50%.”

Nome’s shale report includes topics “Shales Gone Wild,” “Shale Gas: Play By Play,” “Got Haynesville? Drilling Down On A Red-Hot Emerging Shale Play,” “Rockies Shales: Almost Ready For Primetime” and “Shale Shock: Macro Impact.”

On the Haynesville, she has developed a macro-production forecast for the play, with input from U.K.-based energy-research and –consulting firm Wood Mackenzie.

“Our base-case type well analysis incorporates IP (initial production) and EUR (estimated ultimate recovery) assumptions that appear to be near the midpoint of current industry expectations at 10 MMcfe/d and 7 Bcfe per well, respectively.

“Other key assumptions include a $25,000-per-acre base-case leasehold cost—this is ‘baked into’ the F&D shown and also incorporated within the NPV (net present value) analysis as part of the well cost; 80-acre well spacing—although based on other shale plays, ultimate spacing could tighten to 40 and 60 acres; a $1.50/Mcfe operating cost—potentially conservative based upon recent commentary from operators; and an 80% initial-year decline rate—conservative relative to the 73% figure cited by Chesapeake in a July conference call.”

Nome says Haynesville acreage costs “have risen at a very rapid pace. Lease bonuses in the state of Louisiana were less than $200/acre as of early this year, but quickly jumped to the $5,000 to $10,000 realm shortly following the March play announcements from Petrohawk Energy Corp. and Chesapeake.

“More recently, bids and land transactions have been risen into the $15,000- to $20,000-per-acre range, with a mid-June transaction between Goodrich Petroleum Corp. and Chesapeake pricing out at about $17,000.

“Royalties have stayed steady on the whole, averaging 25% to date.”

Contributing to the shale report is Patrick Johnston, an associate analyst with Deutsche Bank.

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com

In the Marcellus shale, Range Resources Corp. is a winner. The Fort Worth, Texas-based E&P that is considered a leader in the unconventional-gas play with millions of acres in the fairway there ‘has exceeded our expectations for progress in the Marcellus in terms of the 2009 development plan,” says Merrill Lynch Research analyst Eric Hagen.

“Going forward, we believe that consistently strong results and achieving its goal of 30 million cubic feet equivalent per day of production by the end of first-quarter 2009 in the Marcellus are key catalysts.”

He sees the company as having 13.0 times 2008 estimated EBITDA. This means, though, that Range shares are already trading well.

“Range trades well above its peers at 7.2 times (2008E EBITDA). Therefore, we do not see enough relative value to drive a change in our rating.” He reiterates a “neutral” recommendation and a price of $74.

Noteworthy, he adds, is that the company has made arrangements for water disposal, a leading issue in the Marcellus play, “that should allow it to execute its plans for the next several years. It also disclosed (in a conference call) that it believes per-well reserves and costs should be consistent across its core areas—southeastern and north-central Pennsylvania—at 3- to 4 billion cubic feet per well for a $3- $4 million completed per-well costs.”

He says, “Range has significant 3P exposure to the emerging Marcellus shale: therefore, delineation results above or below our expectations could undermine our valuation assumptions.”

Also: “The Marcellus shale will likely require substantial investment in infrastructure in order to accommodate significant horizontal development. Given the early-stage nature of the play, the timing and cost of midstream projects could impact growth expectations and stress the (Range) balance sheet.”

Hagen can be reached at eric_hagen@ml.com. Contributing to his report are Rhett Bruno (rhett_bruno@ml.com) and Drew Venker (andrew_venker@ml.com).

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com       

When the bank’s credit terms get tough, their credit goes to…high-yield applicants? Fitch Ratings analyst Mark Sadeghian and team have found that some investment-grade energy-industry debtors have had their revolving-facility capacity pulled back, while some high-yield debt issuers (all refiners) have had theirs increased.

“As has been well documented, declining home prices and the related credit deterioration across a range of mortgage-related assets have put considerable pressure on the banking sector, leading banks to become more selective in extending credit to corporate clients” says Sadeghian. “As a result, some energy issuers have had difficulty rolling over all of their commitments on bank revolvers under existing terms.

“While we believe the difficulty in extending revolver commitments among selective issuers in the energy sector says more about the state of the banks extending the credit than it does about their corporate clients, it nonetheless underscores how problems in the credit and capital markets ripple through the financial system and can potentially affect the liquidity of corporate issuers.”

E&P and related companies whose bank lines have been reduced include Apache Corp. (it’s two largest revolvers, a $1.5-billion one and one for $450 million, were renewed at $1.45 billion and $410 million, respectively); Devon Energy Corp. (its revolver was renewed at only $2.0 billion, from $2.5 billion); Hess Corp. (a small portion of its $3-billion revolver was not renewed); Marathon Oil Co. (some $2.6 billion of $3-billion facility was extended); Occidental Petroleum Corp. (its $1.5-billion facility was renewed at $1.4 billion.); Noble Corp., the drilling company, renewed its $575-million facility that had been $600 million.

“The credit crunch, combined with major banks’ reserve building and focus on their own liquidity cushions, appears to have reduced their appetite to extend credit to corporate clients, particularly credit facilities that would have been sold onward to third-party investors this time last year.

“The result has been a trend of selective reductions in revolver commitments in the energy sector. Although the reductions remain somewhat anecdotal in nature, a few tentative patterns are beginning to form.”

One is a reduction in investment-grade rather than high-yield energy credits, “possibly because the risk-reward balance may have skewed toward high yield given the widening spreads between the two.” Another is that reductions are generally taking place among unsecured revolvers rather than secured revolvers.

He concludes, “While it is somewhat counterintuitive that banks would fail to roll over full commitments in energy given its strong cash flows and credit-protection metrics, the cost of bank capital created by the ongoing wave of write-downs may have forced lenders to tighten their returns-based capital allocations.

“Given the widening spreads between high yield and investment grade issuances, high yield may have a more attractive risk-reward ratio at this point. For example, as of early July, U.S. corporate bond spreads for ‘BBB’-rated industrials were quoted at 240 basis points over Treasuries, versus 468 basis points for ‘BB’ Industrials, a spread of 228 basis points.

“The spread difference last July was just 76 basis points.”

Sadeghian can be reached at mark.sadeghian@fitchratings.com. Contributing to the report are Sean T. Sexton (sean.sexton@fitchratings.com) and Adam M. Miller (adam.miller@fitchratings.com).

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com      

When is a road a road? Or, is a road a road a road? To be a road, or not to be a road? That was the question.

In a federal court, the pipeline won. The “road” lost.

A federal court of appeals has issued a first ruling on Pres. Bill Clinton’s “Roadless Rule” involving a pipeline project—and the pipeline project has won—says Poe Leggette, attorney with Fulbright & Jaworski LLP. The appellate court has agreed with a district court’s denial of environmentalists’ claim that trucks moving in and out of an area in central Colorado to build a pipeline de facto create a road, thus the rule applies.

The case is Wilderness Workshop v. Bureau of Land Management, No. 08-1165.

“This is the first ruling by any federal court of appeals on the application of the ‘roadless rule’ to pipeline construction,” Leggette says. He reports a summary of the ruling in the firm’s monthly “Fulbright Western Lands & Energy Monthly Update” newsletter.

“The chief issue before the court was whether the project proponent’s use of motorized equipment to lay the pipeline made the pipeline right of way a ‘motor vehicle travelway,’ a term used in the ‘roadless rule’ to define what a ‘road’ is.”

The BLM and U.S. Forest Service were on the pipeline’s side in this case, saying vehicles along the pipeline route made that route a road merely for purposes of construction.

“The court reviewed the agencies’ position to see whether it was ‘plainly inconsistent’ with the text of the ‘roadless rule,’” he says.

The preamble of the ‘roadless rule’ in the federal legislation, though, says roadless areas are not the same as wilderness areas “and would remain open for many activities, including ‘motorized uses.’”

Leggette says, “The court also rejected the argument of the environmental organizations that the environmental-impact statement for the pipeline should have treated all future wells that could be connected to the pipeline as ‘connected actions’ under the National Environmental Policy Act.”

For more on this, Leggette can be reached at pleggette@fulbright.com.

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com      

“Is it over?” asks Michael Bodino, lead analyst at Coker & Palmer Investment Securities. No, he says. “As typical with any major sector rotation, the baby appears to be thrown out with the bathwater.” 

Oil prices are falling and, while Bodino is comfortable through 2008, “the economic unknowns regarding 2009 are quite disconcerting. Still there are many attractive E&P investments, he adds. He is raising his gas-price forecast for 2008 to $10.41 and for 2009, to $9.32. His oil-price forecast for 2008, $116.70; 2009, $109.65. 

“We have maintained long-term oil and gas prices at $80 per barrel and $8 per Mcf to reflect where we think energy equities should be valued relative to the forward strip and acquisition-market valuations. We think energy equities are currently reflecting just north of $7 long-term natural gas prices.” 

He likes CNX Gas, Ultra Petroleum, Southwestern Energy, ATP Oil & Gas and Parallel Petroleum. 

He has moved Foothills Resources from “accumulate” to “not rated until additional information is available providing better financial visibility.” 

“While we are in the midst of what we believe to be a seasonal pullback, we think this is a good time for investment into many of the companies in our coverage list. Companies with the best risk/reward and catalyst visibility for second-half 2008 include Bill Barrett Corp., Energy XXI, Delta Petroleum Corp., Harvest Natural Resources, Petrohawk Energy Corp., Plains Exploration & Production and Ultra Petroleum.   

“Looking forward, Carrizo Oil & Gas Inc., Quicksilver Resources Inc. and XTO Energy Inc. are also inexpensive equities and well positioned to generate leading cap-size growth rates into 2009 and beyond.” 

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com     

Is XTO Energy Inc. buying U.S. natural gas assets too aggressively? Ben Dell, E&P analyst at Bernstein Research, doesn’t think so.

“As sentiment in the natural gas market shifts from bullish towards cautious, (XTO’s) earnings release (yesterday) led to a sell-off in the stock, perhaps led by investors concerned that XTO is buying assets at a peak.

“While we have often advocated caution with regard to commodity prices, the long-term outlook for both natural gas and XTO remain good.”

XTO has announced more than $10 billion of U.S. gas assets so far this year, and expects the size of the company to double in the next couple in terms of production and reserves.

Dell says, “In terms of natural gas, we believe gas will increasingly become the fuel of choice for power generation as the costs of carbon rise. Even if prices recede as inventories build this summer, prolonged periods of gas prices below the marginal cost—approximately $7.75 per Mcf today—seem very unlikely to us. And XTO will be present to capture any upside, as the company proceeds with acquisitions in a disciplined and returns-focused manner.”

He concludes, “Although investors appear increasingly concerned about the company’s acquisition strategy, we believe that XTO’s acquisitions this year will be successful for three reasons. First, the reasonable cost of the acquisitions combined with the company’s anticipated growth mean that returns from these acquisitions will be good.

“Second, concerns about reckless behavior are inappropriate since this wave of deal-making is motivated by tax concerns before a new administration comes in, and is unlikely to be repeated.

“Finally, the deals do not present a threat to XTO’s viability since it remains well capitalized and hedged.”

He adds that, of course, oil and gas prices are uncertain. “However, in such an environment, investors would most likely want to position themselves defensively, in companies with seasoned and professional management teams that have the experience to weather different environments.”

For example, XTO.

The sell-down in XTO shares upon its earnings release this week “seems overdone,” he says.

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com     

The theory of relativity applies to all things, actually. It’s about what is and isn’t in terms of one’s own perspective — standing still, in motion or both. In the energy industry, at more than $100 oil and strong natural gas prices, relativity is greatly in play.

Consider the producer who has hedged much of his production at $80 oil. At the time the deal was struck, it was brilliant. Today, he is writing checks for the difference. Still, it is brilliant at $80. We will soon find out if that producer could make it at $80 for much of his production.

Consider too the producer who hedged at $80 and had some production shut in for some reason, and a significant enough amount. That producer is writing checks for what he didn’t even sell. Ouch 2.0x.

Another relevant factor in relativity is how pleased producers are with their recent success. Money — both from the equity and debt markets — is being thrown at them. And, they are using it wisely — wisely at $130 oil and $12 natural gas.

Deja vu, 1980s.

No, this isn’t the 1980s. Most producers are more sophisticated than most were back then, and U.S. oil and gas markets are public now, without government price controls. Nevertheless, there are risks. Some producers — or would-be producers with some money for one idea or another — wouldn’t make it below $100 oil and $8 natural gas.

Play smart. Play relative.

(This is the first in a series of blogs inspired by reading Walter Isaacson’s Einstein: His Life and Universe.) 

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com    

Greenspan, in his autobiography, cites nuclear as the most reasonable choice of electric-power generation. “The major challenge will be to find an aceptable way to store spent fuel and radioactive waste,” he adds.

That’s the extent of his discussion of nuclear waste. While nuclear physics is a tremendous generator of power, the discussion remains of what to do with the waste. Whle the U.S. today takes issue with nuclear power, a more-energy-strapped U.S. may concede.

One place to store it is the moon. The “blue moon” would be the “green moon.”

T. Boone Pickens describes wind power as equal to creating many times the power of a nuclear reactor. While nuclear power can be a near-term source of power generation, which is using an increasing amount of U.S. natural gas and while growing electricity-based endeavors (e.g. powering computers and eventually cars) will require more U.S. power generation, it will help bridge the gap to wind and solar.

–Nissa Darbonne, Executive Editor, Oil and Gas Investor, A&D Watch, OilandGasInvestor.com; ndarbonne@hartenergy.com