El Paso Woes Show Capital Intensity Of US E&P Business
By Spencer Jakab
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--El Paso Corp. (EP), the largest U.S. natural gas
pipeline operator and still one of the largest producers, recently disclosed a
sharp decline in its quarterly natural gas production.
The company said that total gas and liquids volumes were 956 miilion cubic
feet equivalent per day (Mmcfe/d) in the first quarter of 2004 versus 1,363
Mmcfe/d in the same period of 2003, a decline of 30% year-on-year before
adjusting for some asset disposals.
The disclosure follows tumultuous months at the exploration and production
division of the former high-flyer that, even after recovering from a liquidity
crisis, trades at roughly 10% of its peak share price in 2001. A 41% writedown
of reserves earlier this year and the departure of the head of its E&P division
in 2003 have been accompanied by a sharp deceleration in drilling expenditure.
While overall U.S. natural gas production is in decline - various private
sector analysts have calculated drops of roughly 5% in first quarter production
year-on-year - El Paso's fortunes have been considerably poorer than average.
The decline reflects the geographic focus of the bulk of El Paso's production
as well as a cutback in spending on development of reserves at the company in
the last several months.
The company has slashed its drilling budget to $800-$850 million this year
versus $1.568 billion in 2003 and $2 billion in 2002.
"It really isn't that surprising," said Michael Bodino, energy analyst at
Sterne Agee. "You're going to have those kinds of declines if you don't drill."
Bodino's firm doesn't cover El Paso but follows U.S. drilling activity closely.
"There's a significant concentration of their asset base in the Gulf Coast of
Texas and the Gulf of Mexico and those areas are notoriously high in terms of
decline rates," said Frank Bracken, natural gas analyst at Jefferies and Co.
Jefferies doesn't cover El Paso but watches its production levels closely.
He said that El Paso's financial constraints and uncertainty about its E&P
strategy have led to the sharper shortfalls than the rest of the industry. "When
you take your foot off the gas as regards drilling then you have rapid declines
and that's what's really going on here," said Bracken.
"You've gone from a period of time when the company was spending very
aggressively under (former E&P chief) Rod Erskine to a period of slow spending,"
Both Bodino and Bracken believe that the rapid decline isn't linked to changes
in the geology of El Paso's main production areas and they say they would have
expected similar declines if drilling capital had been restricted in prior
"If you decelerate, those declines are going to eat you alive," said Bodino.
"They'd always been in an acceleration mode."
Company spokeswoman Kim Wallace acknowledged that a slowdown in spending had
resulted in a decline in production, but also pointed out that the company was
shifting its focus to regions with more stable production and slower decline
rates such as the coal bed methane.
Though the normal geological decline rates for given regions haven't changed,
what has is the size of finds and the corresponding increase in finding and
Over 1999-2003, overall U.S. finding and development costs have risen by 42%
to $7.77 per barrel of oil equivalent and by an even steeper 49% to $8.48 in
Canada, according to a study by Lehman Brothers (LEH).
But the tightness of the market has more than compensated for this increase
with higher prices, explained Bodino.
"Finding and development costs have gone up over that time materially, but gas
prices have gone up more," he said. "The idea of having a sub-$3.00/MMBtu gas
price in this environment doesn't work."
Indeed, the breakeven point for marginal gas drilling in North America is now
estimated to be $4.50/Mmcf in North America, much higher than a few years ago,
according to RBC Capital Markets oilfield services analyst Kurt Hallead. But he
says that El Paso's cutbacks - while they may illustrate the effect of cutting
spending - don't translate to any sort of trend in North American oil and gas
production. Indeed, he expects drilling expenditure overall to keep rising
through 2006 or 2007.
"You can't stop drilling - if the industry slows down its drilling, you're
going to exacerbate the production declines," he said.
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