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Energy firms likely to trim their spending

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Analysts expect slowdown will create caution

By KRISTEN HAYS Copyright 2008 Houston Chronicle

Oct. 7, 2008, 10:27PM

The financial crisis that has choked credit markets also may stem the flow of capital spending by oil and natural gas companies as the situation shakes out, analysts said.

“All the oil companies, large and small, will cut back their capital spending,” Fadel Gheit, an oil analyst with Oppenheimer & Co. in New York, predicted. “The ones that keep their capital spending intact will be the exception, not the rule.”

Even if companies have the money for new exploration and production projects, “they will say, ‘We will wait for the market to cool off,’ ” he said.

The industry also is watching crude prices, now at around $90 a barrel after approaching $150 in midsummer. Light, sweet crude for November delivery rose $2.25 to settle at $90.06 Tuesday on the New York Mercantile Exchange.

Well-established companies with proven track records, healthy cash flow and low debt — from the largest publicly traded oil majors and independents to the oil services conglomerates and drillers they hire — will weather the credit crunch even though investors have pummeled their stocks along with the rest of the Dow industrials, analysts said.

But unproven or overleveraged companies that need banks to finance projects may find credit markets as well as private equity sources less welcoming. That could lead to asset sales, cutbacks in exploration and production or inability to fulfill contracts.

Tudor, Pickering, Holt & Co. Securities in Houston said in a note to investors that North American operations are vulnerable in two areas: publicly traded companies that outspend their cash flow and cut back because equity markets are too expensive to access or closed to them, and companies that cut back exploration and production spending out of anxiety rather than lack of cash.

“These issues recently cemented our view that domestic E&P spending would have to rein in,” the note said.

Gheit said the oil majors may divert some spending to acquisitions of weaker players — companies more vulnerable to the credit crisis as the price of crude falls, largely on economic concerns.

Tudor Pickering also noted that the crunch creates a buyer’s market as squeezed companies seek to sell assets to raise cash for exploration and drilling programs. They would have to accept lower prices than they want or cut capital spending, Tudor Pickering said.


Asset sales by Plains

Late last month, Houston-based Plains Exploration and Production Co. announced that it was selling its remaining 50 percent interest in oil and gas assets in West Texas, New Mexico and Colorado to Los Angeles-based Occidental Petroleum for $1.3 billion. Last year Occidental bought the first 50 percent — with almost identical production — for $1.6 billion. 

Plains said the deal would allow the company to pay down debt, reduce capital expenditures, and focus on the growing Haynesville shale in East Texas and Louisiana.

John Olson, an analyst with Sanders Morris Harris in Houston, said the crisis won’t noticeably affect the oil majors, which are flush with cash after months of record-high oil prices. Exxon Mobil alone had nearly $40 billion in cash on hand three months ago when it reported second-quarter earnings.

And many independents that focus on exploration and production and have no refining operations “continue to be reasonably strong,” he said.


Funded through cash flow

Chip Minty, spokesman for Oklahoma City-based Devon Energy, said the company’s plan to launch a second project in Canada’s oil sands at a cost of $1 billion stands. 

“Our capital expenditures for 2008 are fully funded through our cash flow, so we aren’t relying on the credit market to allow us to move forward on that,” Minty said.

But Devon is monitoring the crisis and its fallout, he said, particularly its impact on the economy and commodity prices in the long term.


Staying on track

Another major project, Motiva Enterprises’ $7 billion expansion of its Port Arthur refinery, remains on track as well. David Sexton, president of Shell Oil Products U.S., said last month that the financial crisis wouldn’t interfere because the project was financed largely from earnings and contributions from its companies, Royal Dutch Shell and Saudi Aramco. 

But Olson noted that some producers already have announced cutbacks. Last month Oklahoma City-based Chesapeake Energy said it would cut drilling capital expenditures by $3.2 billion and expected $2 billion of excess cash in 2009 and 2010 to pay down debt.

The company, a major player in natural gas including emerging shale plays, also curtailed some output and lowered production growth projections.

In a conference call with analysts last month, Chesapeake CEO Aubrey McClendon attributed the pullback to concerns about natural gas prices, which have fallen 50 percent since July, rather than to the credit crisis.


Cutting the capital budget

Houston-based Petrohawk Energy Corp. said last week it would cut its 2009 capital budget by a third, to $1 billion, and reallocate spending to projects viewed to have the best potential for reserves growth, such as developments in the Haynesville and Fayetteville shale plays. 

“This is in response to lower (natural) gas prices and the credit crunch that most industries are going through right now,” Petrohawk CEO Floyd Wilson told analysts. He noted that the company has not tapped its ability to borrow up to $1.1 billion.

Brian Uhlmer, a senior analyst with Pritchard Capital Partners in Houston, said cash-rich, established drilling contractors — such as Transocean, Noble Corp., Diamond Offshore or ENSCO International — are well positioned to weather the credit storm. But undercapitalized companies face choppy waters.

For example, Norwegian rig contractor MPF Corp. went bankrupt last month because it couldn’t find more financing amid cost overruns for a new ship intended to combine functions of drilling and production. Currently, separate vessels perform those functions — drillships drill and floating production, storage and offloading vessels produce, store and ship oil to shore.


Not willing to risk it

Uhlmer said the overruns, combined with the untested design, left MPF shut out of credit markets. “On the credit side of it, bankers don’t want to take a risk on an unproven design,” he said. 

The same goes for newly formed drillers that haven’t built or operated rigs or drillships before, whether or not they stick to proven designs, Uhlmer said.

Petrobras, Brazil’s state-owned oil company, has awarded 32 contracts for new vessels. Of those, five are with companies that have existing drilling operations with more than two rigs, Uhlmer said.

“We said six months ago when Petrobras bid all these contracts that most of these won’t get built, wondering who would finance them.” Now, the financial crisis “kind of magnifies the situation.”

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