Filed Under:
Tickers in this Article: CHK, NBR, PTEN, HP, XES
The recent announcement of drilling cutbacks by one of the North America's largest independent producers of natural gas shows that energy stocks may not be a bargain at these levels despite a nearly 50% fall from prices reached in July 2008. Chesapeake Energy (NYSE:CHK) announced a major cutback in its drilling program over the next several years, and the shut in of current natural gas production.

Management said it took the actions due to falling prices for natural gas and concerns by management over a possible surplus in storage.

The Cutback
The cut in its multi-year exploration and development plan by Chesapeake Energy totals $3.2 billion or 17% of the total capital plan for the 30-month period beginning in the second half of 2008 and continuing through the end of 2010.

Chesapeake Energy also decided to temporarily curtail a portion of its unhedged natural gas production in the Mid-Continent region due to low wellhead natural gas prices.

Approximately 100 million cubic feet (mmcf) per day of net natural gas production would be shut in until natural gas prices recover from the recent range of $3.00 - $5.00 per thousand cubic feet (mcf). This represents 4% of company production. (To learn how these companies make their money, check out Oil And Gas Industry Primer.)

Growth Forecast Slashed
Because of the cutback in capital expenditures (CAPEX) for drilling, the company also cut its production growth forecasts for 2009 and 2010. Full year 2008 production growth is now expected to be 18%, down from 21%. Production growth for 2009 and 2010 was reduced to 16% from 19%. The company said that asset sales also reduced the growth estimates.

Aubrey K. McClendon, the CEO of Chesapeake Energy, said "We believe it is in the best interests of Chesapeake's shareholders to temporarily curtail a portion of our natural gas production, reduce the company's drilling CAPEX and lower our production growth to provide time for rising natural gas demand to catch up with increasing natural gas supply."

McClendon also said during a conference call that other exploration and production companies would soon make similar announcements and predicted that 200-400 drilling rigs would be idled over the next six months as drilling is cut back.

During the company's second quarter conference call held on August 1, 2008, the company gave hints about today's announcement. Management said, "If (natural) gas prices were to stay below $9 Henry Hub for some period of time, I think that the shale plays probably continue to move forward but I think you'll see a lot of rigs drop out of what you would call conventional drilling ... We're pretty confident that much below $9 you'd see a drop off in drilling activity particularly among the conventional drilling."

Drilling Industry Suffering
Stock prices for drilling contractors Nabors Industries (NYSE:NBR), Helmerich & Payne (NYSE:HP) and Patterson-UTI (Nasdaq:PTEN) have already fallen nearly 50% from the peaks they reached over the summer, and the Chesapeake Energy announcement is not good news for these land drillers. Chesapeake controls approximately 7% of the land drilling fleet, and owns many of its own rigs as well. If the management of Chesapeake is correct about 200-400 rigs being idled over the next six months, plunging utilization will lead to much lower prices for day rates.

Other oil service companies have also fallen from the peaks in July. The S&P Oil & Gas Equipment & Services Spider (AMEX:XES) is down 40% from its peak. This index contains companies that are not primarily involved with drilling.

Bottom Line
Despite the hype about the bull market in commodities, the energy industry is still intensely cyclical as demonstrated by the recent stock price sell offs in the sector. Although some investors may feel that the stocks are good buys here at these lower levels, there may be more pain to come as the financial crisis that began on Wall Street spreads to Main Street and the rest of the world.

To learn more, check out Cyclical Versus Non-Cyclical Stocks.

comments powered by Disqus

Trading Center