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Tickers in this Article: CPE, RDS.A, BP, MUR
Ever since the energy bubble burst over the summer, energy bulls have clung to what some call the "snapback theory". This theory holds that as prices for oil and gas fall, companies will cut back on higher cost production and on projects that don't make sense economically anymore, thereby cutting supply and bringing the market into balance and stabilizing the price.

There is some evidence that this is happening, but it is not a cure all for every energy company.

The Callon Story
In late November, Callon Petroleum (NYSE:CPE), an oil and gas exploration and production company with operations mostly in the deep water and continental shelf area of the Gulf of Mexico, announced that it was suspending development on the Entrada field due to lower commodity prices and cost overruns.

The Entrada field is located in the Garden Banks area of the Gulf of Mexico and is operated by Callon Petroleum, which has a 50% interest in the field. BP (NYSE:BP) used to have an 80% working interest in the field but was bought out by Callon Petroleum in April 2007.

While decisions like this will ultimately cut supply and bring balance to the market, it was devastating to Callon Petroleum, as the stock lost 67% of its value between November 26 to November 28, after the news became public.

This is an important field for the company because it has 73% of the company's estimated net proven reserves at Dec 31, 2007. It was also important, as success here would have established Callon Petroleum as able to operate in deep water areas of the Gulf. (Find out how to take advantage of this market without having to open a futures account in A Guide To Investing In Oil Markets.)

Other Projects

Aside from Entrada, the company's main deep water focus is on the Habanero and Medusa discoveries in the Gulf of Mexico.

  1. The Habanero field is also located in the Garden Banks area and is operated by Royal Dutch Shell (NYSE:RDS.A). The well was first drilled in 1999, and production came on line in 2003. This is typical for a deep-water well due to the expense, difficulty and lead-time needed to build infrastructure. There are now two wells producing in the field.
  2. The Medusa field is located in the Mississippi Canyon area and is operated by Murphy Oil (NYSE:MUR). The field was discovered in August 1999, with production also coming on line in 2003. There are now eight wells producing in the field.
One problem with Callon Petroleum is that since most of its production is offshore, its earnings and revenue are regularly hurt by hurricanes in the Gulf of Mexico. During the third quarter the company reported that 12.6 million cubic feet of natural gas equivalent per day, or one-third of its production, was "deferred" due to Hurricanes Gustav and Ike.

Bottom Line
The snapback theory has some validity, but its effects will be felt long term and investors need to be wary about exploration and production companies that are heavily dependent on a single field or project.

Before jumping into this hot sector, learn how these companies make their money in our Oil And Gas Industry Primer.

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