The recent earnings season for the third quarter of 2011 has provided some insight into upcoming 2012 capital budgets for the exploration and production industry. This information can help investors determine the general level and trend of drilling activity next year. (To know about measures for capital budgeting, read Which Is A Better Measure For Capital Budgeting, IRR or NPV?)
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.

Lower Spending
Some operators are proposing 2012 capital budgets that are lower than 2011 spending levels. Comstock Resources (NYSE:CRK) expects to spend $575 million in 2011 on exploration and development activity across the company's properties in the Haynesville and Eagle Ford Shale.

In 2012, Comstock Resources is concerned about weak natural gas prices and has announced a preliminary exploration and development budget of $396 million. The company hopes that this level of spending will be covered by the company's cash flow without financing.

While this may be a prudent move by Comstock Resources, it will lead to lower production growth for the company in 2012. The company is expecting production to grow in a range from 8 to 12% next year, down from the 28 to 32% growth in 2011.

Comstock Resources is also putting more capital towards oil development and plans to reduce its operated rig count in the Haynesville Shale by two, leaving the company with only one rig working this play.

Infrastructure Issues
Another issue impacting 2012 capital budgets is infrastructure constraints, as the industry can't seem to build processing and transport capacity quickly enough to accommodate the rapid growth in production emanating from many high-growth plays.

Continental Resources (NYSE:CLR) is one of the more active operators in the Bakken and reported average production of 34,505 barrels of oil equivalent (BOE) per day from this formation in the third quarter of 2011.

Continental Resources announced a $1.75 billion capital budget for 2012, slightly lower than what the company expects to spend in 2011. The company expects this level of spending in 2012 to lead to production growth ranging from 26 to 28% for the year. Continental Resources cited infrastructure issues in North Dakota as one reason for the reduction in 2012 capital spending relative to 2011.

Although Ultra Petroleum (NYSE:UPL) won't finalize the company's 2012 capital budget until early next year, the company issued a range of Marcellus Shale production growth estimates for next year based on various levels of capital expenditure.

Ultra Petroleum said that if the company allocates $300 million in drilling and completion capital to the Marcellus Shale in 2012, production here would be flat relative to 2011. The company estimates that a $550 million budget would provide 8% growth and $1 billion in capital would lead to growth from 18 to 30% over 2011.

Ultra Petroleum is also trimming capital spending for the current quarter and plans to release two rigs in Wyoming and reduce drilling in Pennsylvania.

No Capital Needed
Another theme that has emerged from third quarter of 2011 earnings season is that many exploration and production companies are making efforts to convince investors that 2012 capital budgets can be financed out of expected cash flow and alternative methods without having to access the capital markets for debt or equity.

SandRidge Energy (NYSE:SD) plans to spend $1.8 billion in 2012 and will fund this budget with operating cash flow generated during that year. The company will also use financing options that do not add debt to the balance sheet or dilute existing shareholders by issuing equity. This would include creation of royalty trusts or joint venture funding. (To know more about operating cash flow, read Operating Cash Flow: Better Than Net Income?)

The Bottom Line
Although 2012 spending plans won't be approved until early next year and are subject to change based on commodity prices, they can help investors determine the evolution of the North American drilling cycle.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Eric Fox did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Fundamental Analysis

    4 Predictions for Oil in 2016

    Learn four predictions for oil markets in 2016 including where prices are heading and the key fundamental factors driving the market.
  4. Fundamental Analysis

    Performance Review: Commodities in 2015

    Learn how commodities took a big hit in 2015 with a huge variance in performances. Discover how the major commodities performed over the year.
  5. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  6. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  7. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  8. Stock Analysis

    The Biggest Risks of Investing in SandRidge Stock

    Learn about the significant risks of investing in SandRidge. Read how the company may not be able to service its substantial debt load.
  9. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  10. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
Trading Center