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-- Posted Thursday, 29 October 2009 | | Source: GoldSeek.com
With the oil-and-gas price link weaker than it's been in over a decade and with natural gas too dependent on a fierce winter to fuel demand and drive pricing up, CRT Capital Group Senior VP Duane Grubert likes oil better than gas. Consistent with that stance, he also prefers producers that are leaning more toward oil than gas. In the gas arena, he tells The Energy Report in this exclusive interview, he's sticking with players who are diversifying and tends to choose those that are involved in exploration as well as production. The Energy Report: Basically, Duane, we'd appreciate a top-down overview of where you see natural gas and oil going in the short run and then long term, and where you see the markets both domestically and internationally.
Duane Grubert: I'm primarily focused on North American markets, and the link between oil and gas has been falling apart over the last year or so, which is one of the very investable themes out there right now. Let's start with the natural gas side. We've really had this revolution; in the last five or seven years producers have discovered that they could produce gas out of really terrible rock—the gas shales. In the last year, with really high prices in 2008 as an incentive, the sector has been very creative in increasing the productivity of these wells in effectively bad rock to the point where there really is a sea change.
Gas is now abundant; very credible producers are saying they have tremendous volumes of project backlogs. So we're in a situation where gas prices are really going back to gas-on-gas competition and the clearing price of gas being set by the sector's cost structure.
TER: And the oil side?
DG: It's a lot different on the oil side. Time and time again, we've seen politics, macro factors, infrastructure constraints, etc. It's much less researchable to talk about where oil prices are going relative to gas prices (again, for North America), because effectively you have this island market for natural gas and dominantly a domestic supply.
We certainly pay attention to cost structure on the oil side and we certainly pay attention to things like social budgets of some of the Middle East nations. But in terms of a number, which ultimately everybody wants, we start with the first question: What will investors be willing to assume as a long-run normalized price? I'm very comfortable thinking that gas markets will reflect a clearing price of something like $6 per MMBTU, which is miserable relative to where oil is trading currently.
Right now the stock and bond markets are reflecting something like $60 oil, even though the current prices are a lot closer to $80. So in terms of an outlook for price, I am comfortable telling people to think about a normalized $6 gas price for the medium and long term, but I am a lot less certain on the oil side. Because of cost structures and so forth, we're kind of a $60-plus shop in terms of an outlook. We recently bumped up our view of what securities will reflect to $65 oil in our target setting, but left gas alone at $6.
TER: So the opportunity appears to be in natural gas because you're looking at a 50% upside from the current price?
DG: The situation has really changed quickly. We had a period in the shoulder season when people didn't use either air conditioners or heaters, between summer and winter, where the spot price of gas dipped below $3, but we very quickly recovered from that. In mid-October, November gas was priced at over $5, with the strip for next year very close to that clearing price I've been talking about—around $6.
So it was correct early in the year to say gas prices must go up. They did go up, and they've gone up toward this clearing price. If you're a bull on gas, you're really making a weather call from this point forward into 2010, and there are some moving parts. We have had far less drilling, we may have some economic recovery, but at the end of the day, the weather call is very dominant as a driver of whether gas prices will improve much from here.
TER: What is it typically costing to produce gas out of some of the shale plays you mentioned?
DG: People often confuse the notion of an ongoing cash cost versus an all-in invested cost. In terms of cash cost, most producers now are able to get gas out of the ground from existing wells for about a dollar per MCF. On the capital side, very credible producers are showing numbers that indicate they can have, say, a 10% pre-tax return with on the order of $4 for the gas in the most competitive shales, such as the Haynesville and the Marcellus.
It quickly erodes when we look at a broader universe of types and qualities of wells. The best projects that can tolerate a fully loaded $4 are very material, but very many producers are doing a lot of work on what they perceive to be best-in-class type projects within their own portfolios.
TER: As you said, you need a higher price before it makes sense to get the gas out of the ground.
DG: Yes, and so we've seen a very rational response by the sector laying down drilling rigs. While they're producing and making positive returns on a cash basis, on a project basis prices simply haven't been high enough to justify activity. We've dropped down from about 1,600 rigs drilling for gas mid-to-late last year to about 700 rigs now.
TER: Haven't we seen some uptick since the bottom?
DG: Very small. The last few weeks we've seen a little bit here and there, partly driven by the ability of producers with those perceived best projects to hedge. In the last couple of months, we've had very low spot and near-month NYMEX prices, but very big spreads moving into next year such that producers could have sold forward at $6 or even $7 per MCF for 2010. So we're beginning to see a little bit of an uptick in activity related to hedging and also to some of the producers needing to drill to retain their acreage.
TER: How would you tell investors to divide oil and gas in their portfolios over the next 12 months?
DG: At this point, we're much more constructive on oil names than the gas names. That doesn't mean staying away from gas as much as it means sticking with the gas players who are diversifying.
We would definitely be very positive on getting exposure to both the under-rewarded oil leverage and taking an element of exploration exposure.
In summary, we like oil better than gas; we like the gassy players that are getting oilier, and we like an element of exploration with some track record attached to it.
Covering the energy industry, Duane Grubert is Senior Vice President and Principal of CRT Capital Group LLC, a Wall Street broker-dealer with research that covers the entire capital structure, based in Stamford, CT. He joined the firm in 2007 after working at Sanford C. Bernstein, Fulcrum Global Partners and Execution LLC. In his first two years as a publishing analyst, he was voted Institutional Investor Magazine's "Up and Comer" for both exploration and production and for natural gas; he ranked in the top 10 for both categories thereafter.
Prior to turning to Wall Street, Duane spent 17 years with Unocal (now part of Chevron Corporation [NYSE:CVX]), as a petroleum engineer, in international business development and finally as general manager of corporate strategy and business intelligence. He served stints in Thailand, Alaska and California, executing on $100 million worth of drilling projects, obtaining a technical patent, driving large-scale contract negotiations and working with executive management in the U.S., Latin America and Asia. Duane has a BS in Petroleum Engineering from Stanford University and an MBA from California State University. Streetwise - The Energy Report is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Inc. and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported. Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Thursday, 29 October 2009 | Digg This Article | Source: GoldSeek.com
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