Healthy Appetites

Despite low natural gas prices, capital providers are not pushing back from the oil and gas funding table. A recent analysis of capital markets by Barclays Capital’s equity and credit market research team shows no slowdown in debt and equity issuance in 2011 from 2010 levels. Only joint-venture capital funding declined during the period.

How much has the natural gas price fall-off hurt capital raises to set up a reduced drilling and supply scenario? Bar-clays analysts note that defining the effect of poor gas prices is difficult, because producers do not raise money for gas and oil drilling separately. “Nevertheless, some of the capital raised is used to fund gas-targeted drilling,” they say.

“Capital markets are open for all but the most challenged companies. In other words, look for other factors when trying to determine what might slow gas-directed drilling, and therefore supply.”

Access to capital is vital for vigorous upstream activity and maintaining production levels, especially give the high decline rates of existing wells. “We believe capital markets are not a disciplining factor in the market today, but with two caveats,” say the report’s authors, Shiyang Wang and Michael Zenker, commodities research analysts. Those factors are the shift by producers to liquids-rich and oil targets, which Wall Street supports, and the resulting lack of pure-play gas producers. These may mask the market’s attitude toward natural gas.

While joint-venture funding did decline from 2010 levels, those were record highs. JVs in 2011 attracted $44 billion compared with $50 billion in the previous year. Excluding the effects of JV investment, 2011 funding overall fell just 1%. (Revolvers and hedging revenue aren’t included in the capital survey.)

The Barclays analysts called the steady equity and debt stream to the E&P space “remarkable.” It reflects the relative attractiveness of E&P compared with other sectors. “In other words, in the current market environment, investors consider the EP sector a better-than-average one to place capital given the ability to value the hard assets and hedging that provides some downside protection.”

Master limited partnerships (MLPs) have become greedier. Their share of equity capital raised has grown. Their equity issuance year to date in 2012 is off only marginally from the 2011 pace, “a year which was marked by a few large offerings (e.g. EOG Resources, Continental Resources, and Kosmos).”

High-yield issuers continued to dominate activity in the debt markets. “Borrowing costs have been relatively stable, with yields for investment-grade issuers down slightly from 2010 to 2011, and then a bit lower again this year,” according to the analysts. Costs of high-yield borrowing are flat to date in 2012. Issuance by high-yield companies, however, is nearly two times that of the 2011 year-ago period. “The debt credit market is open for all but the most risky names,” the report notes, although proceeds may not go directly to drilling budgets.

JV dollars declined along with natural gas prices. These partnerships were plentiful in dry-gas plays in 2008 and 2009 as producers tested technology and built up their reserves and production. After first-quarter 2010, however, all but one JV have targeted liquids-rich plays. Even though such deals have slowed, “We anticipate that the last of the JV deals is not behind us,” say the authors.

“Assuming no additional JV funds raised (unlikely), drilling carries drop in half next year relative to this year….Given that these carries subsidize drilling efforts, and thereby lower the price threshold at which drilling is cost effective, the expiration of drilling carries removes one stimulant to drilling.”

Borrowing bases don’t appear to be shrinking overall, despite drops in the gas forward curve, which damages asset value. “…our credit analysts believe that banks that are funding revolvers will remain accommodative for the majority of producers, mostly preserving the size of revolvers, which is consistent with how banks reacted in past gas-price drops.

“Only the gassiest E&P producers, with little to no liquids production and proved developed reserves, will likely see cuts to their borrowing bases in the fall redetermination process. Even then, we believe banks would be loathe to push producers into bankruptcy.”

Thus, looking over the capital menu, which includes assets sales, the analysts don’t see capital constraints for the E&P sector. “This doesn’t mean that all producers are maintaining the same pace of gas-targeted capital spending as in 2010 or 2011,” they say. “Indeed, as producers shift their efforts away from gas, some are raising capital-spending projections while others are lowering them.”

It is this shift in drilling that will set the gas production table, not meager funding.

—Susan Klann