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06-08-2012 18:03:00

Weaker Oil Prices Challenge U.S. Companies' Migration To Crude

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By Alison Sider

HOUSTON--A global economic slowdown has prompted a moderation in crude prices, leading many U.S. oil companies to outspend their cash flow as they move their rigs from unprofitable natural gas areas to oil-rich formations that are expensive to drill. If prices keep at the current level for an extended period or fall further, they may have to sell assets, borrow more, or dial back their ambitions, analysts say.

"Everybody is doing this 180 degree turn into liquids. What if prices go down? It will rain on their parade and cool enthusiasm significantly," said Fadel Gheit, an analyst with Oppenheimer & Co.

The most prominent company caught in this dilemma is Chesapeake Energy Corp. (CHK), where funding and governance issues led to a successful revolt by shareholders calling for more restraint in spending. The company reports quarterly earnings Monday. Others on analysts' radar are Quicksilver Resources Inc. (KWK) and Exco Resources Inc. (XCO).

Quicksilver has said it plans to sell some of its Barnett Shale assets into a master limited partnership and will use the proceeds to reduce debt. Rival Exco, based in Dallas, last week announced it cut its workforce by about 300 people in a bid to reduce costs--and to keep its debt ratio in line with the covenants struck with lenders. The company at the end of last year had 23 rigs operating, and now expects to end this year with seven to nine; the company is also trying to unload some of its conventional gas assets, and has discussed for several months plans to sell its midstream subsidiary, TGGT.

But asset sales are not so simple--especially when everybody is putting properties on the block at the same time. They may take longer than expected or bring less money than thought.

"In the asset market it's a buyer's market," Jefferies & Co. analyst Subash Chandra said. "Buyers are becoming more sophisticated, more experienced and more jaded, if you will."

The dilemma underscores a fundamental challenge in the nature of the energy industry, which must mobilize billions of dollars in long-term investments that can quickly turn unprofitable if market conditions change. At the end of the second quarter, when the economic slowdown became evident, oil prices that had been averaging above $100 per barrel fell sharply; after dropping below $80, they rebounded to around $90 per barrel last week-- but still tend to swing wildly as concerns about the euro-zone crisis or U.S. and Chinese economic growth make investors jittery.

Also, an unexpectedly quick rise in U.S. oil production is itself contributing to the weakness in prices. Hydraulic fracturing and horizontal drilling--tchniques used to unlock previously inaccessible natural gas and oil in shale formations--has led to the highest domestic crude production levels since 1998.

The federal Energy Information Administration estimated that on average, more than 6.2 million barrels of oil a day were produced in the U.S. during the first quarter of 2012. That's up 12% from a year earlier and 22% from the first quarter of 2006.

Even large companies are feeling the pinch of market volatility: ConocoPhillips (COP) cut its share buyback program and is outspending cash flow to pay for its ambitious drilling program and its dividend, and Marathon Oil Corp. (MRO) said last week it would reduce drilling expenses.

"We could continue to maintain higher rig levels and grow volumes at a faster rate," Marathon chief executive Clarence Cazalot said, but "we don't see that makes a great deal of sense."

One point in favor of oil and gas companies: lenders seem to be flexible when discussing debt covenants with oil companies because they are bullish about energy. They proved to be understanding in 2009, when natural gas prices plummeted in the wake of the financial crisis.

"When gas prices got low, I expected lenders to apply more pressure but just didn't see it," said Pearce Hammond, an analyst with Simmons & Co. "Thus far, the banks have been very supportive." As long as prices don't dip below $85 per barrel for long stretches of time, most producers should be all right, Mr. Hammond said.

Also, so far, even though several companies have announced write-downs of the value of natural gas assets, Tudor Pickering Holt analyst Brian Lively said he would not expect to see the same happen for oil assets, as crude prices would have to stay low for an extended period of time.

Write to Alison Sider at alison.sider@dowjones.com

Subscribe to WSJ: http://online.wsj.com?mod=djnwires

(END) Dow Jones Newswires

August 06, 2012 12:03 ET (16:03 GMT)

Copyright (c) 2012 Dow Jones & Company, Inc.

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