In Natural Gas Market, Advantage Goes to 'Fire Sale' Buyer

NEW YORK ( TheStreet) -- Spot market pricing weakness has placed exploration and production companies focused on natural gas in a tough spot. In a sale of gas assets made by Carrizo Oil and Gas ( CRZO) on Friday, it looks like the market is favoring the buyer.

Shares of the company that purchased the dry gas assets from Carrizo, Atlas Resources Partners ( ARP), rose by 32%, while Carrizo shares saw a bump of just 1%.

It's no surprise that natural gas-weighted E&Ps have suffered as pricing has weakened. The situation is so severe that the companies have already put a stop to natural gas production to combat excessive supply, from independent producers to oil and gas majors like ConocoPhillips ( COP).
As natural gas companies look to sell uneconomic assets, the advantage goes to the buyer.

The production cuts haven't done anything to help natural gas prices rebound, though: Spot market prices hit a decade-low level this week, shortly before Carrizo completed its sale of dry gas assets in the Barnett gas basin to Atlas for $190 million.

Since the end of 2010, the rig count in the Barnett basin is down 27%, according to Stephens, as drillers migrate away from the uneconomic gas plays.

The natural gas pricing conundrum has raised the issue of whether a fire sale is coming in the market, with independent E&Ps forced to sell out to majors like ExxonMobil ( XOM); in other words, the big balance sheet, low cost of capital players that can buy at depressed prices and wait for a better day in the natural gas market.

There are two conspiracy theories about ExxonMobil and the natural gas issue as these divestitures begin.

ExxonMobil said earlier this year that it had no plans to stop natural gas production that it gained through its acquisition of XTO Energy, in contrast to most peers cutting back, and leading to the theory that it would be in Exxon's best interest to see the independents fail, allowing the company to buy up these dry gas assets at a discount.

Add to this the fact that ExxonMobil has received a steady stream of criticism for the XTO Energy price tag -- valued at roughly $8.50 to $9 for natural gas that is now trading around the $2.25 mark -- and buying up lots of depressed natural gas assets would ultimately allow Exxon to bring down the blended cost of its natural gas production, making that $8.50 to $9 no longer look quite so expensive.

Carrizo's deal won't answer any of the conspiratorial questions, but it does show the market giving a lot more short-term credit to the company able to buy up these dry gas assets at a reasonable price than to the seller trying to transition away from the natural gas story to the hunt for liquids .

The assets sold by Carrizo produce 35 million cubic feet of natural gas production per day, which when divided into the $190 million price tag, suggests a price paid of roughly $5,400 per flowing cubic feet per day.

Stephens analyst Will Green said the estimated price is significantly lower than what had been the norm in recent years, a range of $7,500 to $12,500 per flowing cubic feet per day. Peer companies have traded based on a $7,700 assumed value. Yet all of that was based on a world of $4 natural gas, a world that seems like a distant memory now.

The Carrizo deal is one of the first divestitures of dry gas assets since the historic slide in natural gas pricing began this year. While the bump to Atlas shares comes as a direct result of the impact the additional assets -- all of which will be hedged -- will have on EBITDA earnings before interest, taxes, depreciation and amortization and cash flow, Carrizo still has its work cut out for it in proving to the market that it's also a winner in this deal.

Green thinks Carrizo is a winner, though, or ultimately will be, and the market is missing the point of the deal for the seller.
  • Carrizo's dry gas production in the Barnett is less important to its cash flow profile than the market assumes.
  • Stephens estimates that the gas assets being sold represent 3% to 5% of cash flow.
  • The company is transitioning to the search for liquids and production in the Eagle Ford shale -- one of the hottest shale plays of all.
  • Carrizo is trying to de-complicate its story, while also generating the cash to de-lever its balance sheet, and moving away from natural gas by selling the assets accomplishes this goal.
  • "Investors should view what matters most and what matters most is oil growth," Green argues. "From 2003 until now they made a lot of money on the Barnett natural gas but it's become a low return asset and selling a quarter of production that is only representing 3% to 5% of current cash flow doesn't change the meaningful part of cash flow."

    The analyst sees Carrizo as a unique seller, as opposed to kick-starting a natural gas market fire sale.

    "They are not giving it away. They may as well monetize the Barnett though, since investors aren't giving them any credit for it," Green said, adding that the sale came in toward the high-end of a range previously provided by Carrizo when it first told the market to anticipate a deal between $150 million and $200 million.

    Yet if the market is missing the point in one of the first sales of natural gas assets by an independent E&P that is calling it a day with "yesterday's cash flow model," only time will tell.

    --Written by Eric Rosenbaum from New York.

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