The recent uptick in gas-directed rigs illustrates the capital allocation optionality and potential value available to some North American exploration and production (E&P) companies, according to Fitch Ratings.
Production optionality is available to North American E&P companies with a diverse portfolio of liquids and gas assets. This optionality is particularly valuable in the current oil price downcycle for leveraged, liquidity-constrained E&P companies, since gas drilling may provide a more favorable return on investment over the near term.
Crude oil price declines in excess of 55% have led E&P companies to scale back early-stage evaluation and development activity, especially in liquids-rich areas. This is evidenced by the drop in oil-directed rigs by 49, or roughly 4%, over the past week, resulting in an 18% overall decline in oil-directed rig counts from their peak in October 2014. Gas prices and overall gas-directed rig counts have also experienced considerable declines of nearly 40% and over 11% from their peak in November 2014, respectively.
However, the increase of six gas-directed rigs, or about 2%, over the past week suggests that for some operators natural gas may provide an economic alternative to liquids drilling. A portion of the gas-directed rig count increase seems to be from oil-to-gas switching in the Barnett (-1 oil/+1 gas), Eagle Ford (-6 oil/+2 gas), and Williston (-13 oil/+1 gas) basins, while others appear to be starts or restarts in the Fayetteville (0 oil/+1 gas) and Marcellus (0 oil/+1 gas) basins.
Comstock Resources, for example, announced its intention to pursue a more aggressive gas-directed drilling program. The company, under its 2015 capital program, announced in mid-December 2014 that it intends to released or move all rigs in its liquids-rich Eagle Ford and early-stage Tuscaloosa Marine positions. Rigs will be placed in the natural gas-oriented Haynesville given the company's belief that technological improvements will lead to strong returns.
Fitch does not anticipate an increase in gas-directed rigs that offsets the decline in oil-directed rigs but recognizes that this capital allocation optionality provides North American E&P companies with additional flexibility to potentially strengthen their returns and financial profiles. However, current gas prices may not encourage activity in some plays, and the US natural gas market remains exposed to oversupply conditions in 2015 that could weigh on the effectiveness of a large-scale shift to gas.