The industry is focusing on liquid-rich plays, but some gassier regions offer solid returns, asserts Joel Musante, senior research analyst for oil and gas exploration and production with Euro Pacific Capital. With oil trading over $100 per barrel, liquids-rich plays are most attractive. Prices may pull back, even though the surge in merger and acquisition activity suggests that some companies might believe that these price levels are here to stay. Ultimately, producers must consider development costs as well as product types and margins to enhance returns. In this interview with The Energy Report, Musante discusses how to identify keys to success in the oil and gas industries.
The Energy Report: Joel, how do you identify winners in the crowd of junior oil and gas companies?
Joel Musante: I look for companies with an attractive property base, good dealmakers and resilient leadership. It's important to have a good land position where a company could drill commercially economic wells. Many smaller E&Ps have limited financial resources, so it is also important not to overpay for properties. A poorly structured, overleveraged balance sheet could be the death knell for a junior oil and gas company. Good dealmakers usually find creative ways to buy quality properties at attractive terms. I think it is also important to have a resilient management team that can stick it out through the rough patches, which seem to be inevitable in the oil and gas industry.
TER: In the past you've identified keys to an oil and gas company's success, such as valuable properties, access to funding and strategic leadership. How do those criteria rank in importance to you?
JM: It is hard to rank which criteria will be most important for a company's success, because it depends on external factors as well. Properties are very important, but I've seen strong management teams do pretty well with a mediocre property base and unfocused management teams fail with good properties. Access to funding is critical in many cases to growing production and reserves, but companies generally build their investor base up over time.
TER: Are there any innovations in technologies that you find especially interesting?
JM: The improvements in horizontal drilling and hydraulic fracking is the most recent innovation that has changed the landscape of the oil and gas industry, making it possible to develop oil and gas deposits in shales and other tight formations. But this is old news at this point. Currently, most oil and gas companies utilizing this technology are trying to improve these operations in their specific development areas by finding the optimal frack design. The ultimate goal is usually to optimize returns by improving recoveries, increasing production rates and lowering costs. Some investors may find a discussion boring about the optimal number of frack stages or whether to use ceramic or sand-based proppant, but that's where we are at now.
TER: Is there a sweet spot for the oil and gas mix in the companies' proved reserves?
JM: When you're talking about reserves, liquids are generally better than gas because the margins are better. However, when deciding on the best place to drill a new well, you also have to take into account the investment cost. In this case, it seems like the wet gas plays or volatile condensate/oil plays earn the highest returns. These parts of the reservoir typically have a lot of energy, resulting in higher production rates and better recoveries. This will drive the economics of the well even though the product mix may include more NGLs and natural gas, which realize lower prices than oil. By drilling in the oil window, the price realizations may be higher, but production rates and recoveries are often less. In the natural gas window, production rates and recoveries could be high, but price realizations are low.
TER: West Texas Intermediate (WTI) has ranged from $100 per barrel ($100/bbl) to $110/bbl since early July, while natural gas has remained stuck below $4 per million British thermal units ($4/MMBtu). Is this the new normal for oil and gas?
JM: I model for $90–100/bbl oil prices and $3–4/MMBtu gas prices on a going-forward basis. Obviously, the prices could go above that, but I think we lack the demand to keep prices much higher than that. If prices go below that, I don't see them staying there for very long because development would likely fall off at lower prices.