E&Ps: Expletives and Profanities

The recent share price explosions among explorers and producers are enough to make one utter expletives and profanities. A G-rated version might be: "Golly gee, that's a lot of Texas tea!"

A flurry of reports came out yesterday, so I'll pick and choose among the whizzes working wonders with West Texas Intermediate (or gunning for natural gas).

Possibly too exciting
First up is EXCO Resources (NYSE: XCO  ) , which counts T. Boone Pickens as a top shareholder. Production at the gas-focused exploration and production (E&P) company has more than doubled in a year. Adjusted earnings have quadrupled. This would be a staggering feat had the company not shelled out a huge amount of cash for property acquisitions last year.

It's not often you see a company highlight its record capital expenditures in a press release, but EXCO did just that yesterday. I'm not crazy about the company's aggressive spending style -- acquisitions plus development expenditures were multiples of operating cash flow in 2007 -- but at least the company is up front about it.

I'm not sure what exactly has fired the imaginations of EXCO investors. Maybe it's the Marcellus shale acreage in Appalachia, or perhaps it's the Haynesville shale play. EXCO just doesn't have the same level of drilling cachet as neighboring shale aces like EOG Resources (NYSE: EOG  ) or XTO Energy (NYSE: XTO  ) , so I admit to being a bit puzzled by the shares' popularity.

Speaking of the Haynesville, Petrohawk (NYSE: HK  ) also reported yesterday.

Watch it like a hawk
I've mentioned the takeover chatter surrounding this outfit ever since Chesapeake Energy (NYSE: CHK  ) broke the Haynesville story. There actually is a rather strong Petrohawk-Chesapeake connection: Petrohawk's principal sold one of his past ventures to Chesapeake in the late 1990s. This fellow is serially, and seriously, successful.

It appears that management is fully capitalizing on the buzz surrounding Petrohawk's Louisiana shale play. Investors are being asked to swallow a significant capital raise, which was announced concurrently with earnings. Petrohawk is offering 21 million shares, which amounts to a double-digit dilution, even before underwriter over-allotments. Sure, the money's for a good cause -- paying down debt -- but this is a bit painful nonetheless.

The capital raise almost overshadowed strong quarterly results. In the Fayetteville shale, Petrohawk's busiest development area, initial production rates from new wells were up 20%, and drilling costs were down double digits. The company also drilled a monster horizontal well over in Louisiana's Elm Grove field, another core operating area. Overall, production was up 10% sequentially, after netting out divestitures. That is tremendous. Other E&Ps are leaping on year-over-year growth rates in that vicinity.

To make sense of the dollars and cents, it's safe to ignore the non-cash hedging loss mucking up Petrohawk's per-share earnings figure. This company's production costs are rock-bottom, at sub-$0.60 per thousand cubic feet of gas equivalent for the sixth straight quarter. For comparison, low-cost EOG's lifting costs came in closer to 80 cents, and XTO's are hovering around a buck. Of course, getting gas out of the ground is only one piece of the cost equation, but it's a core item that reflects well on the economics of Petrohawk's operations -- no matter what the GAAP earnings say.

Ultra-low cost producers win
As long as we're on the subject of low-cost leaders, we may as well check in on Ultra Petroleum (NYSE: UPL  ) , which is quite possibly the reigning champ. Thanks in part to a terrific employee incentive program, results at this Rockies player continue to be incendiary.

On a like-for-like basis, first-quarter production volumes surged 31% over last year, and operating cash flow flew 51%. Perhaps most pleasing is the company's profitability: a 74% cash flow margin (versus 63% at XTO) and a 34% return on capital employed (compared to 22% at on-pause Apache (NYSE: APA  ) . These are the numbers of which E&P dreams are made.

In the unit cost game, Ultra is nigh unbeatable. All-in costs -- meaning production, transportation, depletion, the whole shebang -- came in at $3.32 per thousand cubic feet of gas. That's lower than Petrohawk's depletion cost alone. This cost structure tells you a lot about Ultra's prospects in the face of a natural gas pullback.

In fact, forget a pullback -- it would take a nat-gas nuclear meltdown to take Ultra out of the gas game.

Related Foolishness:

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Fool contributor Toby Shute minds his Ps and Qs as well as his E&Ps. He doesn't have a position in any company mentioned. The Motley Fool's disclosure policy never depletes.


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