With US natural gas production continuing to surpass expectations, led primarily by Pennsylvania's Marcellus shale, many commentators expect natural gas prices to remain depressed for at least the next couple of years.
That's why investors seeking a margin of safety would do well to consider Southwestern Energy (NYSE: SWN ) , a low-cost gas producer with a solid foothold in two of the most economical shale gas plays in the country, a strong management team, and potential upside from liquids-rich projects. Let's take a closer look.
Solid assets and low-cost structure
Southwestern's most prized assets are located in the Marcellus shale of Pennsylvania, where it commands roughly 340 ,000 net acres, and in the Fayetteville shale of Oklahoma and Arkansas, where it boasts nearly 915,000 net acres. Combined, these two plays account for roughly 95 % of the company's total reserves and helped deliver 19 % year-over-year production growth during the third quarter.
Indeed, Southwestern's low-cost structure in both plays is one of its key value propositions. The company boasts one of the lowest finding and development costs out there, averaging just under $1.50 per Mcf over the past three years. The only other companies with lower three-year average F&D costs are fellow Marcellus shale producers Ultra Petroleum (NYSE: UPL ) , Range Resources (NYSE: RRC ) , and Cabot Oil & Gas (NYSE: COG ) , which had F&D costs of a little over $1 per Mcfe, just under $1 per Mcfe, and roughly $1.20 per Mcfe, respectively.
Thanks to Southwestern's low-cost structure, its best Marcellus wells can generate a 20% pre-tax rate of return with gas prices as low as $3 per Mcf, while most of its Fayetteville wells require $4 gas to generate those kinds of returns, though some are profitable even at $3 gas. Crucially, despite heavily drilling over the past several years, the company still has thousands of drilling locations left across both plays, with an estimated reserve life of roughly seven years.
Disciplined, returns-focused management
Another reason to like Southwestern is its disciplined, returns-focused management team, led by president and CEO Steven Mueller, which has been a great steward of shareholder capital over the years. Management was instrumental in acquiring Fayetteville and Marcellus leasehold acreage at attractive terms, as well as expanding into liquids-rich prospects as part of the company's New Ventures initiative.
Company executives also deserve credit for establishing the midstream infrastructure in the Fayetteville that has allowed the company to dramatically ramp up production from the play while keeping costs in check. Overall, Southwestern's management has done a great job in profitably growing production and reserves at average annual rates of 38% and 23%, respectively, from 2007 to 2012, while annually replacing over 325% of production at an extremely low F&D cost of just $1.36 per Mcfe.
Upside potential from liquids-rich prospects
In addition to its leading positions in highly economical shale gas plays, Southwestern may have significant upside potential from its liquids-rich projects. Under its New Ventures program, the company has identified a handful of oily prospects, including southern Arkansas and northern Louisiana's Lower Smackover Brown Dense, Colorado's DJ Basin, New Brunswick in Canada, and other undisclosed ventures.
While these liquids-rich prospects are still in the early stages of being proved up, success in even a couple of them could provide a big boost to Southwestern, helping to diversify its commodity mix and sources of cash flow. Investors would do well to track the company's progress in these plays over coming quarters, especially in the Lower Smackover Brown Dense project, where the company drilled its best well to date in the third quarter.
The bottom line
While Fayetteville growth has slowed slightly in recent years, Southwestern's low-cost structure and leading position in the Marcellus should continue to drive low double-digit production growth over the next few years, especially as new midstream infrastructure comes online in the play over the next year. With a deep inventory remaining across both plays, a highly capable management team, and exciting liquids-rich projects in the pipeline, Southwestern is one stock I'm watching closely.
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