In reporting its fourth quarter results, Cabot Oil & Gas Corporation (NYSE:COG) again confirmed the high quality of its assets, but the report also highlighted a lingering problem. Cabot continues to produce monster wells in the Marcellus shale, yet it can't get market prices due to infrastructure snags. Similar to other firms, Cabot is reducing the projected 2014 capital spending budget while improving performance. In addition, the company is holding back on further expanding the Marcellus drilling program to seven rigs due in part to lack of infrastructure forcing the company to curtail growth efforts.
The current $15 billion market valuation of Cabot makes for an interesting comparison to Chesapeake Energy (NYSE:CHK) at only $17 billion. Even more interesting is the aggressive hedging by both firms as natural gas prices roared into the $4 per Mcf range this winter.
Investors interested in Cabot need look no further than the monster wells producing massive dry gas in Susquehanna County, PA. The wells are so impressive that Cabot only drilled 181 gross wells in 2013 to achieve the current market valuation compared to roughly 1,300 at Chesapeake Energy. Below were some sample production numbers from the big wells:
- Ten-well pad completed with 170 frac stimulation stages with an initial production, or IP, rate of 201 Mmcf/d and a 40-day production rate of 168 Mmcf/d.
- Four-well pad completed with 117 frac stages with IP rate of 114 Mmcf/d and a 30-day production rate of 88 Mmcf/d, including two wells with an estimated ultimate recovery rate of 25 Bcf.
- A four-well pad completed with 95 frac stages with an IP rate of 100 Mmcf/d and a 30-day production rate of 84 Mmcf/d, including three wells with EURs over 20 Bcf.
Normally a company would be happy with IP rates a fraction of those levels, but infrastructure issues are pushing down regional prices and limiting the ability to expand further.
As with anything, too much of a good thing can actually create short-term headaches. In the case of Cabot, the prolific Marcellus wells are creating price differentials for natural gas of between $0.60 to $0.65 below NYMEX settlement prices. The concerning part is the strong NYMEX pricing during the severe winter weather isn't helping the producers in the area due to a lack of infrastructure.
In the last week alone, the EIA reported that natural gas storage levels plunged to lows not seen in over a decade, yet Cabot can't even obtain reasonable prices. Chesapeake Energy discussed similar issues with larger than expected price differentials and higher infrastructure charges in key growth areas. Chesapeake is facing high gathering and transportation charges in areas of high growth.
Similar to the price differentials of being in a region that can't get new supplies to market efficiently, hedging can have a meaningful impact on actual results. Chesapeake hedged 68% of 2014 production at prices of around $4 per Mcf. Similarly, Cabot has approximately 1.2 Bcf/d of natural gas volumes hedged at a weighted average floor of $4.11 per Mcf.
Cabot produced roughly 1.2 Bcf/d during the fourth-quarter so it has hedged existing production levels for the year. At this point, the company has limited its exposure to potentially higher natural gas prices to only production growth for 2014. Remember that the production gains are being somewhat constrained by not being able to move forward with a seventh rig in the Marcellus.
Cabot continues to blow the doors off production efficiency, but it is almost detrimental to pricing. The company is forecasting 2014 production growth of up to 40%, yet infrastructure issues are holding back the growth rate and price realizations. The question at this point is whether Cabot is the better value at 15x cash flow or Chesapeake at 3x cash flow. So far, investors have not shown any interest in value plays like Chesapeake, making the recent plunge in Cabot attractive. The growth potential remains intact and the infrastructure issues will be resolved long term.
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