The past few years haven't been too kind to most natural gas producers. Gas prices have slumped sharply since 2010, reaching a low of slightly under $2 per Mcf in April 2012 and spending the majority of this year under $4 per Mcf -- a level at which many gas wells are unprofitable.
As a result, several energy producers have drastically curtailed gas drilling activity, choosing instead to focus on liquids-rich opportunities, which are more profitable in the current environment. Many are also focusing on improving efficiencies through pad drilling, which allows them to drill more wells using fewer rigs, and other cost-cutting techniques.
Let's take a closer look at three energy producers that are aggressively slashing costs and their motives for doing so.
Chesapeake Energy
Chesapeake (CHK +0.00%) is perhaps the most severe case of a company that spent freely and aggressively for years as it built up a massive shale portfolio, yet has recently slashed expenses as it seeks to unlock greater value from its existing asset base.
In the third quarter, it spent just $1.2 billion on drilling and completion activities, down $350 million from the second quarter, while production expenses and adjusted general and administrative expenses declined 10% and 12%, respectively, year over year. This year, the company's capital spending is estimated to be just $6.9 billion, less than half its capital expenditure of $13.4 billion last year.
In combination with asset sales and increased liquids production growth, Chesapeake hopes that its cost-cutting measures will allow the company to fund the majority of its drilling program through its operating cash flow. It is also opportunistically hedging a larger portion of its expected oil and gas production to provide greater cash flow reliability.
Encana
Like Chesapeake, Encana (ECA 2.33%) is making big changes to become a leaner, more disciplined energy producer. It recently announced plans to cut its workforce by 20%, close an office in Plano, Texas, and slash its quarterly dividend by about two-thirds, as part of a broader effort to rein in spending.
Next year, the company is aiming for just $2.5 billion in capital spending, down 30% from $3.5 billion in 2012 and almost half of its $4.6 billion capital spending in 2011. Roughly three-quarters of this capital budget will be directed toward five liquids-rich plays: Canada's Montney and Duvernay shales, Colorado's DJ Basin, New Mexico's San Juan Basin, and the Tuscaloosa Marine Shale in Louisiana and Mississippi, as part of Encana's strategy to diversify its commodity mix away from natural gas, which currently accounts for 90% of production.
Devon Energy
Lastly, Devon Energy (DVN 4.42%) is also making good progress in reducing capital spending and improving capital discipline, as it increasingly targets liquids-rich opportunities in North America, while drastically curtailing gas drilling activity. In the first nine months of this year, Devon posted $5.2 billion in capital spending, down from $6.2 billion during the same period last year. Roughly 90% of this money is being directed toward development activity, with the remainder going toward leasehold and exploration spending.
Devon also continues to improve capital efficiency as it optimizes its drilling program, with service and supply costs down 3% this year for its core Permian drilling program and drilling days in the Midland-Wolfcamp down more than 50% since 2012. This year, the company plans to devote roughly $1.6 billion of its expected $4.9 billion-$5.3 billion upstream capital budget to drilling more than 350 wells in the Permian.
The takeaway
Chesapeake and Devon are both good examples of energy companies that were once heavily concentrated in natural gas but have improved the share of liquids in their commodity mixes significantly over the past few years. Both are targeting double-digit liquids production growth, while simultaneously reducing capital spending, meaning capital efficiency will be the key to their success.
Encana, on the other hand, is still very much focused on natural gas, but is making a major effort to diversify its commodity mix, while also trimming its capital budget. This year, roughly three-quarters of its reduced capital budget will be directed toward liquids-rich plays.
