Last week, Cabot Oil & Gas (NYSE:COG) reported solid fourth-quarter and full-year 2013 results, fueled by stellar operating performance in the Marcellus shale that saw companywide production surge to record levels. Let's take a closer look at two important takeaways from the company's performance.
Marcellus performance continues to improve
Cabot reported fourth-quarter net income of $77.9 million, or $0.19 per share, up from $40.9 million, or $0.10 per share, a year earlier, and full-year net income of $279.8 million, or $0.67 per share, up 115% over the previous year. Meanwhile, operating cash flow jumped 57% to a record $1.025 billion, as production surged 55% to a record 413.6 billion cubic feet equivalent (Bcfe).
One of the things that really impressed me about Cabot's performance last year was that it managed to once again significantly improve Marcellus EURs, while simultaneously decreasing Marcellus cash unit costs. The company's average EUR per Marcellus well in 2013 was 16.9 Bcfe, up 20% from 2012 and more than three times the average EUR of 5.0 Bcfe in 2008.
The sharp improvement in average EURs was due primarily to the company's use of longer laterals. This year, Cabot plants to drill even longer average laterals, which should lead to further improvements in EURs. Meanwhile, Cabot's fourth-quarter Marcellus cash unit costs fell 10% year over year to $0.76 per Mcf, while companywide cash unit costs for the year plunged by an even more impressive 26% to $1.28 per million cubic feet equivalent (Mcfe).
As a result, Cabot's returns have improved dramatically. The company estimates that its pre-tax returns now exceed 100% at a wellhead gas price of just $3.00 per MMBtu, up by a staggering 70% over 2012 levels. By comparison, Range Resources (NYSE:RRC), another low-cost Marcellus operator, requires a gas price of $4 per MMBtu to generate similar returns of 96%-106%, while Chesapeake Energy's (NYSE: CHK) northern Marcellus wells earn a 117% rate of return at a gas price of $4 per MMBtu.
Marcellus price differentials remain a challenge
The one weak point from Cabot's Marcellus performance, however, was lower-than-expected natural gas price realizations. Despite the surge in gas prices over the past few months, Cabot's fourth-quarter natural gas price realizations were only $3.44 per Mcf, which is actually 12% lower than the fourth quarter of 2012, when average gas prices were much lower.
The main reason for this was a massive oversupply of natural gas in the Marcellus, which led to sharply wider price differentials. While the markets reacted unfavorably to the lower-than-expected realized prices, sending shares of Cabot down 8% in Friday's trading session, I think price differentials should gradually narrow with time as Marcellus takeaway capacity improves with the addition of new pipelines.
Cabot recently made a big move to secure additional takeaway capacity by executing a binding agreement with the Williams Companies' (NYSE:WMB) Transcontinental Gas Pipe Line Company, LLC (Transco) for a new pipeline from Cabot's Marcellus operations in Susquehanna County, Pennsylvania. Combined with its recently announced long-term sales agreement with Sumitomo for delivery to the Cove Point LNG export terminal, the agreement gives Cabot a total of 850,000 MMBtu per day of firm capacity on Transco's Atlantic Sunrise expansion project.
Major expansion projects along the other two pipelines that transport the majority of Cabot's production -- Kinder Morgan's (NYSE:KMI) Tennessee Gas Pipeline 300 Line and the Millennium Gas Pipeline -- and the addition of the Iroquois Pipeline and the TransCanada (NYSE:TRP) Pipeline via Iroquois over the next few years should also allow Cabot to further increase its takeaway capacity from the Marcellus.
The bottom line
Despite strong competition from the likes of Range Resources and Chesapeake, Cabot has emerged as one of the lowest-cost and most capable operators in the Marcellus, demonstrating continuous year-over-year improvement in IP rates and EURs. Given the exceptional economics of its Marcellus drilling program and its deep inventory of approximately 3,000 remaining drilling locations, Cabot should be able to deliver outstanding growth in production, earnings, and cash flow for years to come.