The Rising Influence of Rising Affluence

[DewDiligence]

Since wsj.com is a subscription website, I posted the full article.

›Gas Drillers' Painful Growth Paradox

By LIAM DENNING
SEPTEMBER 25, 2009

Growing, growing, gone? America's oil and gas exploration-and-production industry faces a shakeout.

The E&P sector is addicted to high growth. That is expensive: E&P capital expenditure has outstripped cash flow pretty consistently over the past decade, estimates James Murchie, founder of Energy Income Partners LLC. In contrast, Exxon Mobil, consistent winner in terms of return on capital, has reinvested just 41% in that time.

In turn, E&P capex leaves little for dividends and buybacks, meaning investors demand more growth, meaning ... you get the idea. The model works when commodity prices are rising and capital is plentiful. But the price of natural gas -- the fuel that constitutes more than two-thirds of the sector's reserves and production -- has slumped on oversupply. That is what happens when every company needs superior growth rates.

Bob Gillon of consultancy IHS Herold points to a structural disadvantage as well. E&P companies' appetite for growth, especially when energy prices are rising, leaves them "having the most amount of money to spend when costs are the highest; the least to spend when costs are the lowest."

A growing realization of the challenge should curtail access to capital. Bank credit lines, predicated on the value of reserves, are being renegotiated.

Consolidation, resisted at the trough of the market, also should pick up. That would help in an industry where the largest company accounts for only 3% of production. That is one reason why U.S. natural gas is so cheap compared with OPEC-influenced oil.

Larger, better-capitalized companies would be better placed to develop America's vast gas reserves without relying on an intravenous drip of capital to fund it. Investors, in turn, could look forward to more sustainable rewards.‹