Sunday, December 28, 2008

St. Mary Land & Exploration Cutting Back Capex Budget

It's an oft-repeated story, but St. Mary Land & Exploration announced last week that it has scaled back its capital expense budget for 2009. By the end of January 2009 it will idle six drilling rigs and keep nine working, focusing on the Haynesville, Eagleford and Marcellus plays. Their expectation is that things will be tight for the first half of the year but if they generate a suitable amount of cash flow they will expand their capital expenditures during the second half of the year.

In its press release, St. Mary focuses on the concept of being flexible. This is has also been repeated by many other E&P companies that are slashing capital budgets. It's another way of saying, "We have no freakin' idea what is going on with oil and gas commodity prices, but when prices go up we'll start drilling like crazy again." It's the way of the industry - they are slaves to commodity prices. It's hard to be proactive in an environment where you can't borrow money, you can't sell your product for much of a profit and a bunch of hedge funds are shorting your stock as commodity prices drop. You just have to hold on for dear life.

Announcements of capital budget reductions have been coming out so often that it's hard to follow. Chesapeake has already lowered its capital budget four times since mid-summer. One thing to remember, however, is that the companies that did lots of leasing over the past year have only three to five years (depending on the lease terms) to drill before losing the leases. Given the fact that many of the leases are small, that's lots of potential drilling sites. Don't forget also that drilling rigs (both the equipment and personnel) are a constraining resource. Once things stabilize with commodity prices and the capital markets, I believe there will be a rush to restart drilling. When those two factors occur, however, I have no idea.

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