Swift Energy, Forest Oil Corp. and Noble Energy Inc. are among producers that could use some lower-exploitation-cost, longer-life reserves, according to an analysis done by Shannon Nome, Houston-based E&P analyst for JPMorgan, and her colleagues. In a position to share some of this type of reserves are Occidental Petroleum, Quicksilver Resources Inc. and XTO Energy, Nome says. She and her fellow research-team members have developed an "asset intensity" measure to evaluate E&P companies with the most potential for growth. "For E&P companies, having an extensive portfolio of exploration and development projects to drill is only half the growth equation: also important is the extent to which the existing production base is declining, and the cost at which that production can be replaced," she says. The new yardstick is "perhaps the single-most-important E&P performance metric when it comes to separating the future winners from the losers," she adds. And, "not only does asset intensity make sense in terms of understanding the trade-offs implicit in varying reserve lives, but more importantly, it has also correlated well with stock-price performance during the past two to three years." She expects longer-reserve-life companies such as Occidental, Quicksilver and XTO Energy to lead the group of winners. Meanwhile, Swift Energy, Forest Oil and Noble Energy could improve their profiles if they can lower their finding costs, she adds. Occidental and Quicksilver are among turn-around stories, along with Pioneer Natural Resources Co. and Burlington Resources Inc., she adds. These companies' asset intensity is most improved from their 1998 profile. Meanwhile, steady performers through the years have been Apache Corp. and XTO Energy. "By no coincidence, these six companies have enjoyed group-leading share-price appreciation during the past 12 to 24 months." Anadarko Petroleum Corp. and Newfield Exploration Co. are also at the bottom of the asset-intensity ranking, with Swift, Forest and Noble. Nome says Noble and Newfield are most likely to be able to reduce finding costs during the next two to three years, thus improving their asset intensity. Generally, longer-reserve-life companies fare better in the asset-intensity test, she says. "...There is a slimmer margin for error-that is, less ability to absorb drilling 'dry spells,' or periods of reduced drilling investment-when a company must fight a 35%-plus intrinsic decline rate each year." Some companies with assets that have quick decline rates "have to add new assets that are yielding initial production at a rate faster than its base is declining. This is easy enough to do in a given year, except that adding faster-decline production has the effect of 'turning up the treadmill' over time." That's tough to do year after year. Producers with more asset intensity tend to be valued higher by the equity market. "As we firm up out-year estimates for the companies under coverage over the next several months, we will be looking hard at asset intensity as a key performance metric into 2005 and beyond. In fact, we plan to base many of our future ratings revisions upon updated assessments of the companies' asset intensity," she says. She and her colleagues conclude that "the ideal E&P company would have the shortest possible reserve life-so as to maximize rates of return and the net present value of the asset base-along with infinite growth sustainability via an endless drilling inventory of low-risk, high-impact prospects." For all other E&P companies, the answer is a more gently declining base. -Nissa Darbonne
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