Out of aces? Here's some advice. "If you're gonna play the game,...you gotta learn to play it right," according to the sage gambler in the Don Schlitz song made famous by Kenny Rogers in 1978 that was during another oil-price boom, and the words hold true today. The aces in the new E&P game are North American prospects and proved undeveloped reserves. "Those who haven't set up a large drilling inventory are going to have to pony up [and buy]...If they don't, they're going to be out of business in a few years," Shannon Nome, a managing director and senior E&P analyst for JPMorgan, told producers at an IPAA/Tipro program in Houston recently. The face cards are existing production, which is delivering for strong cash flow. With this, producers who are low on potential for growth-or even sustainability-can raise the antes to buy what they need at the bidding table. Kerr-McGee Corp. took Westport Resources out of the game. EnCana Corp. took out Tom Brown. Apache Corp. flushed Anadarko Petroleum out of the shallow Gulf of Mexico. Noble Energy paid out Patina. Pioneer Natural Resources made Evergreen Resources an offer it couldn't refuse. XTO Energy and Chesapeake Energy continue to close a deal virtually every month. XTO's latest purchase is of Paul Rady's Barnett Shale start-up, Antero Resources. Rady had sold his Rockies gas-focused Pennaco Energy to Marathon Oil just a few years ago for approximately $450 million net of debt. His deal with XTO is valued at about $685 million and it involves a no-compete in which Rady and partners won't be involved in the Fort Worth Basin for two or three years but can work in other basins. But to just fold can be as hard an answer as continuing to play. Schlitz wrote, "Every hand's a winner and every hand's a loser." Therein lies every risk-taker's dilemma-deciding what to do after winning. Is it time to walk away or run? Time to hold or time to fold? If deciding higher prices will continue, "go out and buy something," say John S. Herold Inc. and Harrison Lovegrove & Co. analysts in their Global Upstream Performance Review 2004. "You'll gain control of operations and increase earnings in the short term while the exploration programs mature. Admittedly, asset prices are high now, but the acquired properties are strategic to the growth plan." Or, if deciding prices will trend down, "now is the time to divest assets, or even the company itself. Selling high-cost assets now avoids escalating costs as production further declines. Even noncore assets that are cheap to operate divert management attention from higher-reward assets in the portfolio." What about the next hand? Herold and Lovegrove say, "Keep the cash for a rainy day, and be ready to buy back in later in the cycle, when assets inevitably will be cheaper." But don't sit out, the firms' analysts add. The worst response is to do nothing. "Even with balance-sheet strength, selling some noncore assets while buyers are prepared to pay very high prices would be prudent." In effect, know what to throw away and know what to keep, according to Schlitz. The prospect-rich are holding the best hands today. Dan Pickering, president of independent-analysis firm Pickering Energy Partners Inc., said at the IPAA/Tipro program that 2004 was the first year in eight years when it was cheaper to drill for new assets than to buy them. "You may see some money shift from buying to drilling," he said. According to Herold and Harrison Lovegrove, it was generally cheaper to buy proved reserves than find and develop them in the 1999-2003 period. Their analysis of 2004 figures will be published later this year. Data from other sources, such as Randall & Dewey Inc., Waterous & Co. and IHS Energy, indicate that both means of booking more proved reserves were considerably more expensive in 2004. Using internal analysis, many producers have already decided their own odds, and are doing their asset buying and selling. -Nissa Darbonne, Executive Editor

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