A natural gas market with intense competition and possible oversupply will not deter Cabot Oil & Gas (ticker: COG) from increasing production volumes by 20% to 30% in 2015, the company said on Friday. Cabot, the second largest producer in the Marcellus Shale, increased production by 3.7% on a quarter-over-quarter basis in its Q3’14 earnings release. The volume is a 24% spike compared to volumes from Q3’13.
Cabot versus a Difficult Market
“Even during a period when we experienced lower natural gas price realizations and some unplanned production downtime, we were still able to provide top tier growth in production and cash flows while generating top tier returns, which is a testament to the quality of our assets and our operations,” said Dan Dinges, Chairman, President and Chief Executive Officer of Cabot in a conference call following the release.
The company removed one rig from its Marcellus region and the future rate of development will depend largely on market conditions, management said. Nine rigs are currently in operation, with five in the Marcellus and four in the Eagle Ford.
Despite the recent bear market, COG said the company is still realizing 50% returns with oil prices at $80. On a base case of $2.80/Mcf and $88/barrel, typical returns in the Marcellus and Eagle Ford are 80% and 60%, respectively.
Pipeline Access on the Way
Management expressed excitement regarding the approval of Constitution pipeline – news that reached the wire just hours before Cabot’s conference call. Now that the Federal Energy Regulatory Commission has green-lighted the project, COG believes construction could start as early as Q1’15 with the pipeline becoming operational as early as the end of 2015.
“We believe we are going to get 0.5 Bcf of our gas to a different price point, and that price point has historically been better than the general market,” said Dinges.
The addition of Constitution is the most impactful near-term inflection point for Cabot, but even more projects are on the way. “There are numerous projects that affect us both directly and indirectly and will certainly expand takeaway during 2015, 2016 and 2017,” said Jeffrey Hutton, Senior Vice President of Marketing. The Rose Run and Columbia East Side pipelines were singled out as future contributors, and the Leidy Southeast line was defined as a project of particular importance to Cabot. The Atlantic Sunrise pipeline, expected by 2017, will provide $850,000 in daily takeaway capacity.
“All in all, it’s shaping up,” said Hutton. “We’re thrilled about Constitution’s step forward, but there will always be additional capacity on the horizon.”
Eagle Ford Update
Cabot’s main focus area has always been the Marcellus, but the company is dialing up its presence in the Eagle Ford. COG acquired 30,000 acres in September to bolster its Buckhorn area, which now consists of 60,000 acres. The first Buckhorn well is expected to be placed online before the end of the fiscal year.
Ten wells outside of the Buckhorn area were placed online in the quarter, returning an average 30-day production rate of 751 BOEPD (91% oil). The company is actively testing 300-foot downspaced wells and two pilots returned a cumulative total of 230 MBOPD in the first six months of production. If the full downspacing test is successful, the company believes its drilling inventory will exceed 1,000 locations.
Q3’14 Eagle Ford production was 10.3 MBOPD. The company does not plan on restricting production any time soon, saying spot prices would have to fall below $70 in order to consider adjusting the program.
The Eagle Ford is expected to receive 46% of Cabot’s 2015 capital budget, which is slated at $1.53 billion to $1.60 billion. The Marcellus will command 52% of the budget. Overall, Cabot expects to drill 180 to 190 net wells in 2015 (80 to 85 in the Eagle Ford).
“The addition of this high margin production should help us offset some of the lost margins we are seeing from our natural gas sales in the current price environment,” concluded Dinges.
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Analyst Commentary
KLR Group (10.24.14)
Investment thesis
We are increasing our target price $4 to $47 per share driven by greater Eagle Ford execution. Our ’15 production growth expectation of ~26% is slightly above the midpoint of company guidance (20%-30%). Our ’15 liquids production expectation of ~19 Mbpd is at the midpoint of guidance (18-20 Mbpd).
Eagle Ford returns modestly exceed Marcellus with divergence in oil and gas price realizations
Marcellus wells average ~20 Mmcfpd the first 30 days and should recover 15-20 Bcfe for a cost of ~$7 million per well (~50% IRR). Eagle Ford wells should recover ~575 Mboe per well for a cost of ~$7 million (~60% IRR). Cabot is conducting a four-rig program and plans to drill 80-85 net Eagle Ford wells next year. Development is primarily in the ~60,000 net-acre Buckhorn area. The company has ~1,000 drilling locations on 40-acre spacing or ~12 years of drilling inventory. Approximately 50% of expected ’15 capital spending is allocated to the Eagle Ford.
Recent complementary Eagle Ford oil window acquisition
Cabot recently announced the acquisition of ~30,000 net acres in the Eagle Ford for ~$210 million in cash, which includes ~17,000 net acres near the company’s Buckhorn area. Current production associated with the properties is ~1,600 Boepd (~90% liquids). The company added a fourth rig to its Eagle Ford development program.
Superior capital productivity evident in ability to achieve competitive production/CFPS growth at cash generation
An illustration of COG’s differential capital productivity is its ability to achieve competitive production/CFPS growth (’14E-’16E), while spending in line with cash generation, as Marcellus peers spend ~40% beyond cash generation.
Outstanding capital yield (cash-on-cash recycle ratio)
Given the industry’s lowest capital intensity, Cabot should generate a ’15 capital yield of ~160% ($4 NYMEX gas) versus the industry median ~120%.
Gross Marcellus production should double by ’19
Cabot’s current gross Marcellus production of ~1,700 Mmcfpd should increase to ~2,000 Mmcfpd in late ’15 and subsequently increase almost 400 Mmcfpd per annum to ~3,400 Mmcfpd in ’19. Marcellus takeaway should increase to ~2,500 Mmcfpd in early ’16 with the commencement of Constitution pipeline (Iroquois Zone 2/Tennessee 200 interconnects). Further, COG has secured ~850 Mmcfpd of takeaway on Atlantic Sunrise commencing in 2H/17. By ’18, Cabot should have ~3,400 Mmcfpd of gross Marcellus take away capacity.
