Cabot Oil & Gas Profits From Low-Cost Marcellus Shale

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Forget about low natural gas prices.Cabot Oil & Gas ( COG ) has location on its side.

It works the most prolific shale gas region in the U.S., the Marcellus, near densely populated East Coast markets where demand for fuel is high.

And within that vast region, which spans multiple states, Cabot has secured 200,000 net acres in the "sweet spot" of Susquehanna County in northeast Pennsylvania, says Matt Portillo, director of exploration and production research at Tudor Pickering.


"Cabot owns one of the lowest, if not the lowest, cost dry gas plays in the U.S," he said. "Cabot's wells are wildly economic."

Low gas prices aren't a problem for a company that can start making money on its output when natural gas prices are as low as $1.50 to $2 per million cubic feet. Prices are now around $4, still relatively low but up from last year's even lower lows of $2 to $3.

Sustainable Free Cash Flow

"Marcellus economics rival most oil plays even at low gas prices," noted Jefferies & Co. analyst Biju Perincheril in a recent report on Cabot titled, "Promised Land: Free Cash Flow From Shale Development."

"Sustainable free cash flow is one of the ultimate goals of shale development, and Cabot is one of the first companies to reach it," Perincheril wrote. "The company will soon have to wrestle with the novel question of what to do with all that cash."

How much cash? In the first quarter alone, Houston-based Cabot generated $212.7 million in cash flow from operations.

Jefferies & Co. estimates Cabot will have a cash flow surplus of $60 million in 2013 and at least $300 million in 2014, based on a $3.60 to $4.00 gas price and $1.1 billion to $1.2 billion in capital spending.

Portillo expects gas prices to stay range bound between $4 and $4.50 through 2015 as the number of gas rigs rises because of higher prices fetched this year and as coal takes back market share lost when natural gas prices fell below $3.

Management didn't respond to a request for an interview. But it's indicated that higher investments in the Marcellus would be the most likely use of free cash flow. Other options include a dividend hike and share buybacks.

Another option would be further investments in infrastructure, something akin to the Constitution Pipeline, in partnership withWilliams Partners ( WPZ ), set to go into service in March 2015.

The pipeline will be capable of moving 500,000 cubic feet of gas per day from Marcellus fields in northeast Pennsylvania to markets in New York and New England.

Takeaway capacity is one of the biggest constraints to production growth. Even so, Cabot expects production to grow 35% to 50% this year.

"As additional infrastructure projects throughout our Marcellus position come online during the year, it will afford us further increases in production," CEO Dan Dinges stated in the firm's first-quarter report.

Cabot says it plans to spend around $1 billion in capital improvements in 2013.

Perincheril calls Cabot "a high-growth company with a top-notch position in the Marcellus."

The company's southern U.S. oil projects such as the Marmaton in Oklahoma and Eagle Ford in Texas are "still side shows," he noted.

Those smaller oil plays "will struggle to compete for capital in the organization and to capture the attention of investors given the much larger scope and the outsized returns of the Marcellus," he said.

Investors have already run up Cabot's stock, with shares more than doubling in the last year. Though they fell 1% Thursday,they're still up over 46% this year.

Cabot has cornered 15% of the total supply in the Marcellus, making it one of the region's biggest players, along withRange Resources ( RRC ), a liquids producer;Chesapeake Energy ( CHK ),EQT Corp. ( EQT ),Southwestern Energy (SWN) andTalisman Energy (TLM), Portillo says.

With a sixth rig Cabot expects to bring into the Marcellus in early fall, wells drilled per year could rise from around 85 to 100, Perincheril estimates.

Seven-Fold Increase

Through hydraulic fracturing methods, gas production in the Marcellus has soared almost sevenfold since 2009, going from 1 billion cubic feet per well a day to 7 billion currently, Portillo says.

Cabot generally spends $6.5 million to drill and complete one well, he says. That well will produce reserves of about 14 Bcf, at the high end for the Marcellus, which starts at 4 Bcf per well for the dry gas.

In contrast, some of the legacy fields that initially drove the shale revolution in the U.S., such as the Barnett in Texas, produce 1 to 3 Bcfs per well, Portillo adds.

Cabot's production in the Marcellus has grown quickly, with the first quarter setting an all-time record of 89.3 Bcf equivalent, up 50% from last year.

Dinges noted that per-unit costs were down 15% over last year's same quarter.

Earnings in the quarter rose 90% to $54.2 million, or 26 cents a share. It was the third straight quarter of double-digit profit growth.

Analysts expect full-year profit to grow 129% over last year to $1.51 a share, and go up another 72% next year.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: CHK , COG , EQT , RRC , WPZ

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