Wall Street watches as BHP, Southwestern deals impact Fayetteville Shale Play

As BHP Billiton begins the difficult job of marketing its Fayetteville Shale assets, a top Wall Street analyst says prospective suitors will definitely have an advantage in negotiations with the Australian industrial giant – especially in the current low-price environment for natural gas.

Fadel Gheit, one of the nation’s top-rated oil and gas analyst, made his observations to Talk Business & Politics on Tuesday, one day after BHP Billiton CEO Andrew Mackenzie said in an investor presentation that the Sydney-based conglomerate would divest the Arkansas shale play “if it maximizes value for shareholders.”

However, Mackenzie did not elaborate on what price shareholders expect from the mature dry gas development in central Arkansas. BHP Billiton Petroleum, a wholly owned subsidiary of BHP Billiton Limited, paid $4.75 billion in cash in early 2011 to purchase nearly 487,000 net acres of leasehold and producing natural gas properties from Chesapeake Energy Corp.

The influential Wall Street oil and gas analysts at Oppenheimer & Co., said now that BHP has publicly announced its intent to sell the Arkansas properties after only 3-1/2 years in the play, “there is (likely) also a buyer at a certain price.”

“Given the low current and future gas prices, it would be a buyer’s market,” said Gheit, who is managing director and senior oil and gas analyst at the Wall Street investment house in New York City. “The Fayetteville (Shale) is a low cost dry gas, which has low risk, low cost and low price. It can still be profitable, but at low margin and return.”

At the same time, several oil and gas analysts have recently noted that the Arkansas shale play is likely reaching maturity, even though Fayetteville Shale leader Southwestern Energy Co. said last week that it topped its highest production ever in Arkansas play in the third quarter and also logged the 10 straight quarter of positive cash flow.

“We placed a total of 106 wells online at an average initial production rate of roughly 4.3 million cubic feet of gas per day,” Southwestern COO Bill Way told analysts during a recent conference call. “Two of them are in the top ten ever drilled at over 10 million (dollars) a day each.”

What also came out of Southwestern’s third quarter conference call with analysts is that the driller is quietly shifting a larger share of its production from the lower section to the upper end of the Arkansas development. In the Upper Fayetteville formation, Way said Southwestern has placed 15 wells online through the first nine months of 2014, with an average production rate of 3.4 million cubic feet a day. Three of the new wells had an average initial production rate of over 5 million cubic feet of gas per day, with the highest well touching 6.6 million cubic feet of gas per day.

“We plan to drill five additional Upper Fayetteville wells in the fourth quarter and complete them in early 2015,” Way predicted. “While it's early, we estimate that the Upper Fayetteville may span over 130,000 acres or 1,000 wells.”

The other factor that may have a major effect on the company’s capital budget and production in the Fayetteville Shale is Southwestern’s announcement on Oct. 16 that it agreed to purchase natural gas and petroleum liquids assets in the Marcellus and Utica shale plays for $5.4 billion. The seller in that deal was also Oklahoma City-based Chesapeake Energy, formerly the nation’s largest oil and gas driller that sold its holdings in the Fayetteville Shale to BHP three years ago for about the same price.

Although Southwestern has said it intends to continue making major investments in both shale plays, Wall Street analysts and investors are watching to see what actually happens. In the past week, at least five analysts covering the Fayetteville Shale leader have upgraded the company’s shares and given the driller’s stock a “buy” rating. Still, other Wall Street firms like Morgan Stanley and Credit Suisse have downgraded the company’s stock based on mixed ratings from the Marcellus deal.

“While we applaud SWN management for making a bold acquisition that plays to the company's core strength …, we believe it comes at too high of a purchase price as the transaction looks meaningfully dilutive to our net asset value and cash flow forecasts,” said Credit Suisse analyst Arun Jayaram said in a recent research note, while lowering Southwestern one-year price target from $41 to $36 per share.

“Given rapidly deteriorating natural gas fundamentals, we believe SWN shares are poised to lag its peers, particularly with an equity overhang looming,” Jayaram said on Oct. 23.

Analysts also say natural gas prices will play a big role in fortune of pure-play natural gas drillers like Southwestern. BHP’s McKenzie noted on Monday that the company is shifting most of its capital investment in the U.S. to wet liquid plays to seek better returns with higher crude oil prices.

Gheit concluded that natural gas prices will affect how successful the near-term production in the Fayetteville Shale will be, and how high potential buyers are willing to bid for BHP’s assets in Central Arkansas play.

“Oil and gas future suggest flat prices in the next three to five years,” the Wall Street analyst predicted.