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Credit crunch not over for gas

Some gas companies are struggling to raise finance, others are using innovative means to secure investment, while the Chinese just carry on spending, writes NJ Watson

CHINA NATIONAL Petroleum Corporation raised a $30bn loan last month for acquisitions, indicating financing is available despite the recession and low natural gas prices. But funding mostly remains the preserve of larger players. For smaller companies, access to energy financing remains worryingly tight.

Oil prices have doubled since February, but the gas market is still depressed. With industrial production around the world slowing to a virtual standstill, the US Energy Information Administration (EIA) expects domestic gas consumption in 2009 to fall by 2.4% from 2008. Gas prices fell to seven-year lows in September – below $3/m Btu and down by almost 80% from last summer's high.

Lower prices have forced companies to reduce exploration activity; there has been a sharp decline in the gas rig count, to 775 from a high of 1,585 in September 2008. Despite this, production rose slightly between January and June, according to the EIA – as a result of technological advances and shale-gas developments. This year, output is expected to be almost 1% above the 2008 level.

With cargoes of liquefied natural gas (LNG) being diverted from recession-hit Europe to the US, production marginally higher and domestic demand down, there is a gas glut in North America and storage levels are at historically high levels.

Have prices hit the bottom?

Although some analysts claim the gas market contango (when futures prices are greater than spot prices) suggests prices have bottomed out, others say they may have further to fall – an unpalatable prospect for all producers, but especially small companies struggling to raise the cash they need to stay in business. "Prices don't reflect a view that the market bottom in natural gas has been reached," says Philip Weiss, an analyst at Argus Research.

Access to finance is not a new problem: the credit crunch began in 2008. But many companies had built up cash reserves during the price boom that preceded the recession, using these to finance their operations as credit markets tightened. Companies have adopted a range of approaches to the shortage of funds. Some have farmed out a share of their assets: faced with limited capital and rising debt, Chesapeake Energy sold down interests in three of its four main onshore shale-gas areas, netting about $4bn in cash and $4.6bn in drilling commitments. It also introduced a system of volume production payments, selling a portion of future output from mature conventional properties.

Others have simply sold their shares in assets to larger companies in better financial health. "Well-capitalised larger players are potential funding partners or, in some cases, simply acquirers of junior companies' working interests," says Jon Clark of Ernst & Young's oil and gas transaction advisory services team. The recent deal for Breagh, a UK North Sea gasfield, is an example of both outcomes, with some companies selling their entire stake in the asset to RWE and Sterling Resources selling just part of its stake and continuing to work alongside the German firm. Completed in August, the transaction leaves RWE with a 70% share and Sterling with 30%.

Such deals have been instrumental in keeping some companies in business. But despite the difficult circumstances, the markets began to show some signs of life in the second quarter. According to Ernst & Young's most recent Oil and Gas Eye, a report on energy companies listed on London's Alternative Investment Market, the second quarter saw secondary share offerings worth a total of £281m ($466m) – a steep rise from the £25m raised in the first quarter and the highest level since fourth-quarter 2007.

"We've seen challenging times for financing in the junior oil and gas sector over the past 12 months, particularly for those without existing production ... [but] there is some evidence of equity investors and potential lenders returning," says Clark.

For example, Aurelian Oil and Gas, focused on several emerging European countries, raised £11.6m in June, while Volga Gas, which explores in Russia, raised about £16.6m, also in June, from a secondary share offering.

For many others, however, bankruptcy or forced mergers look like the only options available. In September, Canadian gas explorer Trident Resources filed for Chapter 11 bankruptcy protection in the US, citing the drop in gas prices and exchange-rate fluctuations between Canada and the US. A week earlier, BJ Services, which specialises in unconventional gas technology, agreed to merge with Baker Hughes in a cash-and-stock deal worth $5.5bn.

Further consolidation is likely, says Andy Brogan, an analyst at Ernst & Young. "Market turmoil has opened up new acquisition opportunities for cash-rich players, particularly in countries perceived as high risk, where valuations have fallen the furthest."

But high-risk countries, even those with considerable oil and gas potential, are struggling to attract traditional financing. In September, Hungary's Mol – unable to source capital from anywhere else – was forced to sell $3.57m of treasury shares to help finance a gas project in Kurdistan, Iraq. In addition, many bankers view Russia – with its questionable commitment to respecting property rights – as a high-risk place to fund projects.

Gazprom is struggling to raise the $1bn or more it needs to purchase the Kovykta gasfield from TNK-BP, a deal agreed in 2007. And the company's Shtokman project, in the Barents Sea is also in trouble. Last month, deputy chairman Alexander Medvedev said Gazprom might delay the launch of the gasfield beyond 2013 should demand in Europe not recover fast enough.

The cost of credit is also on the rise. In early September, for example, Standard & Poor's lowered its credit rating on Shell by a notch to AA and its ratings outlooks on Eni and Total, a Shtokman partner, to negative from stable. "A lot of that goes back to lower oil prices during 2009 and record low gas prices," says John Martin, managing director of the oil and gas strategic client coverage group at Standard Chartered Bank.

These big LNG players are now struggling to cut costs while maintaining investment sufficiently to profit from a future upturn in demand. "They're going through a difficult time trying to manage the cutbacks without damaging their business in the long term," says Martin.

Indeed, larger companies are sticking to their commitment to invest through the downturn. Last month, Chevron said it would proceed with the Gorgon LNG project (see p27). A large part of Gorgon's output has been pre-sold to Chinese companies, which have access to plenty of funding – up to $2 trillion according to some estimates – and are likely to continue to make asset acquisitions and support demand for gas and oil.

While Western governments may resist outright take-overs of energy firms by Chinese state-owned companies, they are unlikely to try to stop them taking minority shares in projects. Australia is one target market, says Martin. But he adds that any project with funding shortages or any project that could provide physical supply to China will be targets for the country.


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