Energy Company Downgrades Hit E&P Companies (RRC, SWN, DVN)

News from the energy patch just keeps getting worse. Global consumption is down, consumer prices are down, and just about every company is reducing spending on exploration and production. This morning a Deutsche Bank analyst rubbed a little more salt into the wounds, cutting Range Resources Corp. (NYSE:RRC), Southwestern Energy Co. (NYSE:SWN), and Devon Energy Corporation (NYSE:DVN).  These were formal ratings downgrades where the companies were cut from ‘buy’ to ‘hold’.

Last quarter Range Resources reported net income of $285 million, anincrease of 384% from the same quarter in 2007. A miracle? No, anon-cash revenue from derivatives of $299 million. It’s also true thatthe company increased its production to 388 million cubic feetequivalent/day, on its way to an planned 400 million cubic feetequivalent/day for the current quarter. But natural gas prices keepfalling, so producing more just doesn’t look like a winning strategy.

The company’s cash position is not all that attractive either: At theend of last quarter, the company had less than $60 million in cash andinvestments, and almost $1.2 billion in long-term debt. Falling priceswon’t cure that.

As for Southwestern, it didn’t get a similar bump from its derivatives,but it did sell $240 million worth of properties, some $220 million ofwhich was booked in the third quarter. Southwestern also sold its lastlocal distribution company in July and booked a pre-tax gain of $57.3million on that sale in the third quarter. The company’s net income forthe quarter was about $218 million, up 328% from the previous year.

Southwestern’s production was also way up in the third quarter onhigher volume and higher prices. But natural gas and crude oil priceshave been dropping, and Southwestern’s cash position shows about $67million in cash and short-term investments against about $992 millionin long-term debt.

The downgrade to Devon Energy shares again reflects today’s realitythat good operational performance and substantial assets don’t countfor as much as the volatile price of crude. Crude prices have jumpednearly $3.50 this morning, raising Devon’s shares nearly 2% in earlytrading. When crude prices drop again, so will Devon’s share price.

The price rise in crude results from expectations that OPEC will cutproduction by another 2 million b/d. That will push prices up, butprobably not for long. If OPEC tries to move prices up to July levels,the cartel simply contributes to the deflationary pressure on theglobal economy, which leads to lower prices. Then the weakest OPECmembers, like Iran and Venezuela, can only suffer domestic troubles orpump more oil at lower prices. Either way it’s a losing strategy.

As we’ve noted elsewhere this morning, a crude price increase to around $70/b lets exporters make a profit without holding a gun to consumers’ heads.

Paul Ausick
December 15, 2008