Peyto gets ahead of skyrocketing energy costs

Share

Worried that rising natural gas prices will drive up demand for talent and equipment this summer, natural gas darling Peyto Exploration and Development Corp. adopted an unconventional approach to its drilling strategy.

Instead of all but shutting down its drilling rigs during the spring breakup, when the ground starts to thaw and the ensuing mud can become a nightmare to work in, Peyto kept most of its operations up and running, betting that dealing with the mud would be less expensive and time-consuming than competing for labour in a bull market.

With natural gas prices soaring, now hovering around $4.50 per thousand cubic feet after plummeting under $2 per mcf, Peyto worries that rivals will ramp up their drilling as soon as the spring breakup subsides, sending costs through the roof across the industry.

If drilling activity spikes, "I fully expect that it's going to strain the returns," chief executive officer Darren Gee said last week, adding that it doesn't make sense to drill when the company doesn't get a decent return.

Not only does human capital cost more when the industry is buzzing, "but we also see experience levels in the industry go down, because the service industry has to expand and hire a bunch of new people," Mr. Gee said. "They've got to train those people. There's a lack of experience in the industry. Mistakes get made. Those mistakes cost us at the end of the day. That's the type of thing that really starts to factor in when the industry starts to pick up its activity in a big way."

To get ahead, Peyto decided to keep seven of its nine rigs running through the breakup, and wants its last two back in full operation by early June.

The decision has analysts wondering whether Peyto is onto something, especially considering the problems soaring capital costs have created in the boom times of years past.

"Ordinarily, not much newsworthy happens during spring breakup in the oilpatch," Raymond James analyst Andrew Bradford wrote in a note to clients. "Rig counts taper; there isn't much to discern from pricing signals because of low equipment utilization; and the return to activity is as much dependent on how producers structure capital plans around anticipated weather patterns as the actual weather itself. There simply isn't a great deal of useful information out of the oilpatch that tells investors how the industry is tracking."

But Peyto's contrarian strategy – to keep drilling through the spring, and then curtail their capital spending if costs soar during the summer – "sounds fairly wise from our perspective."

"Given the information available to us today, it seems likely to us that pricing on higher-performance drilling rigs and pumping services will move higher by late summer/early fall, consistent with Peyto's thinking on the matter," Mr. Bradford wrote.

Ultimately Peyto could be proven wrong, especially if natural gas prices fall because the summer is rather cool. But it's still interesting nonetheless to see a company take on such a contrarian strategy.