Drilling for Cash, Not Oil and Gas (PXP, OXY, CHK)

This morning Plains Exploration (NYSE:PXP) announced the sale of its oil and gas properties in the Permian and Piceance Basins for $1.25 billion to Occidental Petroleum (NYSE:OXY). This sale highlights two of the main difficulties facing mid- and small-cap energy firms.

First, of course, is access to cash, either through borrowing or equityissues. Plains makes it clear that reducing its debt is a significantreason for this sale. The announcement notes that this sale will reducethe company’s debt by "at least $1 billion", about half it’soutstanding long-term debt on June 30th. The company had also plannedto invest $1.35 billion in capex in these properties, and now theydon’t have to do that either.

It isn’t clear whether or not Plains could have raised cash byborrowing or a stock issue, but the company obviously decided not totake the risk. Its long-term debt-to-cap ratio was about 50%, and itsshare price was much closer to its 52-week low than to its high.Issuing new stock would only have diluted its share price further.

The second problem that this sale solves for Plains is dealing withwhat it calls the "challenging differentials" in wellhead prices fornatural gas. Natural gas from the Piceance Basin of western Coloradosells at a steep discount to natural gas from the Gulf or the shaledeposits of Texas and Arkansas. In fact, some wells in the West arebeing shut-in because the sales price of the gas doesn’t cover theoperating cost of the wells.

In its announcement, Plains says it will focus on its 20% investment inChesapeake’s (NYSE:CHK) 550,000 acres in the Haynesville Shale. Thecompany expects higher wellhead prices and much longer-lived productionfrom its estimated 8 trillion cubic feet of un-risked potential inHaynesville. The assets sold to Oxy have produced 13,000 barrels of oilequivalent per day, and total about 92 million barrels of provedreserves. The acquisition cost to Oxy was about $13.50/barrel.

In an economy that could afford to carry the risk, Plains wouldprobably have held onto the assets it sold today. Oxy can afford tohold them, but Plains can’t. Plains took advantage of a similarweakness at Chesapeake last July when it bought its share of theHaynesville play. Cash is once again king.

Paul Ausick
September 25, 2008