Newfield Exploration Company (NFX)

TOP CONTRIBUTORS

Michael Francis

Newfield Exploration Company is in independent oil & gas production company that focuses on the acquisition and drilling of oil & gas producing properties. The company focuses primarily on natural gas acquisitions and drilling opportunities in the Anadarko and Arkoma basins of the mid-US, the Gulf Coast, Rocky Mountains, and Gulf of Mexico.^[1] NFX's strategy has been to move increasingly toward low-risk, low-potential natural gas drilling opportunities over time while keeping a small but not insignificant portfolio of higher-risk, higher-reward opportunities.^[2] Their onshore continental properties are generally lower risk and the company benefits from efficient use of drilling technology and operational management rather than from reaping the potential rewards of a risky play. Higher risk operations are generally the deepwater and off-coast properties such as those in the Gulf of Mexico.

The company is largely a natural gas producer as gas wells are around 73% of proved reserves and gas accounts for some 78% of production. Rising natural gas prices have been a particular boon to the company, and with this tailwind behind them the company continues to invest largely in the promising Woodford Shale (an area which they entered sooner than competitors), Monument Butte, and Mountain Front Wash plays in the mid-continent while dabbling in international and deepwater plays in Malaysia & China and the Gulf of Mexico, respectively.

Financial and Operating Metrics

Below are relevant operating data for the company. The company has benefited from increasing oil & gas prices, though between 2005 and 2006, the company experienced the effects of a lower average selling price of natural gas, which comprised the majority of its production.

As evidenced by the following chart, the company operated primarily in the low risk areas of the mid-continental US and Gulf Coast, though it also maintained higher-risk properties in the Gulf of Mexico and internationally.

Trends & Drivers

• Newfield got into the promising Woodford Shale earlier and at lower cost than many competitors. The Woodford Shale is widely believed to have gas-producing potential reminiscent of the Barnett Shale in Texas, which has proven one of the largest and most economically vital formations in the US. Newfield began obtaining Woodford leases before they met with significant demand, giving them a lower cost basis. If Woodford continues to play out as promised, this can juice returns for Newfield vis-a-vis competitors. Additionally, Newfield has been selling off higher risk operations and foreign properties in order to focus increasingly on lower-risk continental properties like Woodford. This should allow the company to leverage expertise in fewer areas and with lower geographical risk and lower risk of capital loss, and, potentially, greater economies of scale.

• Rising natural gas prices have been a major tailwind for Newfield. The company is highly dependent on favorable market prices for natural gas, which tend to fluctuate significantly over time, but have risen notably of late.^[5] Over the past few years, rapidly increasing demand for energy coupled with constrained supply has led to higher prices for natural gas. This has juiced returns for Newfield, while providing strong cash flow and favorable access to capital as creditors place significant weight on market prices of the company's production. Increases in the prices of oil and gas are not, however, without negative side effects. Because drilling for oil and gas becomes much more profitable when prices are on the rise, the company faces much stiffer competition for the acquisition of land or drilling rights to oil- and gas-rich properties. These properties' market values rise in proportion to the rise in the value of the commodities underneath them, which cuts into the company's possible return on investment and puts a damper on hope for rapid growth. A similar phenomenon can occur in buying or leasing drilling equipment, as prices are driven by eager competitors bidding them up in order to drill for the commodities.

• Hybrid and Alternative Energy Technology - Rising oil and natural gas prices and environmental consciousness have led both consumers and companies to seek out alternative sources of energy and to invest in renewable energy such as nuclear, solar, as wind technologies to heat homes and generate electricity. Global consumer demand can shift toward renewable energy sources in the long run and incentives to develop long-term solutions to the world's dependence on oil and gas become stronger due to recent environmental concerns over climate change, consumer consciousness and the entrepreneurial profit motive. And, to be sure, Congress is probably quite likely to incentive R&D and renewable energy usage through subsidies, target minimums, or other means over the next several years. While no massive legislation has taken effect, several bills have been proposed and Congress generally has renewable energy high on the to-do list.

• Deepwater Oil Exploration. Traditional oil producing basins have matured, particularly on land, and oil exploration and production companies have started to look for new reserves in more challenging, deep-water environments. The recent increases of oil and gas costs have enabled offshore drillers to engage in deepwater oil exploration that was once too expensive to pursue. Moreover, as oil and gas prices continue to rise, the economic incentive to develop new technologies increases as well. The prospect of oil exploration and production is more economically feasible than ever due to substantial returns companies are enjoying because of higher energy costs. Off-coast drilling also involves much more physical risk. The company, for instance, drills risky deepwater wells (even calling them "Treasure projects") in the Gulf of Mexico, which is more prone to the risks of damage caused by hurricanes.

Competition and Market Share

As a seller of a commodity product, the company operates in a highly competitive environment in which all firms are price-takers, selling their oil and gas production at given market prices. Firms generally compete on their ability to drill efficiently and earn high returns on investment through intelligent property acquisition and operational prowess. Scale does matter some, as companies with greater production levels and revenue can generally cover many administrative expenses over a wider base of properties. Below, for instance, is a regression of revenue and operating margin for 14 independent oil & gas companies.

Below is a table comparing several independent oil & gas companies across several metrics.^[6] It is worth noting that the Energy Information Administration reports that there exists around 170 trillion cubic feet of natural gas proved reserves in the United States.^[7] Given this, an estimated "market share" for Newfield's 1.58 trillion cubic feet gas reserves would be just under 1%, indicative of the dispersion and fragmentation of the natural gas industry in the US.

Footnotes

1. ↑ NFX 2007 10-K, "Business," pg 2
2. ↑ NFX 2007 10-K, "Business," pg 1
3. ↑ NFX 2006 10-K, "Selected Financial Data," pg 20
4. ↑ NFX 2006 10-K, "Business," pg 3
5. ↑ NFX 2006 10-K, "Risk Factors," pg 5
6. ↑ All data compiled from company annual reports and 10-K's
7. ↑ Energy Information Administration - Annual Energy Outlook 2002
8. ↑ MMcfe/day, or millions of natural gas cubic feet equivalent, is a measure of the level of production per day that converts oil into the energy-yielding natural gas equivalent using a ratio of 6 to 1 (natural gas to oil)