TLM

We have upgraded domestic energy explorer Ultra Petroleum Corporation (UPL) to Neutral from Underperform, reflecting the company’s portfolio repositioning initiatives.

Houston, Texas-based Ultra Petroleum is an energy firm engaged in the acquisition, development, exploration and production of oil and gas properties. The company’s operations are focused on the Green River Basin of southwest Wyoming, mainly covering the Pinedale and the Jonah fields.

Both of these areas are endowed with rich natural gas reserves, which have remained largely untapped to date. Importantly, Ultra Petroleum seems well positioned to sustain the strong growth momentum for quite some time based on its impressive exposure to the high-return Marcellus Shale play.

As of year-end 2011, Ultra Petroleum had 4.98 trillion cubic feet equivalent (Tcfe) in proved reserves, of which more than 96% was natural gas and about 41% was developed. Production averaged 245.3 Bcfe during the year, comprising 97% gas and 3% crude oil/ liquid hydrocarbons. Ultra Petroleum’s high natural gas exposure raises its sensitivity to gas price fluctuations, compared to its more-diversified independent peers with higher oil production.

A supply glut has pressured natural gas prices during the past year or so, as production from dense rock formations (shale) – through novel techniques of horizontal drilling and hydraulic fracturing – remain robust, thereby overwhelming demand.

As a matter of fact, natural gas prices have dropped more than 50% from 2011 peak of $4.92 per million Btu (MMBtu) in June to the current level of around $2.45 (referring to spot prices at the Henry Hub, the benchmark supply point in Louisiana). Incidentally, prices hit a 10-year low of $1.82 last month.

To make matters worse, a near-record mild weather across most of the country curbed natural gas demand for heating all winter, leading to an early beginning for the stock-building season. The grossly oversupplied market continues to pressure commodity prices in the backdrop of sustained strong production.

This has forced Ultra Petroleum – and other natural gas players like Talisman Energy Inc. (TLM), Encana Corp. (ECA), etc. – to announce drilling curtailments. Taking a cautious view of gas prices, Ultra Petroleum’s capital program specifically focuses on the promising liquids-rich Niobrara Formation in Colorado, which is a major shift away from dry natural gas development.

The company has trimmed its current year capex by 25% from the original guidance, while still looking for an up to 6% improvement in its production.

While subscribing to management’s outlook, we believe the realignment of Ultra Petroleum will take some time to bear results. The company also lacks geographic diversification, which somewhat hampers its competitive positioning.

As such, we expect Ultra Petroleum’s growth potential to be restrained with little room for meaningful upside from current levels. Our new long-term Neutral recommendation is supported by a Zacks #3 Rank (short-term Hold rating).

 
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