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US natural gas: easing the burden

Kenny George, a directional driller from El Campo, Texas, left, Gregg Stiles, a floor hand from Montourfalls, New York, center, and Eric Mosley, a steering hand from Conroe, Texas, change a directional tool on a Chief Oil and Gas, LLC natural gas rig in Mifflin Township, Pennsylvania, U.S., on Wednesday, March 19, 2008. Range Resources Corp., the best- performing oil-and-gas producer in the Standard & Poor's 500 over the past year, is leading a natural-gas rush in Pennsylvania, where Edwin Drake drilled the world's first commercially successful oil well in Titusville in 1859. Photographer: Mike Mergen/Bloomberg News©Bloomberg

The one imperative for US natural gas producers: deleverage as quickly as possible. Yet two situations this week show that easing a debt burden can take multiple forms with different outcomes for shareholders. In one case, SandRidge Energy filed for bankruptcy protection seeking to clear away nearly $4bn of debt. Not only will shareholders be wiped out but creditors are very likely to take a hit on their claims as well.

The equity owners at two other gas explorers should have a happier outcome. Range Resources announced it would acquire rival Memorial Resource Development for $4.4bn in total value. Rather than writing off debt, the two will reduce this burden through an all-stock merger, smartly using equity value while it still exists.

The mild optimism driving an oil price rally does not exist for natural gas. Daily US gas production of 80bn cubic feet per day in February was the second highest level ever. A warm winter hurt demand, so inventories are at record highs. The spot US gas price is off a third from the depressed $3 per million cubic feet seen a year ago.

Despite cost cuts and fewer wells in production, output has boomed because of productivity gains. Weaker explorers have succumbed to bankruptcy — SandRidge is just one of a string of failures (shifting to oil production proved futile).

Range and Memorial, with their acreages in the most productive shale regions, were not financially distressed. By acquiring all of Memorial’s earnings but paying for those only in shares, Range will see its debt to earnings before interest, tax, depreciation and amortisation ratio fall from a testing
5 times to a safer 3.5 times. Range shares fell a tenth on Monday; its shareholders disliked the share issuance. Still, the augmented Range will have an equity value of $9bn. Miffed shareholders should understand that its prospects could be worse. Just ask the crushed shareholders over at SandRidge.

Email the Lex team at lex@ft.com

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