TLM

Concerned by the current weak sentiment for natural gas, we have downgraded independent outfit Ultra Petroleum Corp. (UPL) to Underperform from Neutral.

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.

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 about $5.00 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 $2.23 in late January.

To make matters worse, mild winter weather across most of the country has curbed natural gas demand for heating, indicating a grossly oversupplied market that 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. The company has reduced its 2012 capital budget by 38% year over year to $925 million. Ultra Petroleum's investment for development drilling has been slashed even more drastically, down 50% to just $650 million from the $1.3 billion expended last year.

While subscribing to management’s outlook, we believe the realignment of Ultra Petroleum’s strategy will take some time to bear results and we expect the company to continue to struggle unless the outlook for natural gas prices improves.

Given these concerns, we expect Ultra Petroleum to perform below its peers and industry levels in the coming months. As such, we see little reason for investors to own the stock. Our long-term Underperform recommendation is supported by a Zacks #5 Rank (short-term Strong Sell rating).

 
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