Five Oil and Gas Companies Analyst Joel Musante Digs

TICKERS: AXAS, CHK, DNR, EPM, GPOR, NBL, PDCE, SARA

Source: Zig Lambo of The Energy Report  (3/7/13)

Many observers believe that the best days of domestic oil and gas production are long gone—and they may be right. But that doesn't mean there isn't a lot more petroleum product to be found right here in North America, even in fields that have been previously worked. In this interview with The Energy Report, Joel Musante, a senior research analyst at C. K. Cooper, profiles several companies that are still coming up with some impressive numbers.


Companies Mentioned: Abraxas Petroleum Corp. : Chesapeake Energy Corp. : Denbury Resources Inc. : Evolution Petroleum Corp. : Gulfport Energy Corp. : Noble Energy Inc. : PDC Energy Inc. : Saratoga Resources Inc.

The Energy Report: If your outlook hasn't changed much since your last interview, "Quality Oil and Gas Stocks Are on Sale," let's jump right into specific companies you follow that look interesting right now.

Joel Musante: One name I like a lot is Gulfport Energy Corp. (GPOR:NASDAQ), which recently established a pretty sizeable position in the Utica shale play. The Utica is one of the newest shale plays, and Gulfport has a sizeable leasehold position there totaling about 128,000 net acres. Based on early well results, production rates for Gulfport look very strong and much better than other companies in the play. I think it's safe to say it is in the sweet spot.

TER: Is that by pure luck or by great engineering?

JM: When you're going into a new area where there hasn't been a lot of drilling, you have to come up with a geologic interpretation of what's going on there. Gulfport leased most of its acreage where there had been little oil and gas development in the past. The company believes the formation on its leasehold is over pressured because it had been sealed by an impermeable geologic barrier. By comparison, Chesapeake Energy Corp. (CHK:NYSE) leased most of its acreage in the play to the north of Gulfport's leasehold, where there had been some shallow oil and gas developed historically. By focusing its leasing efforts on areas with historical development, Chesapeake seemed to be targeting prospective areas. But so far, Gulfport's wells have shown stronger results with better reservoir pressures. In any event, Gulfport's interpretation of the geology has led the firm to lease the more prospective acreage.

Based on early production data from wells drilled to date, Gulfport has had very solid results across most of its leasehold. Gulfport's third-party reserve engineering report reaffirmed the strong production data when the engineer calculated the reserves for one well at 1.8 million barrels oil equivalent, which we thought was a good number.

TER: So how many more wells are going to be drilled there?

JM: The company has identified about 850 gross well locations, but there could be a lot more depending on the drainage pattern of the wells. Gulfport plans to drill 50 wells this year and 70 wells over the next two years. Those are early estimates and as it drills and gets infrastructure in place, those numbers can be increased.

TER: Is it conceivable that all those wells could have similar reserves or was that just the first one?

JM: That particular well was called the Wagner well, and was on the gassier side of the Utica play. Usually gassier wells have more reserves, but because gas is sold at a lower price than oil on an equivalent basis, the reserves may not be worth as much. Reserve estimates for wells containing more oil and natural gas liquids may be lower, but because these liquids sell for a higher price than gas, the returns may actually be higher. Based on what the company has achieved so far, we are expecting good results from Gulfport's Utica development program.

I have a 12-month $60 price target on Gulfport. We are expecting to see a significant ramp-up in production this year. You don't see wells like this every day and the finding costs are extremely low.

TER: What else are you following that looks interesting?

JM: Evolution Petroleum Corp. (EPM:NYSE) is a small company whose main asset is an interest in the Delhi field in Louisiana that's operated by Denbury Resources Inc. (DNR:NYSE). That field had already been produced on a primary basis a long time ago. Now Denbury, a company known for CO2 recovery, is doing enhanced tertiary recovery there in phases. The first couple of phases have ramped up production from nearly zero to over 6,000 barrels per day (6,000 b/d) in the field.

TER: That's a significant ramp up. Is that going to fall off pretty quickly?

JM: No. It's still going through this development phase and will be for the next couple of years, so we expect the production to actually get up to over 12 million b/d on a field-wide basis. Denbury owns most of the field, but Evolution owns a meaningful interest. Evolution's agreement with Denbury allows Denbury to recover its capital costs before Evolution receives its reversionary working interest of about 20% of the production. We expect Evolution's oil production to nearly triple later this year when this reversionary working interest kicks in, after Denbury recovers its initial development costs.

TER: That should give the stock a decent kick.

JM: Right. We think that Evolution's management will put the company up for sale after this reversionary working interest kicks in. The increase in production would likely make the firm a more attractive takeover candidate. Evolution Petroleum shares trade at about $10.10 now and we have a 12-month price target of $14.

TER: That's pretty decent upside. Speaking of which, last time we talked about PDC Energy Inc. (PDCE:NASDAQ), which was in the low twenties after having been hit and you had a $45 target on it. Now it's almost at that price. That's done a nice double here in only nine months. What do you think is going to happen from here?

JM: It had some perceived tight liquidity issues, which is why it was in the low twenties. A couple of things have happened since then. First, there have been some positive developments announced by several operators in the Wattenberg field. Most notably, Noble Energy Inc. (NBL:NYSE), a leader in the Wattenberg field, increased its estimate for horizontal drilling locations to 32 wells for one square-mile section. This was a big value driver for many of the companies that operate in the Wattenberg field, including PDC, which has a substantial leasehold in the area. Noble began drilling horizontal wells in the Niobrara B formation in the Wattenberg field a few years ago with great success. Since then, the company began testing tighter well spacing in the Niobrara B, Niobrara A and Codell formations. So far, horizontal development of these formations also looks very promising.

TER: What was the other point?

JM: PDC put some of its liquidity issues to rest when it announced the sale of its Piceance and NECO gas fields for $200 million ($200M). The company was not doing very much in terms of development with these fields, and by monetizing the assets it could now reinvest the proceeds from the sale into high-return development projects in the Wattenberg field.

PDC also has a sizeable leasehold position in the Utica shale play in Ohio. The company will still need to derisk the majority of its acreage by drilling wells in new areas to prove its potential for commercial development. We think there is a lot of upside potential for the stock if results are good.

TER: So, what do you think the prospects are for the company at this point? Does the stock still have some upside from here?

JM: I think the stock still has upside from here. It looks cheap compared to other Wattenberg-focused companies. We have a $56 price target and the stock is $46.

TER: Are there any other new ones you'd like to talk about that look interesting?

JM: Things look like they're going pretty well for Abraxas Petroleum Corp. (AXAS:NASDAQ). We've had a $3.25 price target and it's currently trading at about $2.03. It's becoming a much more focused company. It's selling non-core assets, paying down debt and reinvesting the money into its two main areas, which are its operating Bakken acreage position and its Eagle Ford acreage position. The company announced last week that it's going to sell its non-operating Bakken properties, which amounts to about 14,000 acres, and Abraxas can then reinvest that money into its operating Bakken acreage and drill more wells on its Eagle Ford acreage.

TER: What amount could Abraxas stand to gain from that sale?

JM: We're estimating probably $50–70M. With that, it can pay down a lot of its debt and have money to drill more wells and grow faster.

TER: How expensive are these new wells to drill?

JM: Depending on how many net wells it drills, it works out to be about $8–9M per net well.

TER: Any other companies you're watching now?

JM: Saratoga Resources Inc. (SARA:NYSE.MKT) is in the shallow state waters of the Gulf of Mexico. The stock's very cheap right now due to some operational problems, which have caused some liquidity issues. After Hurricane Isaac, it lost some production, causing it to borrow some money to keep its drilling program going. The stock sold off with all these events and now it's trading around $3. The value of its reserves are much more than that. It hasn't yet come out with a new reserve report for 2012, but last year's reserves were worth about $9 per share. So we think there's a lot of upside there, but the company's going to have to show the market that it can bring on some low-risk projects. If it does that, we're looking for a rebound in the stock.

TER: Do you have any other thoughts you'd like to leave with our readers?

JM: Last year, we began to see a much more disciplined approach to natural gas development after prices fell below $2 per British thermal unit. Many companies that were drilling noncommercial wells to hold acreage changed their strategies, slowing development and allowing their lease terms on some acreage to expire. While there is still an oversupply of natural gas, storage levels have returned to more normal levels. As a result, we think there is less downside to natural gas prices than there has been in the past. Many of the stocks I discussed today have a balanced mix of natural gas and liquids production, which could be a good strategy if the development economics offer attractive returns under conservative pricing assumptions.

TER: Thanks for speaking with us today, Joel.

JM: Thanks.

Joel Musante, CFA, is a senior analyst in the Research Group for C. K. Cooper & Company, a full-service investment bank. In 1998, he began his career with W.R. Huff Asset Management; in 2000, he joined the exploration and production team at Wasserstein Perella Inc. He has also worked with Ferris, Baker Watts Inc., Zacks Investment Research and John S. Herold Inc. He has a Master of Business Administration from the University of Rochester and a Bachelor of Science in geology and geophysics from the University of Connecticut.

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DISCLOSURE:
1) Zig Lambo conducted this interview for The Energy Report and provides services to The Energy Report as an employee or as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Chesapeake Energy Corp. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Joel Musante: I or my family own shares of the following companies mentioned in this interview: None. I personally or my family am paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Gulfport Energy Corp., Evolution Petroleum Corp., PDC Energy Inc., Abraxas Petroleum Corp. and Saratoga Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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