What's Up With the Wildcatters?

 | Jan 16, 2013 | 6:23 AM EST  | Comments
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Stock quotes in this article:

lpi

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eog

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swn

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chk

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sd

The plethora of little oil and gas companies in this country's pretty amazing. If you run one, even a real good one, yours could easily get lost in the shuffle of the dozens of publicly-traded petroleum entities. .

Last night, for example, I found myself, trying to ascertain how bullish I can really be about a Laredo Petroleum (LPI), a $2.3 billion oil-and-gas concern with prospects in Texas that I had invited on to "Mad Money."

Let me just run through why this is so difficult to process -- call it the pros and cons of small-cap oil-and-gas investing -- using LPI as perfect example of the arduous path you must proceed on to get the right oil-and-gas play for your portfolio.

First, I love the bloodlines of Laredo. Chairman, CEO and Founder Randy Foutch isn't a neophyte. This is his third go-around, third time he has started an oil and gas company and the last two were extremely successful. Although they were private, we know that they were sold for big money, so who is to say that he can't do it again? Foutch would argue that lightning is more likely to strike a third time precisely because it did strike the two times before. He did so on the show.

But, of course, have heard this before from the wildcatters out there. Tom Ward at Sandridge (SD) and Aubrey McClendon at Chesapeake (CHK) have made fortunes before in oil and gas and it's painful to assess how poorly that's worked out for you this time. Painful.

I have had good luck with only a couple of independents that haven't been taken over, meaning if they weren't taken over during the new oil and gas boom then their stocks tend to be lower than they were a few years ago because oil isn't climbing and natural gas, which is more plentiful in this country, has been hideous. Many of these companies got started publicly trading during periods where natural gas seemed less plentiful and spikes in the fuel were fantastic for those who knew how to hedge against them or even profit from that hedging. Think Aubrey McClendon during the heyday. Just by selling futures when nat gas spiked he made billions for his Chesapeake shareholders. But those days are long since gone.

So, I default into thinking what's the best of the non-takeover names? Anadarko (APC)? Apache (APA), Devon (DVN), Encana (ECA)? Ultra (UPL)? Southwestern (SWN)? Carrizo (CRZO)?

No.

It's EOG (EOG). Why? Because it has huge acreage in Eagle Ford and Bakken, the two fastest-growing oil basins in the country.

If a company has substantial prospects in either of those two shales -- AS OPPOSED TO EVERY OTHER SHALE -- it's been a winner. It's either gone higher because of outrageous production growth, like EOG or Continental Resources (CLR), or it's been taken over at a substantial premium like when Statoil (STO) bought Brigham Exploration in 2011.

EOG has the best acreage in BOTH shales.

Laredo, on the other hand, is in the Permian, a very picked-over field from the old days without a lot of excitement to it.

But before you say forget about it, I don't want any Permian, it's too old, remember that Laredo is drilling horizontally on Permian land that used to be drilled only vertically. Left-for-deal deposits, using the new technology, turn out to have a great deal of oil left in them.

But Laredo's less than 50% oil and the only companies that are really doing well are the oil ones, the companies that have already gotten to the point where if they were say 30-40% oil and 60-70% natural gas a few years ago, they have now flipped that ratio to 60-70% natural oil or will be there by this time next year.

Laredo isn't one of them, but it sure is trying to be with a drilling budget heavily skewed toward oil, which is the same thing that almost all of the other companies are doing in the space, too. Remember, natural gas drilling is down about 50% year-over-year even as the price just can't seem to get out of its own way. Natural gas liquids, the ones that can be transformed into plastics with ease, had been holding up, but then collapsed in price last year. Laredo has a fair amount of those more oily gasses, but that won't help the causes in 2013 either.

Laredo, like almost all of the independents, is spending above its current cash flow, betting that the possibilities of hitting paydirt are just too great to go any slower and any less aggressively. Again, that's worked for us with EOG. But it has been a failure with Chesapeake and Sandridge.

So, you have to believe that both Foutch is right about the prospect and the price of oil is going to stay here or go higher to really get behind Laredo here, which hasn't done much of anything since it came public in late 2011.

We are all accepting that natural gas and natural gas liquids aren't going up any time soon and you don't need them to go up to make the Laredo story work higher.

But we don't want them to go down from here either because they represent more than 50% of the production stream. 

Fortunately, Laredo has a $750 million credit line to fall back on if oil and gas go down in value. It's not in a cash crunch and won't have to firesale assets as we have seen from Sandridge and Chesapeake. 

Unfortunately it can always do an equity deal if it needs money and, by the way, one of its insiders already gave you a Laredo secondary not that long ago that you are heavily underwater on if you participated. That would leave a bad taste in anyone's mouth.

But there's also the possibility of joint ventures that will bring out value. We know both large oil public companies and foreign national oil companies want into America for its bountiful oil. Laredo can easily do a deal with one of them for a portion of its acreage.   

But that's just a possibility, not a certainty, and those buyers tend to act only when oil's rising, not when it is stable or going lower. 

Where do I come out?

Pretty simple. It is very difficult to see why you would pick Laredo to buy over many of the other independents out there. The reason it is so hard to differentiate Laredo from the others, even though the bloodlines are real good and the prospects bountiful, is that these stocks are trading almost all in lock step. Good and the bad. .

If you think oil is going up in price, Laredo goes up, perhaps not as much as others because it might issue equity.

If you think oil's going down?

Just forget about it.

Indeed, that is the problem with almost all of these companies. They just can't break away from the price of oil and particularly natural gas. see the hideous decline in the way too nat-gassy Devon and the death rattle of all-nat-gas Ultra Pete. We've struggled with Southwestern Energy of late for Action Alerts PLUS and that is acknowledged to be the best run natural gas company in the industry. Only Cabot Oil & Gas (COG), because of its huge Marcellus holdings, has been able to break out from the nat-gas dominated portion of the pack. .

All in all, I would put Laredo in the category of "better than most" but "still not as good" as an EOG, even after EOG's run, because in the end being in the Bakken and the Eagle Ford's just too fabulous to pass up on. Everything else can be real good, as Laredo is, but not good enough to attract the kinds of buyers that stabilize and take up an oil and gas play.

Random musings: If you are unsure about how the new Facebook (FB) Knowledge Graph works, we have the single best story about it, if you click on Dana Blankenhorn's piece.

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