Rosetta Could Be a Big Shale Play

 | Jan 22, 2014 | 11:00 AM EST
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Shale oil producers have had a tough time in the last three months, with most big names declining mid-to-high single digits. This decline has been amplified among companies in newer shale plays, for example the Permian Basin in West Texas and the Tuscaloosa Marine Shale in Louisiana.

With a decline in the price of domestic oil from $100 to the low $90 range, stocks of companies operating in less-developed shale plays, where commercial viability is less certain, have seen their stock prices drop the most.

This chart shows the decline of EOG Resources (EOG) and Continental (CLR), each the biggest oil producers in both the Eagle Ford and Bakken, respectively, and as we can see, neither has declined by over 10 percent. Rosetta Resources (ROSE), on the other hand, has lost nearly a quarter of its value in the last three months. The reason? While Rosetta used to be an Eagle Ford pure play, last year the company made a huge bet on horizontal drilling in the Permian Basin with several acquisitions in the Wolfcamp shale portion. Rosetta now has more than 53,000 acres in the Permian Basin.

Think of the current situation like this: we know that most Bakken producers can make reasonable profits with oil as low as the high $60s. We know that most Eagle Ford producers will be fine until about $75. But in the Wolfcamp, producers are still in a testing phase. Unconventional oil in the Permian will likely be commercially viable at $100 or $90 WTI, but what about $80? We really don't know yet, and it's that uncertainty which has kept investors away.

 Opportunity Knocking?

 Is Rosetta an opportunity down here? If you have tolerance for risk, I believe that it is. The Permian Basin has been producing oil for over a century. Today, some estimate it to be the world's second largest oil field due to its estimated recoverable shale oil reserves.

This chart from Pioneer Resources (PXD) shows just what kind of potential the Permian has right now. If all that recoverable oil ends up being commercially viable, the very earliest movers, Pioneer, EOG and Rosetta Resources, will be the biggest benefactors. Of the three, Rosetta trades at the lowest price to book ratio at a very reasonable 2.1x.

Rosetta will employ four rigs and drill 24 horizontal test wells in the Permian in 2014. The wells will be dispersed widely over the company's acreage. While this drilling activity is an important step, there will be many more steps to come. The Eagle Ford, for example, was discovered around 2008, but large-scale development didn't start until 2012. Chatter about the Permian's unconventional reserves began only in 2012 and 2013. I believe it will take a few more years to develop this play, and perhaps one more year to get a handle on the play's commercial viability.

With that in mind, I believe Rosetta Resources has potential to greatly reward patient investors. The development of the Spraberry-Wolfcamp shale will take at least a couple of years. While we don't yet know how commercially viable this shale is just yet, an investor in Rosetta should hope that WTI does not drop below and stay below $80.\

If oil can stay at about $90 and the test wells end up being a success, you'll be happy you picked up Rosetta Resources at just over 2x book and 25% off its peak.

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