Missives From EnerCom

 | Aug 16, 2013 | 3:32 PM EDT  | Comments
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Stock quotes in this article:

epm

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gst

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mill

I attended EnerCom in Denver this week. It's a great conference, well run by Greg Barnett and team. The general consensus among management teams: oil prices should remain elevated, gas prices will likely remain at depressed levels, and we are in a window of opportunity where horizontal drilling techniques will continue to produce an abundance.

Remember that oil is a global commodity and natural gas is a local one, which explains the divergent pricing dynamics. Also remember that new drilling techniques are allowing more efficient exploitation of shales, but that is by nature a temporary phenomenon. Shale drilling has moved production up the North American energy curve, rather than shifting the curve, and no one should make the mistake of assuming these shallow reservoirs will yield hydrocarbons forever. It's a now business, for sure, and access to capital is a differentiator.

I enjoyed catching up with managements of Evolution Petroleum (EPM), Gastar Exploration (GST) and Miller Energy Resources (MILL).

Evolution Petroleum

Evolution has been in the news, as production at its Delhi field has been curtailed by an accident incurred by production partner Denbury Resources.  This is a temporary situation and management is confident it will be resolved in the next few months. Once the field reaches a contractually-dictated level of cumulative profitability -- delayed by the accident and now likely to occur in early 2014 -- Evolution's royalty interest reverts to a working interest. Incremental cash earnings will exceed incremental capex and Evolution will face a high-class problem: a huge amount of excess cash.

Unlike larger energy companies that hold assets for the sake of size, Evolution has only 11 employees and management is extremely focused on shareholder value. Like other businesses with private equity roots, Evolution was built to be sold.

The Delhi assets are fairly easy to value, but the key issue facing EPM is the performance of its other major producing asset, properties in the Mississippian Lime formation in Oklahoma. Management has been disappointed in the performance of the first two wells, so success on the third well (to be drilled in September using new tactics) will likely determine Evolution's fate as a public company. Strong results in Oklahoma would make Evolution that much more attractive to a potential buyer.

Gastar Exploration

Similarly, Gastar has a great annuity business in its Marcellus gas wells, but the upside also resides in Oklahoma, specifically in the Hunton Limestone formation. Through brilliant financial engineering, Gastar was able to acquire 68,000 net acres in Oklahoma from Chesapeake for a cost of basically zero.

But how rich is this play? Results from Gastar's existing pre-acquistion wells in the area have been mixed. They are going to keep drilling aggressively, and the oiliness of the play is advantageous given current pricing levels. As with Evolution, Gastar's reserve levels reflect little contribution from Oklahoma and if they are able to book significant reserves, the stock's will look very cheap assuming the current price of $3.04 holds. 

So, if upcoming production activities in Oklahoma yield strong results, the Boards of Directors at both Gastar and Evolution could be in position to sell their companies by this time next year.

Miller Energy Resources

Miller is in a different position than Gastar and Evolution, geographically and strategically. Miller is sitting on a potential windfall on its Cook inlet assets in Alaska. The recently rebooted RU-2A well -- currently producing more than 1,300 barrels of oil  per day -- has performed well ahead of expectations, and with two sister wells going through the same process in the next few months the potential is emerging.

For the home-run hitters out there, Miller's common shares offer the opportunity to participate in a potentially MASSIVE revaluing of the company's reserves, and by implication the stock price. If the next two wells perform anything like RU-2A has, reserves could easily double (or more) from the current valuation. As mentioned in a previous column, the large short position in MILL shares could fuel the share price if indeed MILL's management's thesis is proven and rapid cash flow growth alleviates concerns about Miller's high debt levels.

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