A Preview of Shale Plays

 | Sep 24, 2013 | 12:00 PM EDT
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I'll be attending next week's OGIS Conference in San Francisco presented by the Independent Petroleum Association of America. This event is attended mainly by domestic players, as opposed to international majors like Exxon Mobil (XOM) or Chevron (CVX), so unconventional shale drilling will be a main topic. Four firms I have mentioned previously -- GreenHunter Resources (GRH), Miller Energy Resources (MILL), Magnum Hunter Resources (MHR) and Evolution Petroleum (EPM) -- will be presenting, so let's review them. We'll look at GRH and MILL today, and MHR and EPM tomorrow.

Last week, GreenHunter announced a capital raise in the form of a PIPE (private investment in public equity), as four buy-side firms bought $3.2 million of GreenHunter's 10% Series C preferred shares. It's not a huge amount (and priced at a discount to GRH-C's current price, which already reflects a 25% discount to par), but management assured me that they are still actively seeking financing.

Raising capital is expensive for GRH (the Series C issue was priced to yield 14.3%), but a worthwhile endeavor since the uses of that capital seem endless. All indicators point to robust natural gas production in GreenHunter's largest region, Appalachia, and my research shows that GRH's core business of injecting the briny water produced by fracking in the Marcellus and Utica shales into underground disposal wells is still quite strong. Appalachia is also where GRH is launching its modular surface-water holding-tank product (MAG-Tank), as well as a proprietary fluids recycling service (Frac-Cycle), and it has opened a facility for processing fluids to eventually barge down the Ohio River (GRH has received regulatory approval).

Miller Energy's preferred shares, MILL-C, have risen 22% in the last month and now trade at a premium to par. I have written about the "short squeeze" that has powered Miller's common shares, and it looks like the same thing has happened to its preferreds. To short a preferred with a 10.75% coupon is ridiculously expensive -- and you had better be right. Two weeks ago, Miller reported a solid quarter operationally and management noted on the call that they have begun receiving this year's payments from the Alaska "ACES" production cost rebate program. So anybody betting that MILL would run out of cash was proven wrong.

The other angle is that MILL-C is convertible any time into MILL at a ratio of $10 per share. For bullish investors, this is a long-dated option on MILL with a nice monthly coupon. But that is serious bullishness. Could Miller's common shares really have 50% upside from their recent price of $6.95 after a 75.5% gain year to date?

MILL shares have run on the success of its "sidetracking" of wells previously drilled by Forest Oil (FST) in the early 2000s (RU-2A, in particular, has exceeded expectations) in the Redoubt Shoal and adjacent onshore properties in the Cook Inlet. But the true upside in Miller comes from drilling in new areas -- the Sword and Sabre fields adjacent to MILL's current onshore production, and gas fields in the Olsen Creek area up the Inlet. These areas are not reflected in Miller's current production, thus are not driving Miller's proved reserve values. Drilling the first well in Sword has been challenging for Miller, but on the most recent earnings call management indicated they expected Sword No. 1 to come on-stream in October.

Miller management has a slide in its investor presentation showing its valuation of Miller's assets by well and field. Analysts generally ignore company self-valuations because valuing companies is our job, and we don't expect unbiased opinions from in-house analyses. But if Sword No. 1 comes on-stream at a meaningful rate, Miller's $15 per share estimate (also the price at which Miller can force conversion of MILL-C into MILL) of the value of its "proved plus probable" reserves may not be so far-fetched.

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