Magnum Hunter Poised for Big Production Gains

 | Nov 13, 2013 | 10:00 AM EST  | Comments
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Magnum Hunter Resources (MHR) shares jumped after the company's earnings release Friday as management initiated a target rate of production for year-end 2014 end of 35,000 BoE/day. Given that management's forecast for year-end of 23,000 to 25,000 BoE/day and that current production is about 16,500 BoE/day (including nearly 2,000 bbls/day in properties that are rated as a discontinued operation and will be divested very shortly according to CEO Gary Evans), that's at least a 50% increase in the fourth quarter, and then a 50% increase on top of that rate in 2014. 

How can they do this? Well, I mentioned in my last column on MHR that the company is drilling a mere 41 wells in the fourth quarter. Looking well by well, one can see how fruitful these Marcellus wells are... and the potential of the Utica Wells. Magnum's Collins pad (no I don't own this land, I wish I did) in Tyler County, W.Va., is projected to produce 3,360 BoE/d by the end of the fourth quarter, so that one drilling pad accounts for about a third of the increase assumed for the fourth quarter, and Magnum's Stalder pad is actually more productive on a gross basis, but Magnum has a lower ownership stake.  

The interesting thing about Magnum is the contrarian nature of their strategy.  The hierarchy of attractiveness for unconventional shale drilling would have oil first, then natural gas liquids then dry gas. "Wet" gas contains natural gas liquids like ethane and butane which can be marketed separately, thus drawing a price premium versus dry gas. Oil prices, even with their recent pullback, offer a much higher value per BTU than gas prices. 

Magnum's reserve base sits at 50/50 oil/gas now, but that includes no credit for proven undeveloped reserves in the Utica, and early results from Antero and others show massive hydrocarbon potential in that play. Much like the Marcellus, the Utica is a gas play, so Magnum's "oiliness" will decline as those reserves are booked. In terms of composition of its gas reserves, MHR's recent purchase of acreage in Ohio increases its ratio of dry to wet gas, effectively flipping the current 45%/55% dry/wet ratio.

So, why is Magnum reducing its ratio of oil to gas and also reducing the ratio of  wet gas to dry gas? Rates of return on capital are driven by sustainability of volume, not just initial production rate. Because the decline rates are lower in Appalachia than in other shales, Magnum will be able to produce for longer periods on any given well, thus increasing the ROI. That's how you get from 16,500 to 25,000 to 35,000 BoE/day...the operated wells don't decline as fast as they do in other basins (for instance the Eagle Ford in Texas) because of the unique properties (porosity, etc.) of the Appalachian shales. I am not a geologist, but managements of  Appalachian shale players have noted that the plays adjacent to (or beneath it, geographically speaking,) the Marcellus shale -- the Utica and Point Pleasant -- have even more attractive geological profiles and lower implied decline rates than the Marcellus.

If you have a great deal of dry gas you need an efficient way to get it to market, and Magnum owns one. The Eureka Hunter pipeline. CEO Evans reiterated on the company's conference call that he has received offers for Eureka Hunter that would value the whole entity (Magnum owns 60%) at $1 billion.  But they are keeping it for now... with current volume of 126mmBTU/d, visibility to 200mm by year-end and capacity to go to 350mm, Magnum can keep the asset while actual EBITDA improves (thereby increasing the amount a buyer would pay) and keep moving the gas from Appalachia.

So, moving the gas becomes a strategic advantage, and while the valuation of a pipeline is hidden in that of a driller, having Eureka Hunter will allow Magnum to fully exploit the abundance of gas in the Utica.  Further, Magnum's small size relative to giant shale players like Chevron and Range allows them to generate attractive returns from drilling for dry gas despite its relatively low price. 

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