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Jeffrey Hayden and Chad Mabry: Stay Very Oily

Source: George Mack of The Energy Report 02/15/2011
February 17th, 2011

In 2010, some of the best-performing companies in the E&P space transitioned to a heavier focus on oil, which has been strong, and away from natural gas where prices are weak. That trend is likely to continue this year, according to Rodman & Renshaw Senior Analysts Jeff Hayden and Chad Mabry who remain bullish, even though they're not betting on sustained prices above $100/Bbl. In this exclusive interview with The Energy Report, Jeff and Chad bring some growth and value ideas into sharp focus.

The Energy Report: Your oil price forecast for 2011 is $92.50 per barrel; for 2012, you have it averaging about $90 and $85 thereafter. We're almost there, so where's the growth in equities going to come from?

Jeff Hayden: Well, I don't think stocks are discounting prices at these levels yet; and right now, I think they have room for appreciation. If you look at our numbers, we've got a fair amount of upside still to our target prices—and that's with only an $85 oil price factored in. If commodity prices just hold at $90, we think the group will move higher as the stocks begin to discount $90/barrel. Right now, we don't think that's the case.

TER: You recently trimmed your 2011 gas price forecast to $4.30/Mcf (thousand cubic feet) from $4.50/Mcf. If demand is low, why does production continue at the current pace?

JH: You hear the term "shale revolution" thrown around a bunch, but that's really what it was. With the onset of shales, the U.S. went from a period of expected production declines where we were going to need large amounts of liquid natural gas (LNG) imports to meet our demand—to where we're actually growing production at a pretty nice clip. Production has been outpacing demand; so, we're in an oversupplied situation.

TER: Given that, can gas production be profitable?

JH: Yes, I think gas production can definitely be profitable. Eventually, supply and demand will balance out and some normalcy will return to the market. E&P companies are price takers; so, in a typical cycle, when prices fall, the industry cuts back on spending. This causes supply to drop and prices to recover. And when prices get high enough, activity ramps back up, causing the cycle to start over.

However, there are a few things that are keeping the market oversupplied in the near term, including drilling to hold acreage, drilling with other people's money—thanks to the numerous JV (joint venture) deals in recent years—and strong hedge books. Once we get through these issues, people likely will start looking at the underlying economics and say, "Why are we drilling all these wells into a bad gas tape again?" So, I think you'll see the rig count come down. You'll see supply fall and gas prices move up.

While we do think gas prices will move up over time, we don't really see gas prices spiking to levels seen in the past. We don't expect gas prices to reach significantly into the double digits for any extended period of time going forward because, frankly, we have just found too much potential supply that can come on if gas prices get north of $6/Mcf.

TER: Generally speaking, are these low gas prices discounted into the equities yet?

JH: Actually, looking at current gas prices around $4.50 on the NYMEX, I would actually argue that natural gas stocks are discounting a higher long-term price than $4.50.

TER: So, gas stocks are not value plays at this time?

JH: I think if you look at the natural gas stocks right now, it's tough to call them value plays when they're discounting higher prices than the current strip.

TER: Long term, you think gas prices will go higher. Are you able to put a timeline on that?

JH: Not with any confidence; but I would say that before some normalcy really starts coming back to the gas price market, you need to get through this HBP (held-by-production) cycle and get these hedge books to roll off. So, we think it'll be 2013 at least before gas prices start to get back toward our long-term gas price forecast of $6 again.

TER: What is your favorite play right now, Jeff or Chad?

JH: You know our favorite stock for a while has been GeoResources Inc. (NASDAQ:GEOI). We think it has a good management team and assets. It's built up a nice position in two of the more-interesting oily plays right now—the Bakken and Eagle Ford. The company has accumulated roughly 46,000 net acres in the Bakken, and it's got another 21,000 net acres in the Eagle Ford. GeoResources has been involved in the Bakken for a while as a non-operator with some very good operators, such as Slawson Exploration (private). It just recently kicked off its own operating program in that play and had nice results from its first well, so we expect an active drilling program going forward. The company recently announced an increase in its capex budget to accelerate development, so that should translate into nice production growth numbers. We're looking for production growth of about 15% in 2011 and roughly 30% in 2012.

TER: Ok, another one that you like?

JH: Another one we like here is Triangle Petroleum Corporation (TSX.V:TPO; NYSE.A:TPLM). Again, we're sticking with the oily theme because we like oil better than gas. One of the things we really like about Triangle is that, relative to its market cap, it is one of the most leveraged companies to the Bakken. Right now, Triangle has about 15,000 net acres and is looking to push that to 25,000–30,000 net acres by the end of the year. If it's able to do that, I think there could be significant upside from current levels. You've got a stock here that is currently around $7; if it can tack on another 10,000–15,000 acres at attractive prices, I think this stock could get into the teens.

TER: The first thing I noticed about Triangle was its low market cap of $187 million. You could move that stock with some demand for the shares. The $30 million allocated for the development of the Bakken acreage this year sounds like a large investment. Does that have to pay off for the company?

JH: Well, its announced capex budget is actually about $72 million, and $30 million of that is just for acquiring additional leasehold. That's how it's going to grow to that 25,000–30,000 net acres. The company has another $42 million for drilling capex. This is a sizeable capital allocation for the company's size, which is why TPLM went out and made sure it had the financing in place in order to fund this program. As for whether it has to pay off, the simple answer is, yes—if it wants more funding. But with the predictability of the Bakken play, we think that's the likely scenario.

TER: How about another stock that you like?

Chad Mabry: Sure. Just to talk about one of my names that we recently moved over to our top picks in our preview piece is RAM Energy Resources (NASDAQ:RAME). It's a value name, and it's a stock that really hasn't participated in the recent rally. One of the things it's been doing over the past few months is addressing its high leverage situation. The company has divested a number of non-core assets, and these were pieces of the portfolio that were more gas weighted. They were non-operating assets for which the stock really wasn't getting much credit. It was able to use proceeds from those divestitures to pay down some of its debt load and, in so doing, high grade its asset base by increasing its oil weighting. RAME's trading at a 2011 EV/EBITDA of 5x–6x. One of the intriguing potential catalysts in the near term is a shallow oil-exploration play at its Osage Concession. It's a Mississippian play in northern Oklahoma that the company's been pursuing for the past year or so now. It really is just at the first stages of having some initial results, which could really get the stock moving here.

TER: Chad, you said it's a value play, and indeed it has trailed its peers over the past 52 weeks.

CM: To retrace some of the steps over the past 52 weeks, the stock has seen a fair amount of volatility. The company did announce it was pursuing strategic alternatives, and it got a little ahead of itself for a while as investors priced in a takeover last year. That didn't transpire, and it corrected a bit.

TER: Ok, another company?

CM: Just staying on the value theme here, another name we like is Energy Partners, Ltd. (NYSE:EPL). One of the exciting things about the company is that it recently underwent a restructuring of its balance sheet and finished 2010 without any debt on the books. It has been addressing a lot of plugging and abandonment (P&A) liability issues, and it has been high grading its asset base, reprocessing seismic, etc. The company recently announced a $200 million acquisition from Anglo-Suisse Offshore Partners, LLC, a private company, on the Gulf of Mexico shelf. These assets are right in EPL's wheelhouse on the central shelf. They're very oily and spin off considerable cash flows.

TER: The stock has almost doubled over the past year but, obviously, you believe there's upside left to it.

CM: We do. Talk about a value name—it's trading at about ~3x 2011 EV/EBITDA. So, we do think it's a cheap-looking name here. It's doing the right things to outperform in the near term.

TER: Is there another company either of you can mention?

JH: Rosetta Resources Inc. (NASDAQ:ROSE) is an interesting name due to the leverage it offers to the Alberta Basin Bakken play. We think it's got two nice positions—the Eagle Ford Shale, where it's primarily in the liquids window, and the Alberta Basin Bakken play (not to be confused with the standard Williston Basin Bakken play you hear about). The Alberta Basin Bakken is actually over to the west in Montana. In the Eagle Ford Shale, ROSE has about 65,000 net acres, which are really the driving force behind its near-term production growth and where it's allocating the lion's share of capex this year. That should generate some very nice production growth in 2011, as well as in 2012. But I think most investors are looking at what's going on with the Alberta Basin Bakken as far as really giving the stock the next big move. While I do still believe there's some upside in the stock based on getting a little bit more credit from the Eagle Ford, the big upside for Rosetta will be the Alberta Basin Bakken, where it has 300,000 net acres, give or take, in the play.

A number of other exploration and production (E&P) companies are there, including Newfield Exploration Company (NYSE:NFX), Crescent Point Energy Corp. (TSX:CPG), Murphy Oil Corp. (NYSE:MUR) and we've even heard Royal Dutch Shell Plc (NYSE:RDS.A; NYSE:RDS.B) is in the play—trying to figure out if the Alberta Basin Bakken works. Maybe $4–$5/share of value for the play is currently discounted in Rosetta's stock price; but, if this works, it has the potential to be worth billions of dollars to Rosetta. It's not unrealistic to think that the stock could double if the Alberta Basin Bakken really works. And if it doesn't work, you don't really have a ton of downside.

TER: When can we get data on the Alberta Basin Bakken?

JH: People are actively testing it right now. Crescent Point has drilled some wells north of the border. Newfield has a drilling program going on in Montana, as well as Rosetta. We don't follow Newfield, so I can't say I'm totally up to date on what it's saying but I think it's been telling people it'll be maybe Q2 or Q3 before any results come out from its initial test program. I wouldn't expect any results from Rosetta until probably Q4. So, it's not imminent. It will probably be in the back half of this year before we really start hearing hard data points on what people are seeing based on test programs in the play.

TER: Recently, you put out a note on Gastar Exploration Ltd. (NYSE:GST), saying that, for the sake of your model, you were giving no value to the Eagle Ford. Were you being prudently cautious, or do you feel that it can't match the results another operator achieved south of Gastar's position?

JH: Well, I think the reason we're not currently giving Gastar any credit for that is because we're just being cautious. Gastar is in a different area than the main Eagle Ford play, it's more in the Woodbine/Eagle Ford area. A private company just south of Gastar has put up some very interesting-looking results based on what we've been able to get our hands on, but that doesn't necessarily mean Gastar's acreage will work. It has drilled a test well, and we're waiting on results. So, in general, we try to be cautious regarding how much credit we give companies for a new play or new area of a play until they've actually got some results for us. It's not that we don't think it's going to work on Gastar's acreage. We're just being very conservative.

TER: Ok, thank you.

JH: Thank you.

Jeff Hayden's current coverage list: AREX, BPZ, CRZO, CXPO, EXXI, GST, GEOI, GPOR, MHR, NEP, REXX, ROSE, RRC, SWN, TPLM and VYOG.

Chad Mabry's current coverage list: EPL, GMXR and RAME (all Market Outperform).

Jeffrey Hayden, CFA, is a managing director and senior oil & gas analyst. Prior to joining Rodman & Renshaw in July 2008, he was a senior analyst at Pritchard Capital Partners where he followed the E&P industry. He also previously held sell-side positions at Banc of America Securities and Pickering Energy Partners, as well as buy-side positions at Fischer-Seitz Capital Partners and JP Morgan Fleming Asset Management. Jeff earned a BBA with honors in finance from the University of Notre Dame.

Chad Mabry is a vice president and senior oil & gas analyst. Prior to joining Rodman & Renshaw in July 2008, he was an associate analyst at Pritchard Capital Partners where he followed the E&P industry. He began his career at PricewaterhouseCoopers in Houston and has more than eight years experience in the oil and gas industry. Chad earned a BA in philosophy and an MA in accounting from the University of Texas at Austin.

Source: George Mack of The Energy Report 02/15/2011
February 17th, 2011

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1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Shell.
3) Jeffrey Hayden: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: View Rodman & Renshaw disclosure here.
4) Chad Mabry: I personally and/or my family own shares of the following companies mentioned in this interview: Triangle Petroleum. I personally and/or my family am paid by the following companies mentioned in this interview: View Rodman & Renshaw disclosure here.

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