How to Research an Oil Stock: Part 3

Thanks for joining me again, prospective oil investors. If you missed the first and second installments of my step-by-step analysis of Gulfport Energy (NASDAQ:GPOR), I suggest reading them over to make sure we're all on the same page. All set? Excellent.

So far, we've scrutinized Gulfport's share structure and capitalization, as well as the players involved. Some items have given me pause, but nothing is glaring enough to send me running in the other direction. It's time to press forward with a look at the company's producing properties and reserve profile.

A peek at those properties
Gulfport's annual report tells us that the company's prime producing asset is the West Cote Blanche Bay (WCBB) field, located offshore Louisiana. This is a mature asset that traces back to a discovery by Texaco (now part of Chevron (NYSE:CVX)) in 1940. More than 900 wells later, the field has yielded a 90% success rate. Gulfport's slightly lower 88% success rate since purchasing the field in 1997 is still plenty respectable for an oil drilling program on the Gulf Coast.

Production at the West Cote Blanche Bay field in the second quarter averaged 3,051 barrels of oil equivalent (BOE) per day. That accounted for 72% of Gulfport's daily output. If you're looking for a geographically diversified exploration and production company, this may not be the one for you. What might keep you interested, though, is the fact that WCBB's production was 100% oil-weighted in the second quarter.

Stepping through Gulfport's July 2009 production data, we see high oil ratios across the portfolio:

Data from company filings.

The term "oil company" is bandied about frequently, but many of the better-known exploration and production companies out there are well over 50% natural gas-weighted. EOG Resources (NYSE:EOG), for example, estimates that 65% of its production will come from gas this year. You typically have to look to much smaller operators like Gulfport or Northern Oil & Gas (AMEX:NOG) to find something this "oily."

What's in the ground?
At the end of 2008, Gulfport reported 25.5 million BOE of reserves, with a bit over half attributable to the West Cote field. Reserves are a big clue to future cash flows, given that they represent expected future production.

When reviewing reserves, pay attention to the party (or parties) doing the estimation. Gulfport's WCBB reserves were evaluated by Netherland, Sewell -- a very highly regarded shop with blue-chip clients including ExxonMobil (NYSE:XOM) and ConocoPhillips (NYSE:COP). The remaining evaluation duties were split between Pinnacle Energy Services and Gulfport personnel.

I can't think of any reason why company personnel should be involved in this process. It's akin to auditing one's own financial statements.

Also, the piece of the reserve pie that Gulfport personnel evaluates has grown steadily larger as a percentage of "PV-10" -- a standard industry measure of the present value of future cash flows, discounted at 10%. This percentage rose from 18% in 2006 to 21% in 2007, and then climbed to 24% in 2008. Yikes.

Poking around the PUDs
Next, let's check the breakdown between reserve categories. Nearly 37% of Gulfport's reserves were identified in the report as "proved developed non-producing." This is what you get when you have an old field where hundreds of wells have come and gone: The WCBB hosts twice as many shut-in wells as producing wells.

These shut-in wells have value, however. Recompletion activity can breathe new life into viable old wells. Last year in the WCBB, recompletions outnumbered new wells by six to one.

Elsewhere in the 10-K annual report, we read that 67.5% of Gulfport's reserves were categorized as proved undeveloped (PUD) at year-end. That is a high number, putting Gulfport up there with GMX Resources (NASDAQ:GMXR). This figure also has me confused, as we've somehow accounted for more than 100% of reserves already. PUD and proved developed non-producing are mutually exclusive categories. We haven't even gotten to the percentage of proved developed producing (PDP) reserves!

In a management presentation from August, PDPs were stated at 14%. I see no way to verify this data point using the company's SEC filings, however.

The next step
From here, I had been planning to move on to Gulfport's spending plans (including the potential advancement of its Canadian oil sands interest) and its hedge book, and then finally take a stab at future cash flows and valuation. I might still do that next week, but I'd just as soon move on to the next stock. This one doesn't exactly give me a warm, fuzzy feeling.

Aside from the occasional weird acronym, oil company investing really isn't so different from any other. I hope I've made it just a bit more approachable for my fellow Fools.