Rising Star Buy: Double Eagle Petroleum

The recent swoon in the commodity markets has not been kind to the energy sector. When the price of oil goes down, the prices of companies linked to oil often go down even more. The bright spot is that such weakness also tends to bring about attractive entry points for people who are looking for buying opportunities. One such company worth buying is Double Eagle Petroleum (Nasdaq: DBLE  ) .

The business
Double Eagle is an oil and gas exploration and production company based in the Rocky Mountain basins in the western United States. Its main producing assets are the Atlantic Rim coal-bed methane, or CBM, and the Pinedale Anticline. Going forward, Double Eagle's strategy is twofold:

  • Build on its foundation of low-cost assets by continuing to develop its core Atlantic Rim CBM and Pinedale Anticline areas.
  • Unlock potential value from its exploration assets, especially its position of more than 71,000 net acres in the Niobrara shale.

In the past several years, Double Eagle has undergone a transformation. It all started in 2007, when the company's Atlantic Rim Environmental Impact Statement was approved, which awarded the company the right to drill 1,800 CBM wells and 200 conventional wells in the area. Double Eagle wasted no time and ramped up capital spending, which allowed the company to more than double its proven reserves in a short span, going from about 51 Bcfe at the end of 2006 to 115 Bcfe at the end of 2010. After just a few years, the Atlantic Rim became Double Eagle's biggest source of proven reserves.

Capital expenditures were consuming cash quite rapidly leading up to the major company transformation, but that situation has quickly reversed itself. Double Eagle now finds itself in the enviable position of producing enough cash from operations to fund capital expenditures without relying on debt or equity financing. That's a privilege most small producers simply don't enjoy.

 

LTM

2010

2009

2008

2007

2006

Cash Flow From Operations $25.9 $25.0 $22.1 $22.9 $5.2 $11.0
Capital Expenditures ($22.0) ($21.9) ($28.7) ($45.3) ($42.3) ($22.3)
Sale of PP&E $0 $0 $7.2 $4.5 $0.2 $0
Net Capital Expenditures ($22.0) ($21.9) ($28.7) ($40.8) ($42.1) ($22.3)

Source: Capital IQ, a division of Standard & Poor's. All dollar amounts in millions.

Also, as of the latest close, Double Eagle traded well below its PV-10 of proven reserves of $143.7 million and clocked in at less than 3 times trailing operating cash flow. However, the most exciting part of this story might actually be its Niobrara shale acreage, which doesn't even figure into its proven reserves or its operating cash flow. What makes Double Eagle so compelling is that it produces natural gas at a steady clip from its core assets, trades at a low valuation, and has attractive exploration assets that we get as a bonus.

Most small-cap independent oil and gas companies usually don't offer both strong cash flows and exciting exploratory potential -- it's usually one or the other.

Oil exploration in the Niobrara
The Bakken and Eagle Ford attract a ton of headlines as the most exciting liquid-rich shale plays, but the Niobrara is not to be ignored. There have already been a few asset sales in 2011 at decent prices:

  • In April 2011, Marathon Oil (NYSE: MRO  ) announced the sale of a 30% working interest in its 180,000 net acres for $270 million, or $5,000 per net acre.
  • In January 2011, Chesapeake Energy (NYSE: CHK  ) sold one third of its 800,000 net acres in the Niobrara shale to CNOOC (NYSE: CEO  ) for $1.27 billion. The transaction came out to just over $4,750 per net acre.

What's more, further success in the play would lead to higher acreage values in the future. While the Niobrara is still in an early stage of development, it has still attracted companies looking for oil exposure at a low price. Companies such as Anadarko (NYSE: APC  ) , Noble Energy (NYSE: NBL  ) , Chesapeake Energy, CNOOC, and EOG Resources (NYSE: EOG  ) are among the largest leaseholders.

Risks
While its Niobrara acreage is quite exciting, Double Eagle is a natural gas producer first. It's no secret that natural gas prices have not recovered in recent years, with slow demand growth and the shale gas boom in the Marcellus, Barnett, Fayetteville, and others weighing heavily on the supply side. Double Eagle attempts to hedge at least 50% of its production, which helps smooth out cash flows. Still, it's at risk if natural gas prices plummet.

Even with stagnating natural gas prices, Double Eagle stock would do very well if its Niobrara exploration were to prove successful. The company is expecting to drill an exploratory well this year, with further exploration to come in later years depending on this year's drilling results.

Finally, the Niobrara shale's value depends on oil prices. Even though Double Eagle produces mostly natural gas, it still moves higher and lower as oil bounces up and down. According to a recent presentation, Carrizo Oil & Gas estimates that it will still be solidly profitable in the Niobrara even if oil were to drop to $70 per barrel. That means oil must fall even lower for companies to stop exploration projects altogether in the Niobrara.

Foolish bottom line
Double Eagle produces strong cash flows, trades at a discount to its proven reserves, and offers exciting oil exploration potential for next to nothing. If we win, we win big. If we lose, we don't lose much. That's good enough for a buy in my portfolio.

Paul owns shares of Chesapeake Energy and Double Eagle Petroleum. The Motley Fool owns shares of Double Eagle Petroleum. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (20)

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  • Report this Comment On October 05, 2011, at 8:20 AM, todd303 wrote:

    A note on Double Eagle's Niobrara acreage; it is a couple hundred miles west of where everyone else is drilling in this play. The sweet spot so far has been in Weld County, CO and near Douglas Wy. No one has drilled a successfu well in Carbon County, where Double Eagle has their acreage, so this upside is highly speculative.

  • Report this Comment On October 05, 2011, at 10:39 AM, TMFBabo wrote:

    todd303, thanks for the comment. You're right that the upside is speculative, but I don't think all of DBLE's acreage is in Carbon County. At last count, 37,144 net acres were in the Green River Basin, which would be the Carbon County acreage you're referencing.

    They also have smaller positions in what appear to be Laramie, Campbell, and Fremont Counties (they're listed by basin on the company website materials, so the county locations are approximate).

    The deal here is that the market's not assigning much (if any) value to the acreage, so almost any success at all will bump up its perceived valuation.

    My guess is the company acquired acreage wherever it could get it on the cheap, which explains why it's split up rather than in one contiguous block, which would be preferred.

  • Report this Comment On October 05, 2011, at 11:31 AM, todd303 wrote:

    All good observations. I don't have the detail that you do; I am just aware of Double Eagle's primary operating acreage in Carbon Co. in the Green River Basin. Some speculation that the Niobrara could yield something there, but no evidence yet. Lots of uneconomic wells have been drilled in the last year as companies have been trying to de-risk the play, and most activity has pulled back to Weld in CO, except for what CHK has been doing around Douglas, WY.

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