Should You Scoop up This Energy Stock Before It Soars?

I recently took a brief look at one of the more unique MLPs, Eagle Rock Energy Partners (UNKNOWN: EROC.DL  ) . What makes this company unique is that it's a blend of both traditional midstream MLP assets and oil and gas production assets. Today, I want to take a closer look at those oil and gas production assets, which I think provide investors with a lot of upside potential.

Proven reserves = steady returns
Eagle Rock had 350 billion cubic feet equivalent (Bcfe) of oil and gas reserves as of the end of last year. Those reserves are spread across five main operating areas:

Source: Eagle Rock Partners Investor Presentation

Two-thirds of the reserves are located in the midcontinent, which are well-known for holding great MLP-type assets that have long life and low decline. Peers like LINN Energy (NASDAQOTH: LINEQ  ) and Vanguard Natural Resources (NASDAQ: VNR  ) each has a substantial presence in the midcontinent region. Eagle Rock's reserves there have a heavy natural gas component; gas is 64% of these reserves. However, Eagle Rock has an exciting oil play in the region, which I'll get to in a moment.

The rest of its assets are spread around Texas, Alabama, and Mississippi. These assets are primarily oil assets, and combined produce about 27.5 million cubic feet equivalent per day (MMcfe/d) of Eagle Rock's overall average production of 75.1 MMcfe/d. One particular area of interest is Eagle Rock's Permian Basin assets. Both LINN and Vanguard have invested heavily in the Permian over the past year, as the formation is an excellent MLP asset with low decline rates and long-life, liquids-rich production. The bottom line is that Eagle Rock's oil and gas assets are focused in the same conventional areas as its peers because these are the type of low-decline, long-life assets that are critical to fueling the hefty distributions that these companies pay. 

With a "SCOOP" of upside potential
The most interesting asset, and the one with the highest upside is Eagle Rock's position in the "SCOOP", or South Central Oklahoma Oil Province. Top Bakken producer Continental Resources (NYSE: CLR  ) calls it a "new, high-impact resource play" and Eagle Rock has 16,000 net acres right in the heart of this play. The potential is there for this to be a play with high returns and, therefore, high upside for Eagle Rock. In fact, it has seen a 31% jump in production growth as its interest in nine horizontal wells have come on line.

While Eagle Rock's acreage is dwarfed by Continental's 232,000 net acres, it is a substantial position for a company of its size. These acres could potentially be monetized, or Eagle Rock could earn high rates of return in the 25%-30% range by investing its own capital to drill. The issue here though is that the company doesn't have a whole lot of capital to work with, so selling the asset might be in its best interest.

In fact, a monetization of some sort seems fairly likely. On last quarter's conference call, the company's chairman, Joseph Mills, stated:

We've received several unsolicited inquiries, offers to purchase our position. And you can imagine, they come in all different forms, from outright trades to outright purchases of our acreage. ... Historically, I've talked about the reserve potential here or resource potential could be in the, call it, 35 million to 55 million barrels oil equivalent for our acreage. ... A lot of offers we're getting are kind of per dollar, per acre, which are probably not something that we're interested in. But we've had a few offers where they're interested in trading us potentially proven -- proved developed assets for this upside, and that's kind of interesting to us given, in particular, our MLP structure.

Selling its SCOOP assets could potentially bring in additional assets of value or provide much needed cash to shore ups its balance sheet, which would put the company's distribution on solid ground.

Final Foolish thoughts
Eagle Rock has built a solid reserve base from which it expects to produce for the next 13 years. In addition, there is compelling upside from its position in the SCOOP. Those ingredients are key for the company's ability to maintain and possibly grow its already generous distribution. There is more to Eagle Rock: I've not yet touched on its midstream operations. Stay tuned to for more on this side of its business. 

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Read/Post Comments (5) | Recommend This Article (8)

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  • Report this Comment On July 26, 2013, at 12:37 PM, zorro6204 wrote:

    I'll have to throw some cold water on EROC I'm afraid. Management can claim to see great prospects on the horizon, but their track record is not very encouraging. NGP, the sponsor, messed up badly in setting up the MLP, over leveraged, missed on cash flow and created a box where management units did not share in distributions and probably never would. They hosed retail unit holders by ripping up the agreement and restructuring without subordinate units, driving the unit price into the ground, and suspending the distribution besides.

    Well, all that's the past, right? Leverage is reasonable, the structure is fixed and the unit price came back up over $10. And then Q1 happened, where they whiffed hugely on coverage, way under square. That was blamed on weather and aberrant NGL prices, and everything was suppose to get better. Here we are in Q2, and apparently nothing has gotten better, coverage will be near Q1 levels, and they had to go to the banks to modify leverage ratios in order to keep up the distribution.

    In my mind, the recent recovery to over $8 in the wake of the LINE mess is a gift, a chance to bail on EROC and switch into LINE. You can do so today at almost exactly the same yield, and there's a much better chance for appreciation in LINE units besides . . . and, imho, a better chance to get your distributions covered.

  • Report this Comment On July 26, 2013, at 12:56 PM, zorro6204 wrote:

    I'll have to throw some cold water on EROC I'm afraid, I think there are safer plays. Management can forecast all manner of rosy scenarios, but their track record . . . stinks.

    Right from the start it was badly managed, the sponsor (NGP) created an unsustainable structure with subordinated management units that never had a chance to participate once the bloom came off gas prices. They entered the financial crisis over leveraged, and had to suspend the distribution. When the crisis abated and energy prices recovered a bit, they were able to hold the line, but then crammed a restructuring down the retail owners' throats that wiped out the distribution obligation built up during the suspension. The unit price collapsed.

    Once the new deal was in place leverage was restored to more normal levels, and the distribution was re-started, although at much lower levels. The unit price creeped back over $10 and then Q1 came along, where they whiffed badly, coverage was way under-square. Management blamed that on the weather and aberrant NGL pricing, and everything was suppose to get better. But it didn't, Q2 is apparently going to be just as bad, or close, and they had to go to the banks to amend the leverage covenant.

    In my opinion the recovery of the unit price over $8 in the wake of the LINE nonsense is a gift, a chance to bail out of EROC and into LINE at almost exactly the same yield, and with much better unit price appreciation potential. I'm way more comfortable with LINE's track record than EROC management.

  • Report this Comment On July 26, 2013, at 12:57 PM, zorro6204 wrote:

    I apologize if the above comment was repeated, the post button hung up.

  • Report this Comment On July 28, 2013, at 6:17 PM, TMFmd19 wrote:

    @zorro6204 - I agree, LINE is the better play and its where I've invested. Still, EROC is an interesting company to watch as the potential is there but lots of unknowns.


  • Report this Comment On July 28, 2013, at 8:25 PM, zorro6204 wrote:

    I didn't mention that they also sold off their mineral and royalty interests to Blackstone in May, 2010, at a time when oil was selling under $75. That $200M was needed to make the restructuring work, but in hindsight the only benefit was to the sponsor. It was suppose to free them up to pursue all manner of wonderful midstream projects, and they targeted a $1 distribution (I won't say promised). Instead they only delivered 88 cents, and in Q1 recorded dismal coverage of .64 on that. Even if they didn't have all the temporary problems they admitted coverage still would have been under water at .90.

    I'm not saying the future isn't bright, I'm no prophet. But based on the past I take management representations with a considerable grain of salt.

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