The Shorts Are Wrong About This Natural Gas Company

Lot's of people don't like Ultra Petroleum (NYSE: UPL  ) . 24.4% of the company's float is currently shorted, making it the 45th most hated stock on the New York Exchange. After the crash in natural gas prices, Ultra's position in the market looked far from favorable. Today, with natural gas prices picking back up and Ultra's operations becoming more efficient; that short position is looking less and less attractive each day. Let's dig deeper into Ultra's numbers to see why the company should put this bearish sentiment to bed.

Disappearing reserves?
On the surface, Ultra Petroleum violated of one of the cardinal sins of exploration and production companies in 2012: Always grow your reserves. If you dig deeper, though, you see that a loss in reserves was not something completely unique to Ultra.

Company Proved Reserves Dec, 31, 2011 (in billion cubic feet equivalent) Proved Reserves Dec 31, 2012 % Change
Ultra Petroleim 3,075 4,977 (38.2%)
EXCO Resources (NYSE: XCO  ) 1,291 936 (27.4%)
Chesapeake Energy (NYSE: CHK  ) 15,690 18,789 (16.5%)
Southwestern Energy  4,018 5,893 (31.8%)

Source: Company 10-Ks

Even though Chesapeake did sell off over $10.8 billion in assets in 2012, 56% of that drop in proved reserves came from downward revisions in their natural gas assets from lower prices. The one thing that all of these companies share in common is that they are primarily natural gas companies. Or at least Chesapeake and EXCO were back in 2012. Today, both companies are looking to diversify into more more liquids-rich plays. 

The reason that so many companies' reserves fell off a cliff is because proved reserves that are reported on an SEC document are actually a complicated calculation based on the total oil or gas in place, current operating costs, and the price oil and gas has sold at for the past 12 months. So in 2012, these companies had to report its reserves based on a gas price of around $2.63. As we continue to see natural gas prices pick up and exploration and production companies get better at shale drilling, these proved reserve numbers will pick back up. In fact, Ultra estimates that if prices remain in the $3.50 range, its 3P reserves--proved, probable, and possible-- will more than double what they were at the end of 2012.

Source: Ultra Petroleum Investor Relations

Better bottom line
If you held shares in Ultra last year this time and got out, no one would blame you. The company took a gut-wrenching $1.2 billion loss to earnings in large part from that big asset write down. With capital expenditures exceeding cash flow, a growing debt situation, and no clear sight of improving natural gas prices made hanging onto Ultra's shares seem like financial suicide. 

Fortunately, this situation is improving. The company exhibiting some financial discipline and operational efficiencies. Much like the rest of the gas drilling world, Ultra has embarked on a drilling efficiency program that has brought down individual well costs by 6.4% so far this year and is expected to decrease by a total of 11% this year, which further solidifies the company's position as a low-cost gas producer. Thanks to these improvements, the company has now kept capital expenditures within its operational cash flow for four straight quarters and breaks even when gas prices are at $2.80.

The one thing that may make investors nervous is that large cut in capital expenditures, which is about half what it was in 2012. With decline rates for shale gas so high, companies need to keep a pretty high drilling pace just to keep up with the decline. This is actually less of a problem for Ultra because its Jonah and Pinedale field assets, which account for 72% of the company's production, have decline rates in the mid-20s. This is in stark contrast to places like the Barnett and Haynesville shale plays that have decline rates of 55% and 86%, respectively. This is a major reason why master limited partnership Linn Energy (NASDAQ: LINE  ) bought into the Jonah and Pinedale fields of Wyoming last year. Gas wells in these fields have a long life that will generate cash for years to come, a perfect fit for an exploration and production MLP.

What a Fool believes
2012 gave Ultra Petroleum a large slap on the wrist. At the time its capital expenditure plans were just simply too much for it to handle considering the declining price environment for natural gas. Now that prices have stabilized and the company is no longer growing for growth's sake, it should be in a good position for the future. If you are short Ultra Petroleum, it is definitely worth your time to reconsider that position.

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  • Report this Comment On September 20, 2013, at 3:36 PM, Coltaims wrote:

    Nice Work!

    Finally someone explained the accounting around asset valuation for E&P natural gas companies.

    Did not realize that well draw down was so high in some areas...I would suspect that draw-down is not linear thing though?

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