The most obvious way for oil companies to create value is through production. Selling oil and spilling cash is pretty easy to understand. Chasing those names building production rapidly is equally easy to understand. Companies creating value by other means are a tougher sell for management. Situations like this create value opportunities for investors.
Two paths to value
EPL Oil & Gas (NYSE: EPL ) and Energy XXI (NASDAQ: EXXI ) are each creating value for investors by different means. EPL emerged from bankruptcy in 2009 using its new lease on life to accumulate oil-rich legacy assets in and around the mouth of the Mississippi river.
It completed four acquisitions in three and a half years, growing production 40% annually. This is the kind of growth that spurs big returns, and shareholders saw a 330% return over that timeframe.
If you turn back the clock, EPL looks much like Energy XXI (NASDAQ: EXXI ) , another Junior with a similar game plan, that's just a little later in its lifecycle. From its 2005 launch with a $300 million dollar IPO, CEO John Schiller built a company with an Enterprise Value of almost $4 billion.
Growth was rapid as Energy XXI folded in two major acquisitions. Production almost doubled in two years as a result. Unfortunately, it's been a rocky road since then. The company hit a 50 MBOEd (thousand barrels of oil equivalent per day) glass ceiling on production, and delays in its high profile Ultradeep partnership with McMoRan changed the tenor of the news flow.
Investors drawn by that past burst of growth ran for greener pastures, leaving shares directionless, even as Schiller maneuvered to create value. In some ways, Energy XXI is a different company than it was just a couple of years ago, and the new story has proven a tough sell.
New life for old fields
Both operate oil fields in the same central region of the Gulf of Mexico shelf. These fields simply weren't a priority for their former owners. Just investing new cash can make a world of difference by adding production and even new reserves.
Energy XXI recently borrowed a piece of the onshore playbook, drilling horizontals in some of its fields. Horizontal wells provide more complete field drainage and decreased decline rates. The Estimated Ultimate Recoveries, or EUR on these horizontals far exceed comparable verticals .
The program created substantial value in the last fiscal year. Reserves were up 50 % and most of that increase was organic. There were 62 MMBOE of organic additions, with 28 MMBOE coming from one field alone. That created $2 billion in value as the PV-10 of proved reserves jumped to $6.1 billion.
Unfortunately, few investors noticed as production problems came to the forefront. The needle's stuck around 50 MBOEd. To make matters worse, a hiccup in its horizontal program forced management to reevaluate plans, collect more data and cut back its rig count.
Drilling will focus on the two fields geologically best suited to horizontal development, and cash saved from pared back development will be returned to shareholders. Management raised the dividend payment by 71% and set a $250 million share buy-back in place.
High impact exploration
One problem for Juniors is often a lack of high profile exploration. Striking it rich with a huge find isn't likely with an acquire-and-exploit strategy.
Energy XXI has looked to get some high profile exposure through joint ventures with mixed success. While its McMoRan-partnered Ultradeep project delivered some very large discoveries, it's been plagued by production delays. Delays became such a problem that McMoRan was forced to merge with step-sister Freeport-McMoRan (NYSE: FCX ) as it ran through its cash.
While the project itself is ongoing, it's been slowed and the focus has moved onshore with new partner Chevron. Two wells are in progress, but news flow has dried up. Chevron and Freeport-McMoRan are tight-lipped, with the only news available being that Davy Jones #2, the second well in the program, could begin completion efforts early in 2014.
Apache (NYSE: APA ) and Energy XXI are acquiring new seismic data in and around Main Pass by re-imaging areas around salt domes. The first well, Heron, has shown evidence of hydrocarbons as it works toward final depth. Energy XXI holds a 25% working interest in the JV.
A similar project with ExxonMobil (NYSE: XOM ) covers 11 blocks in the Vermilion area with 50% interest. In line with its current string of luck, the first well encountered mechanical problems and was abandoned. Merlin, the second well is nearly to depth. There are also hydrocarbon signs here, but management remains muted in its comments.
Both Heron and Merlin could exceed 100 MMBOE in gross reserves. There's a lot on the line here, since these are big reservoirs that can add a great deal of value if everything works out.
A buying opportunity
Bumps in the road put Energy XXI in the doghouse. Untimely delays and growing pains in its horizontal program derailed its momentum. What was once a fast-grower like EPL is now a company trying to create value by other means.
Management refocused its drilling program and rerouted its strong cash flow, reducing capex and returning more cash to shareholders by raising the dividend and aggressively buying back shares. Shares remain down 20% from their 2012 high, despite a 50% increase in year-end reserves. And there's more potential upside on the horizon with two large JV projects on the cusp of delivering news. For those with a long term perspective, this looks like a good opportunity to buy this well-run Gulf of Mexico Junior.
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