Magnum Hunter Resources Quietly Secures Stake in the Next Big Play

Magnum Hunter Resources believes it has found the next big shale play in the land down under.

Jan 21, 2014 at 1:10PM

In virtual silence, Magnum Hunter Resources (NYSE:MHR) locked up access to what it believes is the next big shale play. What is just as remarkable is that it went around the world on a quest to find this resource. For a company with limited resources, and one that's selling assets to drill on the land it already has, it didn't appear that Magnum Hunter needed anything else on its plate.

However, Executive Vice President of Exploration Kip Ferguson said the company actually looked at Colombia, Mexico, Argentina, Poland, and China for its next shale buy. Bloomberg reported that Magnum Hunter settled on Australia for its next move.

Digging deeper into the deal
Investors might remember that the company announced last month that it was exiting the rest of its position in Texas via an option deal with Australia's New Standard Energy. That option, if exercised, calls for New Standard to pay Magnum Hunter about $25 million for the acreage in Texas that is prospective for the Pearsall and Eagle Ford shales. Magnum Hunter would receive $15 million in cash and $9.5 million of New Standard Energy's stock. That equity stake will actually make Magnum Hunter Resources the largest shareholder of New Standard Energy, holding 17% of its equity, according a filing with the SEC.

What Magnum Hunter investors probably don't know is that there is more to the story. Magnum Hunter isn't simply unloading the rest of its acreage in Texas. Instead, the company is forming a strategic alliance with New Standard. Part of this will involve providing technical expertise to New Standard as it develops the Cooper Basin in Australia. Magnum Hunter will also offer operational oversight as Ferguson joins the New Standard board of directors. This adds some hidden upside to Magnum Hunter Resources, as well as a huge helping of risk.

Australian shale
According to the U.S. Energy Information Administration, or EIA, Australia holds the seventh-largest shale gas resource in the world. It's also sixth in oil shale resources. However, what caught Magnum Hunter's eye, as well as the attention of global giants like ConocoPhillips (NYSE:COP) and Chevron (NYSE:CVX), is the fact that Australia is a much less risky country to invest in than some of the other top shale resource opportunities. The country has a long history of working with foreign investors to unlock its vast natural resources. When combining that with the sheer potential of the play, it makes for a fairly compelling opportunity.

That said, there are real risks that the Australian shale will prove to be just as tough a rock to frack as other promising locales like Argentina, Poland, and China. Australian shale drilling costs as much as three times as shale drilling in the U.S. However, the EIA believes that the Cooper Basin in Australia could be the first of its six potential shale basins to produce commercial hydrocarbons, with initial results from vertical test wells providing encouraging results.

Investor takeaway
Magnum Hunter is potentially getting in early on what could be one of the first new shale plays to emerge outside of North America. Furthermore, by taking a direct stake in the company pursing the development, it's reducing some risk because it won't be investing directly in a foreign country. At $9.5 million, its equity stake represents no more than an investment in one well in the U.S.

However, if Magnum Hunter does start pumping more money into shale drilling in Australia, or it takes more time to pursue shale fueled growth outside the U.S., it could have a negative impact on the company. That said, at this point this is simply an interesting development that's worth watching.

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Fool contributor Matt DiLallo owns shares of ConocoPhillips. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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