Goodrich Petroleum: Here's 1 Thing Investors Are Overlooking

Goodrich Petroleum is down on initial results from its late couple of wells. However, I believe that the market has lost sight of one very important factor in the profitability of shale oil plays.

Jul 17, 2014 at 8:25AM

If you've been following Goodrich Petroleum (NYSE:GDP), a promising $1 billion exploration company in the nascent Tuscaloosa Marine Shale, you already know that the stock hasn't been doing so well lately. Just last month the stock was as high as $29, but has since dropped some 22%. 

Gdp Sharpchart

Chart by Sharpcharts

The reason for the downturn is pretty straightforward: a string of disappointing well results. Before we go over that, let's put this chart into historical context. See the big gap up on April 14? That was thanks to blockbuster results from the Blades 33H1 well, which yielded over 1,200 barrels of light, sweet crude oil on its initial day of production. Since then, the company has completed three additional wells.

Well (Spud date) Production

Beech Grove

(July 7)

740 BOE/d

Nunnery 12-1H-1

(June 18)

815 

Lewis 30-19H-1

(June 2)

1,450

The next well drilled, Lewis 30-19H-1, which yielded even better results than Blades did, lifted expectations even further. However, the two latest wells have given initial production rates well below that of the Lewis or Blades wells. It's no coincidence that the stock has been on a downward trend since mid-June: It is trading off initial production results. The initial production results were even enough to ding EnCana (NYSE:ECA), another Tuscaloosa heavyweight. 

But how relevant are initial production results? When an oil well is drilled, the first day of production is usually the best day by far. After that, an oil well begins the process of parabolic decline known as "the decline curve." While initial production rates are a good tool in indicating how a well will perform over its lifespan, it is not the only tool in the box. 

Like most independent oil companies, Goodrich gives the public a reasonable amount of information on how its average well performs over time. In the Tuscaloosa Marine Shale, the average Goodrich well will produce more than will the average Eagle Ford well, but less than will the average Bakken well. In other words, the Tuscaloosa Marine Shale produces volumes somewhere in between the two. 

Tms Rig

A rig in the Tuscaloosa Marine Shale. Source: TMS Facebook page.

Well cost is paramount
While initial production rates are important, we already have a basic idea of how the average well in the Tuscaloosa Marine Shale will perform: Somewhere between that of the Eagle Ford and the Bakken. That's great. But here's the catch: In this shale play, the oil is considerably deeper than in either the Bakken or Eagle Ford. Therefore, well costs are bound to be at least a little higher.

Currently the average non-development Goodrich well costs around $13 million to complete. At $95 realized oil, these wells will yield an internal return of somewhere between 31% and 61%. However, if Goodrich is able to bring well costs down to $10 million, which is indeed the company's long-term goal, returns will shift to between 62% and 122%. The Tuscaloosa will go from good to very good. Even at $10 million per well, there is much room for improvement. For example, the average Eagle Ford well costs below $7 million to drill.

I believe that, if Goodrich's engineers are successful, rates of return can consistently be above 100% in the Tuscaloosa Marine Shale. The Tuscaloosa Marine Shale, just like all other shale plays, will have good wells and bad wells, but we already have an idea of what the mean will roughly be. In the long run, drilling efficiency will be the determining factor, and I believe that Goodrich is very well positioned.

Foolish takeaway
Goodrich's latest couple wells have indeed been disappointing, but I believe that the market has gotten caught up in day-to-day news. The big picture continues to be great for Goodrich Petroleum. 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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