How to Research an Oil Stock: Part 5

In part 2 of my dissection of Gulfport Energy (NASDAQ:GPOR), I explained that I started with mundane details like options outstanding and credit facility status, rather than the big picture, because if there are problems with the former, I'm less likely to be interested in the story. Almost every public company can tell a good story. For Gulfport, a big part of that story is the Canadian oil sands.

My sweet Athabasca home
Back in 2006, Gulfport picked up a 25% stake in Grizzly Oil Sands for $8.2 million. Grizzly is a private company, the remainder of which is owned by entities controlled by Wexford Capital. Yes, that Wexford -- the one we met in part 2.

In its 2006 10-K, Gulfport raised the possibility of Grizzly building a 10,000 barrel/day steam-assisted gravity drainage (SAGD) facility with initial production as soon as 2009. Gross capital expenditures were pegged at $195 million, or a little under $49 million net to Gulfport.

SAGD projects, compared to massive open pit operations like Royal Dutch Shell's (NYSE:RDS-A) Muskeg River mine, are attractive for a numbers of reasons. Suncor Energy (NYSE:SU) lists four on its website:

• Resource access (only ~15% of the oil sands are amenable to mining).
• Staged growth.
• Reduced environmental footprint (i.e., closed-loop water recycling and no tailings ponds).
• Potential for lower costs.

Cost creep and commodity crash
We know what happened to costs in the oil sands after 2006 -- material and labor shortages put the squeeze on. By late 2008, Canadian Natural Resources (NYSE:CNQ) was 36% over budget at Horizon, and Teck Resources' Fort Hills project cost estimate had ballooned by 50%.

Gulfport's own gross cost estimate for that first SAGD facility rose from $195 million to "between $225.0 million and $250.0 million" in the summer of 2007, and then to $325 million by the time the company filed its 2007 10-K. The date of potential first oil was also pushed back from 2009 to 2011.

In 2008, oil prices tumbled and Grizzly postponed significant capital spending. That was unfortunate timing, given that the company had just brought on John Pearce as CEO. Pearce used to manage Canadian thermal oil development at Devon Energy (NYSE:DVN), including that of Jackfish -- a 35,000 barrel/day SAGD operation.

Grizzly's hibernation has probably pushed potential startup past 2011, but Gulfport did report that the company plans to file a regulatory application for the Algar Lake project by year's end.

What have they spent?
While Gulfport reports its net investment in Grizzly at $22.7 million, this understates the amount of cash, including amounts extended under a loan agreement, that has been plowed into the venture:

Data from company filings.

Gulfport has thus coughed up $39.5 million, 74% more than the "net investment" reported. The firm has taken various writedowns, including some big currency translation losses, which account for the lower carrying value.

That $39.5 million represents about 15% of operating cash flows generated during this period. It's a significant sum, considering the liquidity situation described in part 1. Maybe if Gulfport asks nicely, it can get back its loan, carried on the books at $12.8 million and due upon maturity in 2012?

About the acreage
When Gulfport first talked about investing in Grizzly, the latter had 115,000 acres under lease in Athabasca. By early 2007, that figure jumped to 315,000 acres, and it leaped again to 511,000 later that year. That's where the number stands today.

Adjacent to Grizzly's Algar Lake project are Suncor's proposed Meadow Creek in situ project, JACOS' long-running SAGD pilot (which it's looking to expand to 35,000 barrels per day in partnership with Nexen (NYSE:NXY)), and Southern Pacific Resources' Hangingstone West project, which has seen some preliminary core drilling.

So how much oil's up there?
In 2007, Gulfport relayed some resource estimates by DeGolyer & MacNaughton, a reputable petroleum consultant:

Data from company press release.

Across the seven properties it evaluated (covering one-third of Grizzly's acreage), D&M estimated 11.9 billion barrels in place.

You can screw your eyeballs back into their sockets now. Original oil in place (OOIP) accounts for every last drop. No oil recovery technique achieves a 100% recovery factor. That's why folks like Denbury Resources (NYSE:DNR) are able to step in and breathe new life into old fields using enhanced recovery techniques.

Gulfport also reported that Grizzly had estimated 4 billion barrels of recoverable resources on these seven properties. "Resources" are technically, but not necessarily economically, recoverable. In that release, Gulfport did not choose to share D&M's estimate of 387 million barrels of probable and possible reserves -- which do consider economics. That would be 96.8 million barrels net to Gulfport.

We'll ballpark the economic value of this oil sands interest, plus the rest of Gulfport's assets, in our final installment.