|Shares Out. (in M):||0||P/E|
|Market Cap (in $M):||450||P/FCF|
|Net Debt (in $M):||0||EBIT||0||0|
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We believe Gulfport Energy (Ticker: GPOR) represents a cheap, low-risk domestic E&P investment. The core of our investment thesis is based on the following factors:
- GPOR is a low-risk play in terms of geographic location of assets, balance of hydrocarbon production, and drilling success rate
- An investor is currently buying GPOR’s proved reserves at fair value of roughly 1.0x PV-10 value based on YE 2005 reserves. This basically implies that the market is only valuing existing proved reserves and is giving no credit to GPORs ability to prove-up and produce additional reserves. We view it as highly probable (almost a foregone conclusion) that GPOR will prove-up meaningful additional reserves
- GPOR should experience multi-year increases in production and reserves. The company can sustain this for years before they have to worry about the optics of peaking production
- We see a high probability that Street analysts will need to revise their 2007 estimates upward. This should happen sometime in the first half of 2007
- There are additional clear and highly probable 2007 catalysts that represent meaningful upside to the GPOR story
First and foremost we believe GPOR is a low risk E&P company. The company (and the investment thesis) faces commodity risk just like any name in the space. But, from an operational and exploratory standpoint GPOR is at the low-risk end of the spectrum relative to other E&P plays.
- Most importantly GPOR has very little ‘exploratory’ risk. GPOR has close to a 90% success rate in drilling wells. In fact, it does not really make sense to think of GPOR as having too much of an exploratory element. Really, they are closer to a development company. Their expertise is in finding and producing small pockets of reserves that previous large companies left behind. They have re-shot and reworked seismic on their key fields. They look for locations where a previous company had a producing well. They then try to determine if the previous well location was sub-optimal (meaning it did not hit the top of the hydrocarbon trap and therefore did not extract all of the oil and gas). GPOR then uses directional drilling to hit the top of the trap and extract the remaining oil and gas (“Attic Reserves”). This is a simple process (relative to other E&P activities) and GPOR should be able to continue this for many years on existing properties.
- Reserves and production are about 80% oil and 20% natural gas. This is in contrast to most domestic producers that that are largely NG. We prefer more exposure oil and less to gas since NG has proven to be a meaningfully more volatile commodity in recent years.
- 100% of GPOR’s reserves and production are domestic. We prefer to not to take political risk associated with foreign oil producing places like
- GPOR has virtually zero net debt and the business plan is self financing. Again this is in contrast to other E&P companies many of which carry high debt loads.
- GPOR has low lifting costs per Boe of $7-$9. These fields are economical even at much lower oil prices.
- Note: GPOR’s assets are near-shore and on-shore on the Gulf Coast of Louisiana – it goes without saying that this area faces hurricane risk. In fact all of their production was shut in during 2005 due to the storm surge associated with Hurricane Rita.
GPOR is trading at roughly 1.0x year-end 2005 PV-10 value. This means that (based on a 10% discount rate) the pre-tax NPV of developing, producing, and eventually abandoning the wells associated with GPORs existing proved reserves is the same as the current enterprise value. Thus, if they never proved up additional reserves and oil stays at $60 for the next 15 years then today’s Enterprise Value and the NAV are roughly equal.
But, we believe and GPOR has demonstrated historically that there is meaningful upside to proved reserves. NAV based solely on proved reserves is understated and the market is not assigning value to reserve upside. How do we know that more reserves will be proved up? Because:
- The majority of GPORs proved reserves and current production is at West Cote Blanch Bay (WCBB). Having reworked all the seismic on the field the company believes there is meaningful upside to existing proved reserves. But, their reserve auditor (Netherland Sewell) cannot give them credit for proved reserves unless GPOR submits substantial data packages on each proposed well site. Basically Netherland Sewell needs to agree that GPOR will be drilling structurally up-dip (at a higher point on the petroleum trap) to a previous producing well. If after much discussion and analysis NS agrees – then GPOR is given credit for a PUD (Proven Undeveloped Reserves) based on a portion of what they are likely to extract. The structural complexity and multiple pay zones at WCBB make this a arduous and time consuming interaction with NS. In 2005 and early 2006 GPOR only had two employees that were capable of preparing these data packages. During 2006 GPOR hired a number of other staff geologists / geophysicists / engineers to assist in the preparation of these data packages. As a result of this we believe that GPOR was meaningfully more active on this front in 2006 than in previous years. NS has been reviewing more data packages which should result in material growth in proved reserves. To put it simply: The whole WCBB field has the same type of geology as that found around the known WCBB PUD locations. It will just take some time to process the data, prepare the packages, discuss them with NS, and get credit for proved reserves. This process is accelerating though and evidence of this will be apparent in the YE 2006 reserve audit
- At the beginning of 2006 GPOR had 122 PUD locations at WCBB. The company believes there are at least 100 additional PUD locations that will come to bear at WCBB. But, because of GPOR’s understanding of their geology they do not only drill PUDs. In fact, as of the Q3 call management noted that of the 26 wells they had drilled thus far in 2006, only four were out of the base of 122 PUDs. This has a number of key effects. First, they do not deplete the existing inventory of PUDs – so, those reserves will be in the YE 2006 reserve audit as well. Also, by successfully drilling a non-PUD, the reserves associated with this new well become proved. GPOR’s success in drilling non-PUDs will by definition bring reserves into the proved category at year-end.
- There is a significant opportunity to prove up additional reserves at their second field (Hackberry). This opportunity is discussed in detail below.
Therefore we believe that we could see a 10% (at a minimum) to 20% increase in WCBB reserves at YE 2006. We believe this can be repeated in 2007 even with the ramp in production.
A lot of the upside to the GPOR story lies at their second field called Hackberry. The company commissioned a detailed 3D seismic shoot of this field and spent much of 2006 processing the data. The company is drilling its first well at WCBB and has already built the production barge that they will move to the field during spring 2007. So – the big question is will GPOR have the same success at Hackberry as they’ve had at WCBB? The facts are as follows:
- The geology is relatively similar to WCBB – both are salt domes that were historically large producers
- The field was largely abandoned 35 years ago when oil was much easier to find
- The quality of the data on the field is higher than at WCBB – 3D seismic of 1200 points per mile over 42 square miles. This means they can ‘see’ the geology and potential traps quite well.
- The field was mostly exploited using random drilling suggesting that many of the hydrocarbon traps were probably not drilled optimally. The strategy for exploiting much of this field is the same as for WCBB - - look at previous known producing wells and drill up-dip where hydrocarbons should remain. Again, there is not all that much complexity to this. That is why GPOR has 90% success at WCBB. We do not see a reason that they will not replicate this success at Hackberry. We believe they will have at least a 75% success rate.
- At present the company sees 40-50 initial potential drilling locations. Wells are expected to about 2x the reserve size as WCBB wells.
- GPOR started drilling its first Hackberry well in 4Q 2006. You can follow the well’s progress at: http://sonris-www.dnr.state.la.us/www_root/sonris_portal_1.htm. Use Sonris Light and look up wells by serial number. Use #233469. You can see that today’s update says WOCR – which means Waiting On Completion Rig. This is a good sign in that they have spent the money on production casing and clearly the well logs looked promising. The WOCR designation will likely remain until sometime in 1Q when they will perforate the well and run a pressure test. They are now using the drilling rig to on a new location – the #145 well we believe.
- By the end of 1Q they should have four wells drilled – and likely at least 3 of 4 will be successful. As well, they will have the production barge in place and Hackberry will start to become a contributor to production and reserve calculations.
To sum up the Hackberry opportunity – this is more or less a repeat of what they have done at WCBB. We do not see it as exploratory risk in the sense of, ‘will they find any oil at all?’ This field is a known producer. Rather, we believe a large percentage of the drilling prospects will become productive. Therefore, it is more a question of execution and timing. We think GPOR is just at the point of proving to the market that Hackberry will be a meaningful value driver for the company.
Multi-year Increases in Production
We believe that with WCBB alone GPOR can increase production at least through 2010. Layering Hackberry onto the profile will only extend the time horizon of production growth. This means that GPOR shareholders will not have to worry for years to come about the optics of peaking production.
Potential Upward Revisions to Guidance
Management has provided production guidance to the Street which does not include any production from Hackberry. We believe that at the end of 1Q both management and the Street will need to start including Hackberry in 2007 estimates.
Hackberry (and potentially WCBB) may have high impact deep gas reserves. In 2008 GPOR will likely drill a 14,000’ deep gas exploratory well at Hackberry. We do not assign any value to this but if they are successful it would represent meaningful upside.
GPOR invested in a 25% interest in a Canadian oil sands project. We see this as non-core and a somewhat complicating factor to the story. It would be in many ways easier if GPOR were just a pure play coastal
GPOR also has a small working interest in a large field in
Charles Davidson of Wexford owns about 40% of GPOR personally. His investment funds sold 20% of the company at $14.00 per share (they needed liquidity due to having held the position for some time). Charles himself did not sell any of his personal shares.
In terms of EBITDA multiples – GPOR does not seem cheap on a forward basis. But, production growth continues to be so dramatic that the multiples look much better heading into 2008. GPOR is only producing from 25% of their prospects at WCBB and obviously none of their prospects at Hackberry. Thus, current production and related revenues/EBITDA understates the cheapness of this asset.
At current share prices an investor is paying roughly fair value for current proved reserves at WCBB. But, due to reasons cited herein WCBB proved reserves should increase nicely in 2006 and for a number of years to come. This should provide valuation protection to the downside. WCBB cash flows will more than finance any capex of the company. Hackberry represents the upside to the story and we think evidence of the potential at Hackberry will soon become evident. This field is about to transform from a dormant piece of land with possible reserves to a producing field with proven reserves and material upside. The combination of these two fields will mean production growth and reserve growth for years to come.
All of this comes from a domestic set of assets that have very little exploration or development risk.
- 1Q update on the success at the first set of wells drilled at Hackberry. (The Louisiana Dept of Nat Resources website gives us an early read on the #143 well)
- Company / Street changes to estimates given the fact that Hackberry will be commercialized
- Increase in 2006 year-end reserves due mostly to increased efforts related to WCBB. This process should continue in 2007 at WCBB and Hackberry will be a contributor as well
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