May 20, 2011 - 6:28am EST by
2011 2012
Price: 17.35 EPS na na
Shares Out. (in M): 221 P/E na na
Market Cap (in $M): 3,837 P/FCF na na
Net Debt (in $M): -536 EBIT 0 0
TEV ($): 3,301 TEV/EBIT na na

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McMoran Exploration Co. has a profile few sell-side analysts could love.  First of all, take that dirty word "exploration" in its name.    Didn't they get the memo which says small cap energy companies are supposed to buy land, then present Wall Street with a neat schedule of cookie-cutter wells to be drilled in the latest hot play?  (The name of the game is "predictable production growth," not "exploration.")  But MMR operates in the Gulf of Mexico (the ne plus ultra of NOT HOT.)  And they drill for GAS, not oil (must have failed to get that memo too.)  And did I mention that their gas is basically UNHEDGED?

So the first positive, as you might guess, is that there's not a lot of love baked into MMR's stock price.  What MMR DOES have going for it is a slew of major near-term catalysts, visionary, determined leadership, and a great, high-concept exploration play -- the ultra-deep shelf.

MMR is the creation of legendary geologist Jim-Bob Moffet, who also founded Freeport-McMoran, the giant copper and gold company.  People said he was crazy when, with a mosquito-sized company, he set out to find and develop the huge Grasberg mine in Indonesia. He proved them wrong, but there's the same level of skepticism about what McMoran is doing in the Gulf now.

The rap against the Gulf shelf has been that all the big finds there have been made long ago leaving only small, rapidly depleted reservoirs for current explorers.  That's true if you only drill to 5,000 feet.  But half a dozen years ago Moffett started looking for deep gas (below 15,000 feet) on the shelf and found Flatrock, a major field (about 400bcfe in size) that, years later, is still producing at about 200 mmcfe/d - so much for the Gulf rapid depletion theory applying to Deep Gas.  MMR is continuing its deep gas program and has just brought discovery Laphroaig#2 on line (28.5% NRI) flowing over 55 mmcfe/d with a lower-risk Laphroaig offset planned. The company is currently drilling three more deep gas prospects.  Hurricane Deep, in which it has a 39% net revenue interest, could double the size of the Flatrock field and is currently drilling at 18,500 feet with 20,000 the planned total depth.  Boudin (59% NRI) and Brazos (81% NRI) are also major wells currently drilling and near total depth.  But as significant as these wells may be, Deep Shelf Gas is no longer the Main Event.  MMR's stock will now rise or fall on the fate of the Ultra-Deep.

It began when geologist Moffett asked himself why the big producing sands in deepwater -- wells like Cascade and Thunderhorse -- were found on land, and then again in the deepwater, but not on the shelf?  So he started drilling ultra-deep (30,000 feet and below) trying to find the Wilcox and the Miocene -- and he did.  At Blackbeard West, MMR successfully completed a well Exxon had begun then abandoned due to well control issues.  Because of the ultra-deep's high temperatures and pressures, McMoran had to temporarily abandon the Blackbeard West discovery until custom high pressure and temperature completion equipment could be developed and manufactured.  Imagine the skepticism!  Short-sellers' heaven.  (After all, aren't nice little $400,000 land wells drilled and completed right away?)  The Ultra-Deep is the next frontier, and many professional investors like repeating what Liberty's John Malone said was the fate of pioneers (they end up with arrows in their backs.)

But, as noted, CEO Moffett has a history of executing the extraordinary (boldly digging where no man had dug before -- creating the Grasberg Mine.)  Instead of a back full of arrows, he ended up with huge pots of gold.  Can he do it again?  So, while waiting for the special completion equipment, MMR and its partners have kept busy leasing up 15 prospects which they believe are basically all the large structures on the shelf with ties to producing deepwater trends.  These 15 prospects represent over 30 Tcfe of gross and over 14 Tcfe net to McMoran of unrisked potential.  Just to put the size of this opportunity in perspective, bear in mind that MMR had just 280 Bcfe of proved reserves at last year's end.

But how can such a little company do this?  The answer is: they're doing it.  It helps that what's deep about the Ultra-Deep isn't the water.  Importantly, from a cost and speed of development standpoint, Ultra-Deep wells are actually drilled in SHALLOW water, recovering near deepwater sized resources at a fraction of the time and expense.  Thanks to a private placement of $900MM in converts, MMR ended 2010 with $906MM in cash.  (In 2011 they should produce $220 MM in EBITDAX from their deep gas properties.  This, plus their cash will fund company capex of $300-500MM, depending on opportunities.  Other capex cash will come from well partners.

After Blackbeard West, McMoran drilled the ultra-deep Davy Jones discovery and is currently drilling a Davy Jones offset, with the huge Davy Jones structure thought to contain several Tcfe of gas.  MMR is also currently drilling ultra-deep prospects Lafitte and Blackbeard East.  By now, much of the special ultra-deep completion equipment first ordered after the Blackbeard West discovery has been designed and manufactured.  The final piece, a massive blow-out preventer, is still on schedule for October delivery.  

Let the flow tests begin!   The first ultra-deep well to be tested and put on production should be the Davy Jones Discovery well in December of this year.  If that well ends up producing 75MMcfe/d as expected, short-sellers will NOT be having a nice day.

But bulls don't have to wait for year's end.  There are plenty of CATALYSTS before that.  First, often overlooked Deep Shelf prospects Hurricane Deep, Boudin and Brazos A-23 are all near total depth with news from Hurricane deep possible in as little time as a few weeks.  Although small by Ultra-Deep standards, if successful, MMR's share of these finds, along with the recent Laphroaig discovery, could potentially double reserves.  Then there's the drumbeat of upcoming Ultra-Deep news:  1) The log from the Davy Jones offset should be completed, interpreted and released within the next 2-4 weeks, helping the market to get a better sense of the size of this discovery.  2) Some pipe lost downhole at Blackbeard East is expected to be retrieved with logging and drilling the last 1000 feet there expected to resume within 3 weeks.  There's so much going on, Wall Street really hasn't focused on the 178 net feet of hydrocarbons already found in the logged upper portion of Blackbeard East.  Located above 25,000 feet, this Deep (as opposed to Ultra-Deep) find would be a separate development with wells costing under $50MM each (Ultra-Deep development wells will cost between 100-125MM.)  MMR has said that, once they finish Blackbeard East's downhole exploration, they will put a rig to work delineating this shallower play (believed to hold 300-500bcfe of gas and liquids right away.)  3) A third Ultra-Deep well, Lafitte, is currently drilling below 20,000 feet to a total expected depth of 29,500.  Results for this well should also be known by mid-late summer.  4) Also of interest will be the choice of the next Ultra-Deep prospect and new potential well partners.  Chevron has an interest in the England Ultra-Deep prospect with MMR holding rights as well. Talk of Chevron possibly buying MMR will heat up if the two of them drill this well together. (Go to the Chevron website and play their recent investor presentation -- in which they talk about one of their two key focus areas, the GOM ultra-deep.) Throughout the fall investors also will be monitoring the arrival of the custom ultra-deep completion equipment.  If the Davy Jones Exploration Well has a successful flow test as planned and is put on production by year's end, it will hugely de-risk the play.  (It's expected to produce at 75MMcfe/d.)  Davy Two should be put on production a quarter or so after, that at around 100MMcfe/d.  (The discovery well was drilled with narrower pipe.)

According to MMR ultra-deep partner Energy EXXI, ultra-deep gas can be produced for an all in of $2 an mcfe -- and that's 100% dry gas.  With liquids it becomes profitable at $1.50mcfe.  While ultra-deep gas is expected not to have liquids, deep gas is about 30% liquids.  (So while Oil Wannabe Gas Co's like CHK are still over 90% gas while touting their liquids, MMR has always had a 70% gas to 30% liquids mix.)

So what's the upside here?  In MMR you have a company with 280 Bcfe of proved reserves exposing itself to wells with multi Tcfes of net potential.  You have a company producing 190MMcfe/d now which could be doubling that by the end 2012 (48% NRI in the Davy Jones wells, plus Blackbeard West being put on line, plus the 56% net revenue interest in Blackbeard East where they're planning a shallower production as well.) Beyond 2012, more development and on-going exploration (the company expects to keep three exploration rigs going in the ultra-deep) should lead to massive growth for many years to come.

One way to look at MMR's value is to take the cash and PV10 value of the proved reserves and then take a guess as to what Davey Jones could be worth to the company.  MMR's share of Davey Jones is estimated at 3 Tcf.. If you value that at $1 per Mcf, Davey Jones is worth $13.56 to MMR for a s total of $20.16 per share.  You get all the rest of their massive acreage for nothing, acreage that could have another 13+ Tcf of reserves.  While we are dreaming, at $1 per Mcf, MMR would be worth almost $80 a share.  At current levels, you are creating that outcome at only $0.21 per Mcf.  There are many in the industry who think even that these numbers could be too low.

Will Davy Jones be a 10 development well project as the company expects? (Each development well is expected to flow at 75-100MMcfe a day.) And what about Blackbeard?  Lafitte?  Or Queen Anne's Revenge and Barataria (rumored to be among the next to be drilled), or the joint effort with Chevron, England?  It all sort of gives new meaning to the phrase "prospect rich."

Of course, bad things can happen.  Disappointment in this or that zone or well may hit the stock for a few dollars for a few days, but there are so many things going on, it would be hard to get stuck there.  When disaster struck in the Gulf thanks to Macondo, MMR went to $8.50 for a day then bounced around between $10-12 that summer when Anadarko was $35.  That was during a sector-wide catastrophe and before several discoveries, so one would think $10-12 is your absolute downside. The only potential disaster that could land you there would be if the Davy Jones well failed to flow...

But if it flows, as a bear said to me, "The sky is the limit."  Even the shorts will stop wondering if this is a major discovery.  The only question will be which major buys them and at what price.



Davey Jones, and multiple more discoveries down the road.
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