Quicksilver Resources' Barnett Shale Gamble

No, Quicksilver Resources (KWK) is not a silver or mercury mining outfit. Nor is it to be confused with Quiksilver Corp. (ZQK), an apparel company. Rather, it is a $900 million market cap., independent energy company. Quicksilver acquires, explores for, drills for and produces natural gas.

Quicksilver’s big story in 2008 has been its foray into Barnett shale gas of the Fort Worth basin of Texas. Here it competes with much larger companies such as Devon Energy (DVN), Chesapeake Energy (CHK) and XTO Energy (XTO).

In August, 2008 Quicksilver spent $1.3 billion for Barnett Shale assets in Denton and Tarrant counties, just as natural gas prices were peaking. For a billion dollars in cash plus 10,400,468 shares of common stock the company picked up 13,000 net acres potentially “containing more than 1 trillion cubic feet of recoverable natural gas resources including approximately 350 billion cubic feet of proved reserves” (see report here). At the time, natural gas was around $13 per 1000 cubic feet. Now, the price is only a little above $4 per 1000 cubic feet. Not surprisingly, Quicksilver, in the 4th quarter, took an impairment charge totaling $633.5 million on its oil and gas properties and lost $2,79 per diluted share (see conference call transcript).

This ill timed foray into the Barnett has in all likelihood contributed to the severely impacted the stock price. Currently, at $5.20/share, the stock is down almost 90% from its 52 week high of $44.98. Total debt of $2.61 billion dwarfs total cash of $2.85 million. Quicksilver was downgraded by Jefferies and Co. from buy to hold on February 26 of this year.

The Barnett shale is composed of sea deposits laid down in the Mississippian age, some 350 million years ago. New technology ,such as horizontal drilling, has opened up the Barnett shale to production in recent years. The “tight” structure of the shale has trapped a plentiful supplies of gas, but with the shale’s structure and 7,000 depth, it can be difficult and costly to tap.

Some of the most plentiful gas reserves in the Barnett shale are found directly under the city of Fort Worth. Churches, parks, the American Cancer Society, golf courses, residential areas and even the girl scouts have participated in the bonanza. Since the bust in natural gas prices in the last half of 2008, however, much of the bloom has come off the boom.

Drilling in the Barnett, as elsewhere, is down considerably. Companies like Quicksilver, with heavy investments in natural gas, may be just hanging on, waiting for higher prices to improve their balance sheets. The gas has been there hundreds of million years, it can afford to wait. The question is: can Quicksilver afford to wait?

Disclosure: No positions

Comments

[hounddog:]

Why did you not print the true facts on the KWK writedown? You wrote a slanted, negative article. Let's see a correction. The write down was reported in the third quarter as well as fourth quarter, but you did not these releases. Very poor job and lack of investigation.

Mar 05 07:44 AM

[Eric Fox:]

Author is correct - from the 4th quarter press release:

"an impairment charge of $633.5 million ($411.8 million after tax) in the 2008 quarter related to the company's oil and gas properties."

Mar 05 07:48 AM

[Eric Fox:]

Third quarter press release:

biz.yahoo.com/iw/08110...

No impairments related to properties

Mar 05 07:51 AM

[DrBill:]

And, KWK has hedged I believe over 80% of planned 2009-2010 production at much higher prices. This should be considered.

Mar 05 08:12 AM

[jerrion:]

Approximately 76% of their 2009 natural gas production is hedged, with a weighted average floor of $8.66, and a ceiling of $10.96. If need be they could further cut capital expenditures for 2009 and 2010 and just complete enough wells to keep production flat and produce at least what they have hedged for 2009 and 2010. Plus their costs of drilling completing wells is 20 to 30 % lower than 2008 levels. Even though they bought the properties at the peak in natural gas prices they hedged to make sure they had sufficient cash flow to meet obligations and fund capital expenditures. They should (can't guarantee anything especially now) be able to suvive this downturn. Drilling for most Natural gas companies has slowed significantly and most conventional wells have high decline rates, therefore prices will comeback with a vengence just not sure when.

Mar 05 12:01 PM

[jerrion:]

There was a loss in the 3rd quarter related to investment in a partnerhsip, but this was not an impairment of oil and gas properties. The author is correct impairment took place at year end not in the 3rd quarter.

Mar 05 12:55 PM

[Breck:]

This is a very well run and managed company with some of the upsteam energy industry's finest technical hands. Dramatic oil and gas price fluctuations are characteristic of the industry and have occurred several times in recent history. Unfortunately, like almost every publically traded company in America, Quicksilver's stock price is way off its high and will require an economic recovery or a significant natural gas shortage before it can regain stock price strength. However, their debt position is manageable and its unlikely that their lenders will abandon them even if things get worse. It's a great buy at current prices if you're a long term investor. Why? Because its proven reserves and future prospects will easily exceed its total debt once gas prices stabalize at a more normal level. This will occur sooner than most think.

Mar 05 02:17 PM

[Bruce Vande...:]

Thanks everyone for the comments. I did not mean to be overly negative. The management and technical people may be great. I did, however, want to point out the timing the the Barnett Shale investment was bad. I might also note that Forbes ran an article at time questioning the price Quicksilver was paying (this while gas prices were still over $9). I chose not to include the Forbes article in the post.

I too think gas prices will rebound big time, just doesn't seem anytime real soon.

Mar 05 06:01 PM

[Eric Fox:]

The company has to do another revaluation of its properties at the end of the second quarter of 2009. If gas prices are the same price then that they are at now, then it is likely that they will breach a covenant with lenders.

"The value of Quicksilver's reserves, measured on a PV-10 basis must equal at least 1.5 times its debt. Also, Quicksilver owns a stake in BreitBurn Energy Partners, and 50% of BBEP's fair market value is added to the numerator when calculating the 1.5 times debt level. "

Mar 06 06:55 AM

[AEB:]

Quicksilver has been active in the Barnett Shale play since 2003, and began drilling in January 2004. There was no 2008 "foray" , just a badly-timed expansion in the "core area" of the play.Quicksilver had focused on the surrounding counties (mostly Hood and Hill counties), but had acreage and drilled wells in the core area in Johnson and Tarrant counties also since 2004. If there was a foray, it was into Denton County where they had not been active before.

Regarding all the negative reactions to Vanderveen's implied criticism of Quicksilver, I think that he is right on. Hedges notwithstanding, how stupid is it to buy into the most overpriced acreage in the play at the highest price-point in the market, and then watch gas prices lose 2/3 of their value? If that is good management, I would love to see an example of poor management!

It amazes me how many people--inlcuding the many bloggers who jumped all over Vanderveen's observations--with investment backgrounds think that they know anything about the oil and gas business. I wonder why you guys don't talk to people inside the industry--like geologists?

I am a geologist, and I have struggled to understand the fascination of the investment community with shale plays. I think that they are all stock scams, in which the executives of public companies get rich because people who don't know anything about oil and gas buy stock and inflate its value (in better times). I've been in oil and gas for 31 years and wouldn't advise anyone to put a nickel in the Barnett Shale geologically or economically. Take a look at Quicksilver's debt sometime, then ask how many of their wells will ever break-even, much less make money. You will be amazed!

Mar 06 07:10 AM

[Eric Fox:]

AEB,

Would you level the same criticism at Devon and EOG for getting into the Barnett at all? Or is it the timing of Quicksilver?

Mar 06 09:36 AM

[AEB:]

Devon currently operates about 3,300 wells in the Barnett Shale, and most of these are marginally commercial or non-commercial. Devon acquired Mitchell Energy's position in the Barnett, and Mitchell began the play. Devon's error, therefore, was not buying into the play after prices and costs had soared like Quicksilver. Devon's mistakes are over-exposure to the play, and some fundamental inability to address the commercial realities of shale gas. In the current issue of the AAPG Explorer, there is an interesting article (www.aapg.org/explorer/...) about a University of Oklahoma study of the geology and geophysics of the Barnett Shale sponsored by Devon. Maybe they realize at this late date that fundamentals must be addressed. If so, good for them, but perhaps not so good for shareholders that have already lost value.

Devon, of course, is a competely different type of company from Quicksilver. Devon is a global independent with broadly diversified assets, so perhaps they can absorb losses in the Barnett Shale. On the other hand, their cost structure is much higher than a company like Quicksilver, meaning that it takes larger resources and more profit to pay for the overhead of all of those people who don't contribute to the core business of finding oil and gas.

If you haven't already browsed to my blog, I have a thorough explanation of what I think is going on in shale plays: petroleumtruthreport.b.../ . It is a bewidlering phenomenon because these plays make little commercial sense, yet investors are happy to shovel billions into them.

AEB

Mar 06 10:48 AM

[AEB:]

Eric,

I forgot to address the part of your question about EOG. EOG is one of the
best of the (bad) lot on unconventional plays. I don't know that much about their participation in the overall Barnett Shale play, but I did an analysis of Tarrant County last April (Tarrant County has some of the "best" core production--that's where Chesapeake paid $20k/acre for the DFW Airport leases).

In that analysis (using $6.25/MMBtu gas price--a dream today), these were the results for percent of wells by operator that met economic threshold:

Encana

Mar 06 11:08 AM

[AEB:]

Eric,

I forgot to address the part of your question about EOG. EOG is one of the
best of the (bad) lot on unconventional plays. I don't know that much about their participation in the overall Barnett Shale play, but I did an analysis of Tarrant County last April (Tarrant County has some of the "best" core production--that's where Chesapeake paid $20k/acre for the DFW Airport leases).

In that analysis (using $6.25/MMBtu gas price--a dream today), these were the results for percent of wells by operator that met economic threshold:

Encana 41%
EOG 39%
XTO 39%
CHK 25%
Devon 19%

Those "success" rates (I cannot imagine justifying wildcat wells based on a 20% or lower success rate, and this is field development!) are against a background of an average of 25% payout by all operators, not just the 5 that I listed.

I think that EOG shifted its focus to the more oil-prone, less thermally mature part of the Barnett after I did that study. That seemed like a good idea when oil prices were above $125/barrel, but probably doesn't look so good now. The problem with the oil play is lower relative permeability to oil vs. gas (it's a bigger molecule to fit through tiny pores), and lower porosity because of some kerogen conversion volumetric factors that you certainly would not be interested in!

I do not invest in oil and gas companies but, if I did, I would choose ExxonMobil and stay away from the amateurs!

AEB

Mar 06 11:16 AM

[Shale Gas:]

For those concerned about groundwater contamination by frac fluids, a study done in the Fayetteville Shale said that it would take more than 800,000 years for frac fluid to vertically migrate from a well drilled at a depth of 4,000 feet to reach an aquifer at a depth of 750 feet.

Jun 06 11:42 AM

[Martin Smith:]

What do you say about Gulftex Operating?
Today Gulftex Operating, Inc. has a successful exploration, drilling and production track record participating in over 35 wells in the Barnett Shale. The Gulftex record includes an impressive 19 wells in the core area of the Barnett Shale.

Jul 20 10:44 AM