Gastar Exploration's CEO Presents at the Johnson Rice & Company 2013 Energy Conference (Transcript)

| About: Gastar Exploration (GST)

Start Time: 15:05

End Time: 15:29

Gastar Exploration Ltd. (NYSEMKT:GST)

Company Conference Presentation

September 30, 2013, 15:05 PM ET

Executives

J. Russell Porter - President and CEO

Analysts

Donald Crist, Jr. - Johnson Rice & Company

Donald Crist, Jr. - Johnson Rice & Company

Okay. We're going to go ahead and get started on our next presentation here with Gastar Exploration, a small cap E&P company focused in liquids-rich in Marcellus and newly acquired Hunton Lime in the midcontinent where they recently drilled their first operated well. Recent acquisitions and divestitures and sale of debt has fully funded this company through 2015.

And with that, we're pleased to have Russ Porter, CEO, back with us again in our conference. Russ.

J. Russell Porter

Thanks, Don. Thank you everyone for coming by to get an update on Gastar. Just off script just a minute, a year ago today we were here and it was sort of D-day, a big litigation number got dropped on us and the stock was down 25%. But since then we settled that litigation which was a headline number of $130 million for $1 million, we bought back 10% of our stock as a result of that or $1.44 and we're trading at about $4.20 a share. So that's been a good one year.

There were some rough days and some black days during that year but overall have been very good for us and we're thankful to be here again to update everyone on Gastar's story. Don mentioned some of the high level aspects here. We're about a $530 million enterprise value company focused in two areas; Marcellus Shale and the very rich portion of West Virginia and then the Hunton Limestone play in Oklahoma where we're playing the up dip pinch-out of the Hunton where it's very high oil cuts. This is not the very high water cut sort of dewatering Hunton that some people may be familiar with.

We've primarily grown to the drillbit and we've grown very rapidly. We are now adding some acquisitions to our story and we'll go through the most recent one of those which includes a substantial portion of proved reserves and a nice production bump for us. Just a locator map here to show you our areas of focus. We're headquartered in Houston, got about 96,000 acres in the Hunton now. That will be about 120,000 acres by the end of November and we're sitting there with our 60,000 net acres in the Marcellus play.

Reserves have grown pretty rapidly. You can see here from 2009 until now from about 50 BCF to 250 BCF. Liquids has been one of our focuses. We wanted to get more liquids rich. We've gone from 0% liquids in 2010 to about 30% liquids in our reserve base today. In oil production basis, our liquids are about 28%, so we've almost caught up on the reserve numbers with the production profile. And you can see our production's grown fairly rapidly as well and we expect to continue that trend into next year and beyond.

Liquids, when you start at 0% all the percentage increases look really good, so you got to view these in light of that but we are showing some pretty strong growth in the liquids portion of our production profile and that will continue because all of our drilling is either in the Marcellus area where you're about 35% liquids or in the Hunton where you're about 75% liquids.

A little recap of CapEx here. This does not include the $187 million acquisition we announced a couple of weeks ago, but you can see here about 193 million excluding that, the Marcellus and the Hunton get about equal billing on the drilling dollars this year. We expect pretty much the same next year although the overall numbers maybe on the drilling side just a little bit higher than this range, because the problem is we've got [indiscernible] with the drilling in the Marcellus that with only 16 days drilling time you can drill a lot of wells with a rig under contract for a year. But as I mentioned earlier, all this drilling CapEx is going into liquids rich plays and we expect to see not only good reserve adds from that but also continued production growth.

Jumping into the assets, I'll start with the Marcellus because that's where most of our capital has gone for the past couple of years and it's been a real driver for our growth. We're focused in the area that's circled in blue here in Marshall and Wetzel Counties, West Virginia; very, very rich gas. We have a JV partner there, a South Korean private equity firm that has 50% interest with us. We also have about 50,000 net acres over here in the dry portion of the Marcellus play which, as you can guess, we're not putting any capital into that. We will have some leased explorations over there in 2015 and '16 but we're not going to chase lease explorations with a drillbit. We'll just let those expire if gas prices haven't recovered and we can go re-lease it in the future if we need to.

Our area of focus, as I mentioned, is Marshall and Wetzel Counties. This is extremely rich gas. For every 1 million cubic feet of gas we produce 30 to 40 barrels per million of condensate or crude oil plus an additional 40 to 50 barrels per million of natural gas liquids. As I'll show you in a moment that drives some very strong economics in the play. We've drilled 57 wells. They've all been successful. As we sit here today we have 115 additional wells left to drill. And on our acreage we're always trying to acquire additional acreage, we're swapping acreage with other operators to block up our position, so that number of future wells will continue to grow.

We've recently drilled wells on tighter spacing, 400 feet between the wells rather than 600 feet and we've actually seen improved results. So our future drilling will be at the tighter spacing. And we're also going to be in the very near future using some enhanced completion techniques, some pretty sophisticated log in that allows us to identify higher versus lower pressure regimes within the Marcellus lateral itself and it allows us to focus our frac stages in those segregated pressure regimes. We expect that to have up to a 20% bump on our EURs and hopefully an equal bump on our IP rates.

And if you think about it with a 115 wells left to drill, there are about 7 BCF wells now if you can add 20% to each one of those, you essentially equal the proved reserves we have today. So there's a lot of leverage to getting the technology to work for us in this play. Just a little map here. The black wells are ones that we've already drilled. The red wells are our PUDs. We only have 27 proved undeveloped locations booked in the Marcellus right now. That's a very light booking. The other wells, the probable wells are shown here in purple in this area and then we have some to the South and then further South in Wetzel County. It's just a play that the only thing it does is get better.

As we've moved to the West, we're getting more and more liquids. We're driving our cost down which has been – is reflected in our revised tight curve here. Our cost used to be $7 million for a 5,000 foot lateral. We're now using 6.7 million and our last pad of wells we drilled 6,000 foot laterals and completed them for $7 million, so the economics are continuing to improve. This is our tight curve. We feel very comfortable with this and if we can get technology to work for us a little bit better, this tight curve has got some upward momentum to it.

A lot of numbers on this chart. I mentioned this but our last pad of wells 6,000 foot laterals for $7 million cost, about 32% liquids on that. The play is just working in every sense of the word. We did have some infrastructure issues here. Those have been resolved for the most part. Our run times on the midstream system with Williams are almost at 100% for the past quarter. That had a big negative impact on us in the first quarter this year. Also pretty meaningful negative impact in the second quarter; third quarter is looking very good.

We've also driven down cost and selling some infrastructure. We have our own water system. We've put about $4 million into a water system that allows us to deliver about 15,000 barrels a day of fresh water for our completion operations. We've taken our water cost from about $2.50 per barrel to about $0.22 per barrel. A system like that probably has got some value even when we're done developing this area. There's a lot of acres to be developed further to the East. Those operators are going to need water, so we can either sell water; expand this system, sell water to them or possibly just sell the system at some point in the future. But the play is very well set up now with all the infrastructure that's needed for a complete Marcellus development.

What's really exciting and in fact we just started talking about this last week is you start looking at the Utica activity that surrounds our position. There are now five operators that are drilling wells that are very meaningful to us and the Utica – in our immediate area. We believe this is dry gas but you're talking about dry gas that underlies the successful Marcellus developments, so all the infrastructure is in place. Our best estimate right now is about 8 to 10 BCF per well, so a very conservative outlook would be 800 BCF to a TCF of Utica gas underlying our Marcellus position. Again, with the infrastructure in place, so you could drill this, develop it, produce it and actually use it to blend with a richer Marcellus gas and take some of the pressure off your processing infrastructure.

We'll probably drill our first well for the Utica in the second half of '14. Between now and then there will be a lot of data points. As you can see here, the other operators are going to have Utica completions that we think will continue to – will start to de-risk our position. Pretty exciting to me when you can talk about almost a TCF of gas underlying about 20,000 acres and that's already been developed for shallower formations, so all the infrastructure is in place.

[Indiscernible] connotations on gas prices, I mean there's a lot of gas and we're not big believers in gas prices going up but we're not believers in them going down either, so as we've seen the opportunity to lock in around the $4 level for the next couple of years, we've done that and we'll go through our hedge position in just a moment.

Moving now to Oklahoma to the Hunton Lime play, this is I think going to generate a lot of excitement over the next year. We think we've got about 100 million barrels net resource potential on the acreage we control today. Our early drilling results have been very encouraging. We'll go through those in just a moment. The play is being de-risked quickly. The interesting thing is Gastar is the only public company in this portion of the play right now, so all the other operators are private.

So there's not a lot of information coming out to the market although we know that there have been about 50 recent Hunton horizontal wells and they look all to be successful and it looks like they're coming in around the tight curve that we publish which we'll go over in just a minute. We currently have 96,000 net acres, so it's a large position that we've got very little cost in and we're adding 24,000 net acres with our WEHLU or West Edmund Hunton Lime Unit acquisition that we'll close in late November.

This is a map of our acreage position. We acquired this area up here about a year and a half ago, just on the ground leasing about 22,000 acres. We then bought from Chesapeake 150,000 net acres. We also bought back 10% of our stock at a very reasonable price as I mentioned earlier. We settled some litigation we had with them. We then sold a portion of that acreage to our AMI partner, about $12 million worth and then we sold what we deemed noncore acreage which was the acreage here in blue, we sold that to Newfield and essentially with those two transitions with the sale to our working interest partner and the sale to Newfield, we paid for the Chesapeake acquisition. In fact we put $4 million in the bank, we got 68,000 net acres for free and we got 2.6 million barrels of producing oil for free. So that was a very good turn for us. When you add the stock buyback to it, we think it should get at the end of the year something like that it's really something very gratifying.

Our new acquisition, a little bit different profile because it's got some substantial proven reserves and production that goes with it. We're buying about 24,500 net acres, about 11 million barrels equivalent of producing proved reserves, producing about 2,100 BOE a day. We've identified about 62 proved undeveloped locations that are limited to only 7,000 of the 24,000 net acres, so we've been very conservative with our evaluation of this from a proved reserve profile.

Beyond that we think there are at least another 100 additional drilling locations not only for the upper but also for the middle and lower Hunton which has been totally unexploited on this property but is working in very, very close proximity with other operators in the area. We'll plan on closing this in late November and we'll probably finance this acquisition with a combination of new perpetual preferred stock and tack on to our high yield notes.

A locator map here shows the area of our recent activity in the North. Our partners had a lot of activity down this area with the rest of the private players and then you can see the WEHLU acquisition as it sits here adjacent to a lot of the acreage that we picked up from Chesapeake. Now this acquisition fits not only operationally, we really don't have to add anyone on an overhead basis to add this property to our portfolio. It also fits very well financially, it's a very easy acquisition to finance because it generates so much cash flow.

It's spilling [ph] off about 36 million a year in cash flow today with about 12 million of that we can finance it and pay the debt or the financing carry costs. With another $12 million to $14 million we can keep this property flat from the production profile. So we've got from 12 million to 24 million a year of free cash flow after financing from this property to reinvest in our other Hunton activity that does have some lease expirations. This entire property is held by productions. We have no timing pressure whatsoever.

Our recent results have been mostly up here in the Northern portion of the play. We have had some variability in those results but we think the results are getting better with every well. We've had wells produce – well, this is after six months in productions it's still producing 670 BOE a day, that well max out at about 1,100 barrels of oil a day. Our most recent well we brought on line is making about 300 barrels a day but that's only from one-third to the wellbore. There's some stuck coil tubing.

Only 8 of the 20 plugs have been drilled out and it's getting very close to our tight curve. Had that well not had the coil tubing stuck in it, it probably would have been our best well to-date. We're bringing another well on line this week. Early signs on it look very good. We'll have another well on line about two weeks after that and we just spudded our first operated well, so we're excited to start operating in this play ourselves.

These stars are the three locations of the first three operated wells we will drill. When you take into account the activity in the North and then our three wells but really the end of the first quarter next year we will de-risk this entire acreage position and we think we'll be in a position where we could talk about a full scale accelerator development program. This is a tight curve with majority of the play, the lower Hunton, 436,000 barrels. This is built on the results not only of our operations but also our partners' operations.

As I mentioned there have been about 50 recent wells drilled. We've got good data on a number of those and that's the basis for this tight curve. The peak rate should be about 400 barrels a day and just over 1 million cubic feet of gas a day. It takes these wells about three to four weeks to reach those peak rates as you recover the frac fluids. We have very low water cuts on these.

Once they settle down, you're talking maybe 10% to 20% water cut whereas other portions of the play where people are moving 90%, 95% water cuts. About 65% liquids on a process basis and about 35% gas with a 73% IRR based on a $5.2 million cost. Our last non-operated well that just was completed came in at $4.5 million. So if you can take the same tight curve and knock $750,000 out of the frontend of the costs, your returns are going to look even stronger than what we show here today.

In our new acquisition we have both upper Hunton and lower Hunton opportunities. The upper Hunton looks like it will generate about a 60% IRR. These wells only cost about 2.3 million because they can be drilled and completed open hole. You don't have to frac these. And then the lower Hunton portion of the new acquisition, it looks like these are about 50% IRR wells. They cost about $4.5 million each coming on at about 350 barrels a day and about 1.4 million cubic feet of gas a day.

So the Hunton play overall we think is a great opportunity for Gastar not only because it's oiler and it fits our goal of getting more liquids into our company but the well costs, the risk profile of the wells, they all fit very well to a company our size and a company of our financial resources. So we look forward to drilling this very aggressively and we think we're going to create a lot of value with it.

Our program for next year looks like it will be about 19 wells, that's probably on the low end of what we'll actually drill. 8 of those we drilled with our partner where we'll have 50% working interest, the other 11 we'll have close to 100% working interest. We will also be forced pooled into a number of other wells with other operators. Those are very difficult to budget for, so we don't show those here on this slide but you can probably guess that we'll have interest in another 10 to 12 maybe even 15 wells that we drilled throughout the play.

A quick financial overview; June 30 balance sheet shown here, pretty straightforward. About 200 million in high yield notes and 100 million in perpetual preferred stock. It's the way we finance the company over the past really two years and as I mentioned earlier, as we look into financing our newest acquisition, we'll probably do it with half in perpetual preferred and half in additional high yield notes. High yield notes we issued back in May, 8.625 [ph] coupon on these, they were issued at par. We hit a very, very good week in the credit markets and I think the holders of these have been happy with the performance.

In our preferred stock, the perpetual preferred has been a fantastic financing instrument not only for us at the time we issued it but also for the investors as it generates today about 9% tax free yield, so I was asked earlier in the one-on-ones if my kids still own it, they own it and they own a lot of it. It's paying for the college, it's paying for cars that they're going to get, all those fun things. And as we issue more of this with the acquisition, then the kids will probably own some more of that too.

Just a couple of slides here on some of the credit metrics. We've got good collateral coverage. When you look at PV-10 to net debt, about 2.9 times is shown here. When we look at bringing in the proceeds from both the Newfield sale and our East Texas sale, you can see it gets about 4.9 times. So we're very comfortable with where we are right now on a leverage basis.

I've tend to look a lot at the EBITDA to total interest and dividend expense. We want to keep that at a comfortable margin. Part of doing that is using hedging to protect those cash flows. We are very heavily hedged for this year and next and we're building positions into the following years. We've already gone out on our new acquisition and hedged the entire PDP stream with the use of deferred premium puts and put spreads and we've also hedged about half of the expected PUD stream.

So we've already gone out and essentially removed the oil price commodity risk from that acquisition. We're adding to our natural gas hedges for '15 and '16. We were heavily hedged for, if you go all the way back to 2011, '12, '13 on the gas side and unfortunately we made a lot of money on those hedges. I'd like to lose just a little bit on every one that we put in, but that's really protecting our cash flows and allowed us to plan our activities accordingly.

So that's an overview of Gastar. We think we're very well positioned in two very high return plays; the Marcellus liquids rich portion of West Virginia and the Hunton Lime. We've got a CapEx program that's going to generate very strong growth. We've got a big inventory here now. We've got 115 locations in the Marcellus and probably close to 350 locations in the Hunton and we can foresee a continuation of our track record of adding reserves, adding production and hopefully continuing to add to our share price.

I see we've got about five minutes left, so Don are we going to do Q&A in the room or…

Question-and-Answer Session

Donald Crist, Jr. - Johnson Rice & Company

The 350 locations that you talked about on Hunton, is that just an upper or lower or is there…?

J. Russell Porter

The 350 Hunton locations includes 62 upper Hunton locations and all the rest are lower.

Donald Crist, Jr. - Johnson Rice & Company

And there could be upside to that.

J. Russell Porter

There could definitely be upside to that. On our WEHLU acquisition we think we probably got another 100 locations beyond what we booked as proved as probable today.

Donald Crist, Jr. - Johnson Rice & Company

Great. And what is the schedule right now for the startup of Marcellus again? I know you stopped to evaluate…?

J. Russell Porter

We've actually started drilling top holes again and we'll start drilling laterals probably in late January '14 and then we'll drill throughout the year.

Donald Crist, Jr. - Johnson Rice & Company

And with your current balance sheet in the state that it is, any possibility of showing maybe in the second half of '14 when you get the initial [indiscernible]?

J. Russell Porter

I'll say yes. If the results are what we expect them to be, then we'd look at a way to potentially accelerate. Whether that's at that point bringing on a JV partner or some transaction like that that would allow us to accelerate or if our stock price has performed then we might even look at the equity markets at some point. But that's often to the future but we think we've got assets that are going to show themselves to be very worthy of acceleration.

Donald Crist, Jr. - Johnson Rice & Company

Yes, that's all I've got. Thank you, Russ.

J. Russell Porter

All right, thank you very much.

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