What a difference a year makes!
Last December, the collapse of crude oil had me seriously spooked. I almost abandoned the energy sector entirely with my Best Stock for 2009 pick. Fortunately, I stuck with what I knew and went with what I dubbed "the ultimate hunker-down oil service stock" -- Core Laboratories (NYSE:CLB). This turned out to be one of the best picks of the bunch.
Given the market's stretched valuation, it will be tough to pull another near-double out of my jester's cap. Of course, that's not going to stop me from trying to repeat my prognostication feat.
Two familiar faces
As mentioned in my recent musing on the market's best energy stock, two of my favorite small cap shops in the space are Contango Oil & Gas (NYSEMKT:MCF) and ATP Oil & Gas (ATPG). Each follows a unique path to upstream profits, and I expect both companies to reward patient shareholders. Contango, which joins XTO Energy (XTO) and Southwestern Energy (NYSE:SWN) on the list of the past decade's 10 best stocks, already has.
I've decided to go with the stock that gets less respect, and also has a clearer catalyst in place to unlock value in 2010. That would be ATP.
If wildcatting gives you the willies, ATP Oil & Gas may be up your alley. The company has a focused program of buying proven, yet undeveloped, offshore fields and bringing them into production. That's exactly what ATP has done at its Gomez Hub and is in the process of achieving at its new Telemark Hub, both in the deepwater Gulf of Mexico.
We've seen the deepwater ding other small players, and even Devon Energy (NYSE:DVN) has recognized that it had gotten in too deep. Did ATP cruise through the commodity crack-up without a hitch? Hardly.
The funding requirements for ATP's Telemark Hub make the Avatar budget look like no biggie. The floating drilling and production platform alone cost over $600 million. ATP has also had Diamond Offshore (NYSE:DO) and other contractors drilling development wells for a pretty penny. These various costs crescendoed right around the time that credit markets were most dysfunctional. ATP's balance sheet became a real burden.
By bringing in General Electric (NYSE:GE) as an investor in one production platform, wringing concessions out of Diamond and other service companies, and raising some dilutive capital, ATP did make it through in one piece. That's a true testament to the quality of both the assets and the people at ATP.
I'm speaking in the past tense, as if nothing can go wrong from here. Several things can go awry from here, but ATP's shares are discounting more risk than is evident to me at this late stage of Telemark's development. We'll return to possible risks once we get a handle on this project's potential.
Telemark looks tantalizing
The Telemark assets, comprising the Mirage, Morgus, and Telemark fields, were purchased from Statoil (NYSE:STO) back in 2006. They are a game-changer for ATP.
In the third quarter, company-wide production came in at 1.4 million barrels of oil equivalent (boe), or a bit north of 15,000 boe per day. Back in March, ATP's President stated that the first Telemark well should produce over 10,000 boe per day. That's the largest of several well completions that we should see at the Telemark Hub by mid-2010. These wells alone should more than double ATP's third-quarter production rate.
As far as reserves upside, we got a taste in September with the drilling results at the Mirage #3 well. ATP encountered twice its pre-drill estimate of hydrocarbon "pay." With a new reserve report right around the corner, this is another potential catalyst for the stock. Of course, investors are far more fixated on ATP's cash flow relative to its significant financial obligations, so reserves definitely take a back seat to production growth.
This pick's not without risk
ATP has kept its head above water, but the firm still has over $1 billion of debt. Roughly equivalent to the firm's entire market cap, this is no trivial sum.
The firm's key challenge in 2010 is to generate enough cash to both cover its capital budget and take a meaningful chunk out of this debt balance. I don't think operations alone will cut it, because a fair bit of operating cash flow will be diverted to satisfy service companies' net profit interests at Telemark. ATP's cash could get tight without a successful monetization of the ATP Titan, the Telemark Hub's floating platform.
GE invested in half of the Gomez Hub's ATP Innovator at cost, and if they or another investor were to do the same with the Titan, that would bring in around $300 million pre-tax. I think ATP can pull this off, but it's not a sure thing.
Another risk is that the Telemark wells experience production problems, and require expensive sidetracks or recompletions. This could also cause ATP to face a crunch in 2010.
This is not a "set it and forget it" stock. ATP's unique situation demands attentive ownership.
Author's Disclosure: No positions in any company mentioned.