Colorado Regulatory Environment Turns Unfavorable, Could Negatively Impact Wattenberg Players

Includes: APC, NBL, SYRG
by: Josh Young

At the state and local level, the practice of hydraulic fracking is being challenged in Colorado. Recently, four towns banned fracking within their borders, including Fort Collins, which is situated on the edge of the Wattenberg field. And also recently, "health officials" at the state level announced new drilling emissions rules which could at least temporarily slow down development and increase drilling and completion costs.

This is relevant because the Wattenberg field and the Wattenberg extension are in the north eastern part of Colorado, and Fort Collins, one of the four towns, happens to be situated on the edge of the Wattenberg field. There is a risk that more towns may ban fracking, and a risk that state-level regulations have an impact on drilling schedules and costs.

Many Wattenberg-focused E&P companies trade at valuations that imply aggressive development of their fields. And some have land in the cities that have banned fracking. Given the increased regulatory risk to operations, perhaps some of the stocks of companies with exposure to the Wattenberg that trade at higher multiples may see those multiples compressed, particularly if the companies have land within towns that have banned fracking.

Synergy Resources (NYSEMKT:SYRG) is a Wattenberg focused company that trades at a relatively high valuation compared to current production, roughly $300,000 per barrel of oil equivalent produced per day. As discussed here (link), this compares unfavorably to recent private market transactions, which transacted at $68,000 per barrel of oil equivalent produced per day. Synergy's valuation is highly dependent on rapid production growth. And Synergy may be affected in two ways from recent regulatory changes - it has some land in the vicinity of Fort Collins, one of the towns that banned fracking. And its development of land not in the Fort Collins area could be slowed down and/or made more expensive by the new Colorado regulatory framework.

Noble Energy (NYSE:NBL) and Anadarko Petroleum (NYSE:APC) are the public companies with the largest exposure to the Wattenberg field. Similar to Synergy, they have land in the vicinity of towns that banned fracking, and their development schedules and costs could be negatively impacted by the recent state-level regulations. However, both companies have substantial other assets outside of Colorado which drive a large portion of their market valuations. Noble has interests in massive natural gas discoveries in the Eastern Mediterranean, among other places, which has driven its stock outperformance. And Anadarko is famous for its wildcat discoveries in the Gulf of Mexico, West Africa, and more recently in East Africa. So they could be less impacted by unfavorable regulations in Colorado than pure-play companies like Synergy.

Other companies that are nearly pure-plays on the Wattenberg Extension are Bill Barrett (NYSE:BBG) and Bonanza Creek (NYSE:BCEI). As discussed here (link), these stocks trade at lower multiples than Synergy, implying they need relatively less production growth to sustain their current valuations. Also, neither company appears to have acreage in the vicinity of the four towns that banned fracking recently. So while they may be impacted, they could be impacted less than others.

Encana (NYSE:ECA) and Carrizo (NASDAQ:CRZO) have a relatively small portion of their assets in the Wattenberg / Wattenberg extension. And their land does not appear to be in the vicinity of towns that have banned fracking. So the recent regulatory changes may have a limited impact on their overall growth rates, cost structures and thus market valuations.

In short, Colorado's regulatory environment has turned less favorable for oil and gas development. The big area of production growth in Colorado at the moment are the Wattenberg and Wattenberg extension fields. Certain companies are more exposed to these changes than others, and certain stocks may be more likely to experience multiple compression than others. The situation is evolving and it is possible that certain regulations may be contested in court, and it is possible further regulations or bans may be implemented.

Disclosure: I am short SYRG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am short SYRG and may buy or sell any stock mentioned with no further notice.