Athlon (NYSE:ATHL) had a very good Q3, which is a bullish signal this soon after its IPO. It is a unique investment, with horizontal exposure to Howard County. Howard County has seen significant vertical development. This has provided very good information as to its geology and prospects at deeper intervals. Its core acreage is not only unique, as there are a limited number of small cap oil producers in the Midland Basin, but also due to its Howard County leasehold.
The map below shows where Athlon's areas of interest are located. It is important to note its second core in Glasscock has been very successful for Loredo (NYSE:LPI). Management is executing. Its Q3 production, cash flows, and earnings per share were ahead of first consensus estimates. Athlon should continue to outperform. It has a very good acreage position that is being downspaced. There are additional benefits from vertical/horizontal development. This is a combination of both styles, where the vertical techniques are used in concert with horizontals. This should prove to be very effective in recovering resource from stacked, thick intervals.
Athlon was a big surprise in Q3. It posted Q3 revenues of $88.4 million, which beat estimates by $10.17 million. Athlon earned $.24 per share, $.08 better than estimates. Revenues increased 110% year over year. In Q3 86% of revenues were from oil, this was 4% better than the same quarter of 2012. The average wellhead oil price was $104.21. While this increased year over year, differentials tightened by $1.61/bbl. Realized natural gas pricing improved year over year to $3.28/Mcf from $2.66/Mcf. Athlon's realized NGL price increased to $33.76 from $31.90.
As Athlon expands, its costs are decreasing on a per barrel of oil equivalent basis. LOEs dropped to $7.19/Boe versus $10.21/Boe year over year. As a percentage of wellhead revenue, taxes improved to 6.2% versus 6.7% over the same time frame. G&A expenses increased in Q3 to $3.33/Boe versus $2.98 for the same period last year.
In Q3, Athlon drilled 45 net operated vertical wells with its seven rigs. Over the first three quarters of 2013 it drilled a total of 120 net wells. By using higher tech rigs, Athlon was able to decrease drill times. This allowed it to complete 5 gross additional wells. Each vertical rig can drill 24 wells per year. Average vertical well costs are $2 million. It also began operating its first operated horizontal rig in August. Drilling cap ex in Q4 will be $110 to $120 million. In Q4 Athlon will continue to run seven operated vertical rigs, and have now raised drilling guidance to 169 gross operated from the original of 161. It drilled its first two horizontal wells in Midland County, targeting the Wolfcamp B. The first was a 5000 foot lateral. The IP rate will be announced after 30 days of production. Athlon states it is producing well. The second is around 8000 feet. Next, the rig will be moved to Glasscock County to drill two medium length laterals targeting the Wolfcamp A.
After this, Athlon is moving its rig to Howard County. This may be the most important catalyst for Athlon. Howard has seen de-risking vertically, but very few horizontals have been completed. It's original plan was to move the rig to Irion County. This change is based on recent activity. Irion is not thought of as a top notch Wolfcamp leasehold. There are now 5 wells that have been drilled, one currently drilling and three permitted. This is bullish Howard County, and Athlon's acreage values. It also has gathered a significant amount of data in Howard, as it has four operated vertical rigs there now. The verticals drilled in Howard are similar to those in Glasscock.
This quarter it produced an averaged of almost 13,000 barrels a day. That was significantly above Athlon's estimate of 11,400. More importantly, this was all vertical production, as there was no contribution from recent horizontals. This 13% beat is attributed to better wells coming on line. This is possible because vertical intervals in this area are up to 4000 feet thick. It continues to better its source rock stimulation, using additional proppant and water. Athlon has now drilled over 300 vertical Wolfberry wells. These verticals use 8 to 10 stages depending on area. These wells begin in the middle to lower Spraberry down to the Atoka and sometimes into the Mississippi formation. Some of these intervals are also possible horizontal targets. Athlon will continue to drill vertical wells, as it is a reliable and less expensive way of getting acreage held by production.
Athlon has an excellent leasehold. The Midland Basin has been productive, but the question seems to be how productive, and more importantly, the number of locations per section. Obviously the Wolfcamp B is better in the west around Midland, Upton, and Andrews counties. In the east, it is the Wolfcamp A. This includes Howard, Glasscock and Reagan counties. There are additional zones that may have good economics. This makes things interesting as acreage values are some of the highest in the country, when the vertical Wolfberry, horizontal Spraberry and Wolfcamp are considered. It will be interesting how much acreage values increase after the Strawn, Atoka and the Mississippian are tested.
The vertical Wolfberry has favorable economics when compared to other vertical plays. The main reason is thickness as it is equivalent to a 4000 foot lateral, drilled vertically. The table below contains Athlon's vertical well production. The table below contains its well production in Howard County.
|Well||IP 30 (Boe/d)|
|Bigony 48 #1||572|
|King 13 #1||681|
|Thomas 8 #5||235|
|Strickland 19 #2||297|
|Hurt 21 #1||316|
|Tubb 34 #2||397|
Athlon's best vertical wells have the highest average in play. This geology seems to be better suited to a vertical development. It has also drilled several very good wells in Midland County. Keep in mind that Powell #19 and RAB Davidson E #15 are both on 20 acre spacing.
|Well||IP 30 (Boe/d)|
|Windham 2B #6||368|
|TXL S 29-2 #3||331|
|RAB Davidson E #15||289|
Athlon also has a core area in Glasscock County, and its well results are listed below. This area has also produced well. The numbers seem to point to east Midland being a better vertical play with respect to production. It does on the other hand not produce as well with respect to horizontal wells. West Midland is a little deeper, and possesses higher well pressures. This creates better horizontal production, but also increases well costs.
|Well||IP 30 (Boe/d)|
|Jost 25 #4||464|
|ED Books 13 #3||277|
|Wilkinson 31 #7||233|
|Tom Ranch 41-4||311|
Athlon has not had as much activity in Martin and Upton Counties. I have included the wells from both areas in the below table. Results have been good as well, but it does not have a significant acreage position in these counties.
|Well||County||IP 30 (Boe/d)|
|Tarzan Standefer 9 #2||Martin||269|
|Woody 36 #7||Martin||230|
|Davidson 46C #7||Upton||288|
Vertical Wolfberry well economics are good. The above wells are some of Athlon's best, and because of this may not necessarily fall into the total well averages. The table below gives a better idea of how these averages compare by county.
|Depth Ft.||D&C Cost MM||EUR MBoe||IP 30 Boe/d||%Oil||ROR%|
This table uses averages of wells completed to date. These numbers are based on $94.71/Bbl oil, and a $2.75/Mcf gas price. It shows how much improvement we have seen in a very short time. IP rates are significantly higher in more recent wells, and in turn would have higher EURs. Also, the results are better in Midland and the other western counties. The combination of deeper intervals and a higher percentage of gas contributes to the higher EURs. Looking at the RORs, we see a decent return, but the more recent wells point to even better economics. Currently, verticals are drilled on 40-acre spacing. As these areas are de-risked, we could see downspacing to 20 acres. This may lower single well EURs some, but will increase total recoveries.
Horizontal development is much different than vertical, and generally speaking it is not used in concert to drain resource from the same acreage. This is not because the applications conflict, as it has more to do with geology. It works here as viable intervals for horizontal development are present with stacked intervals thick enough for viable vertical wells. Athlon has significant experience with vertical wells, but is new to horizontal applications. On average, it's well design is based on a 7500 foot lateral. It uses a 28 stage, 7 million pound plug and perf. This is a hybrid/slick-water frac. It has an average stage length of 250 feet that will receive 250000 pounds of proppant. The well design is more than adequate and one that has been used in the area with very good success. Athlon was smart, as it continued its vertical program long enough to get a good idea of what well design to use. By doing this, it would learn from the mistakes of bigger balance sheets.
Well economics differ in the Midland Basin. This is dependent on area and interval. Results to the southern basin have not been as good. This is why we see a big difference in valuation of Approach's (NASDAQ:AREX) acreage when compared to Athlon, Loredo, and Diamondback (NASDAQ:FANG). The east and west also differ. As I stated earlier, the Wolfcamp is deeper in the west. Also, the B interval is the target, while the A is in the east. The west has seen more activity, and a large number of these wells were short (5000 foot) laterals. It would seem the west would see a medium lateral approach, given its very good results to the west. Below I have provided a Wolfcamp comparison between the east and west Midland Basin.
|IP 30 (Boe/d)||730||625|
The above table is interesting as the 30-Day IP rate mimics the EUR. Keep in mind there are a large number of variables that affect models, and any of these could create a significant change in EURs. So it is not a universal form of determining this, but may be close to Athlon's completions. Unlike vertical wells, there is very little difference in the resource mix. If we find Howard compares this well to Midland County, Athlon's stock is under valued. I have provided well results from its three core leaseholds in Howard, Midland, and Glasscock. The first table is from wells around Athlon's Midland core acreage.
|Well||Operator||24 Hour IP||IP 30||%Oil||Interval|
|DL Hutt C 3H||(NYSE:PXD)||2227||1087||75||B|
|DL Hutt C 4H||PXD||2128||856||69||Cline|
|DL Hutt C 2H||PXD||1712||1107||74||A|
|DL Hutt C 1H||PXD||1693||1402||75||B|
The first four wells were located in Midland County and the last Upton. The Midland wells are very close and to the northeast, while the SM Energy well is further away and to the southwest. All three Wolfcamp wells are good, while the Cline depletes much faster. This is likely due to higher initial well pressures from a larger gas mix and greater depth. The second core area in Glasscock County, includes well results from northeast Reagan.
|Well||Operator||24 hour IP||IP 30||%Oil||Interval|
|Lane Trust C/E 42-2HL||LPI||2147||1217||79||C|
|Lavaca 38 101H||(NYSE:EGN)||861||709||60||A|
|Llano 8-8A 101H||EGN||784||683||69||A|
|Sugg A 143 4HU||LPI||1904||1090||75||A|
|Sugg A 143 3HU||LPI||1673||888||73||A|
|Sugg A 143 2HU||LPI||1160||A|
|Sugg C 271HM||LPI||982||77||B|
|Sugg D 106 2HL||LPI||969||66||C|
|Glass-Glass 10 153H||LPI||1886||Cline|
Glasscock, like Midland is productive through several intervals. The Cline is the only interval without a 30-Day IP rate. Given the number of Loredo wells, it suggests this will be a good result. I would expect a higher rate of depletion as in other areas of the Midland Basin. We see focus shift to the Wolfcamp A in Glasscock. Howard County wells are listed in the table below.
|Well||Operator||24 hour IP||IP 30||%Oil||Interval|
|SFH Unit 23 1H||Element||649||A|
|Hamlin Unit 1522 3H||Element||A|
|Gardner Unit 1510 2H||Element||A|
|Garrett-Reed Unit 37-48 4H||Element||A|
|Hamlin 1918 1H||Tall City||A|
|Hamlin 2029 1H||Tall City||A|
|Guitar 1-4 1H||Endeavor||A|
We have only seen one 30-Day IP rate from the horizontal Wolfcamp in Howard County. I have listed other wells in different stages permitting to production. Hamlin Unit 1522 is on production and we are waiting on those numbers. The Gardner Unit well is currently drilling. Both the Hamlin 1918 and Guitar wells are being completed. The Garrett-Reed and Hamlin 2029 are both permitted. The recent uptick of activity has helped Athlon move up its horizontal development.
In Q4, production should average in a range of 14500 Boe/d to 15000 Boe/d. That represents sequential growth over the original estimates of 12% to 16%, and 66% to 72% growth over fourth quarter of 2012. This extraordinary organic growth is special as it is occurring from only the vertical program. In Q3, it was flaring gas, but much of this was due to infrastructure constraints. Expectations are this will be much lower going forward. Catalysts for next quarter include the IP results of its first two horizontal wells in Midland, and one in Glasscock County. It plans to continue with the 8 vertical rigs, and will get a second horizontal rig Q2 of 2014. This rig will head to Midland County.
In summary, Athlon is one of the better small cap names in the Midland Basin. Its great quarter was powered through conventional production as it continues to provide growth while cutting costs. Significant upside is possible as it begins its horizontal program. Athlon has very good experience as a vertical operator and plans to capture resources using both well types. It's Howard County acreage adds risk, but the reward could be much greater. Although there is some risk of falling oil prices in 2014, this continues to be a good play through year end.
Disclosure: I am long LPI. 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.
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