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Ultra Petroleum's (UPL) management deserves credit for promptly addressing open questions related to the company's recently announced $650 million Uinta acquisition. Just ten days after hosting a conference call dedicated to the Uinta announcement, management made a deliberate effort to go through the transaction details one more time. In the second presentation, management provided significant additional data that was not included in the initial acquisition-related discussion.

The information gap in the initial presentation did a disservice to the stock as key return metrics appeared insufficiently supported by operating data. The additional disclosure - which addressed in much greater detail well performance, well costs, reserve estimates, geology, and economics - provides the necessary remedy.

While natural uncertainties remain with regard to ultimate drilling economics and EUR distribution across the acquired block, the new information provided by Ultra demonstrates a lot more convincingly that the properties represent a unique, highly economic asset. The data provides a much greater degree of comfort that, despite the very high price paid in the acquisition, the investment has a good chance of earning an attractive return.

The Acquisition

As a reminder, on October 21, 2013, Ultra announced the acquisition of the Three Rivers tight sands project in the Uinta Basin. The oil-producing property includes ~8,200 operated acres with 100% working interest located in the vicinity of several large, prolific legacy fields, including the Monument Butte, Altamont-Bluebell, Natural Buttes and Wonsits-Red Wash (slide below). Current production from the properties is ~4,000 barrels of oil per day net from 39 vertical wells, with shallow decline profile. Ultra estimates the PV-10 value of proved developed reserves at $265 million. 79% of the acreage is held by production. Drilling economics benefit from the moderate 18% royalty rate.

While Ultra is acquiring what appears to be a high quality exploitation asset with excellent drilling economics, the $650 million price paid in the transaction is quite high. Using the $265 million as an estimate for the value of proved developed reserves, implied valuation of development potential of the properties is $395 million, or approximately $50,000 per undeveloped acre. The transaction's metrics represent a significant premium to two comparable acquisitions in the area that occurred in the past two years, by Bill Barrett (BBG) and Crescent Point (CSCTF). However, the higher valuation reflects the assets' differentiated quality.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

The stratigraphy of the play is characterized by a thick stacked pay column which is akin to Pinedale's. Ultra's vertical development plan targets multiple oil-bearing sand sequences primarily within the Lower Green River formation. While Ultra is acquiring the Three Rivers property for its Lower Green River oil value, the company also sees significant oil potential in Upper Green River interval and gas potential in some of deeper sands, including Wasatch and Mesaverde.

According to Ultra, Three Rivers is unique economically when compared to adjacent fields due to the combination of shallow depth, low well cost and very attractive EURs. What makes Three Rivers stand out from a geologic standpoint is the thickness and quality of the Douglas Creek and Travis members which yield up to 370 feet of thick, "blocky" sand pay saturated with oil. Thicker sands typically have higher quality and carry the day when it comes to reservoir performance.

Very attractive economics in the field are illustrated by the fact that production has ramped up over a very short period of time with a modest amount of drilling capital invested. First production in the field began in April of 2012, with only 3 wells online as of September 2012. In May of 2013, the production had ramped up to 1,000 barrels of oil per day, with 14 wells online. From May of 2013 through October 2013, in just five months, production grew from 1,000 barrels of oil per day to over 4,700 barrels of oil per day, with only 25 additional wells brought online. (Production figures are gross before royalties.)

Well Performance Data

Detailed well performance statistics for the acquired properties is perhaps the single most important set of new information provided by Ultra. The slide below shows, in a summary format, normalized average daily oil production for two groups of wells.

The graph implies that the most recent 19 Green River wells (the orange line), on average, are tracking close to the company's 380 Mbo type curve. Obviously, the wells have limited production history (150 days or less) and it would be premature to draw affirmative conclusions about the long-term fit relative to this or any other type curve. However, the average production data appears to confirm the flat trajectory also exhibited by the group of the first twelve wells (the dark blue line) that have substantially longer production histories. The first 12 Green River wells, as a group, track just under the company's 258 Mbo type curve. (Please note the logarithmic scale used on the graph for the production axis).

The graph displays an improvement in well performance for the group of the recent 19 wells relative to the first 12 wells. For comparison, the first 12 wells averaged 106 barrels of oil per day over the first 8 months on production. The recent 19 wells, on the other hand, averaged 168 barrels of oil per day over the first 144 days of production. Ultra attributes the improvement to the operating learning curve.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

A similar set of data is also presented on the cumulative production graph below. Quite notable on this graph is Ultra-estimated full payout threshold of 23,000 barrels of oil (gross), which has been reached by the first 12 wells in less than one year, on average, and will likely be reached by the recent 19 wells in less than six months, on average. The wellhead crude oil price assumption of $80 per barrel that is used in the calculation of the payout threshold is a rough equivalent of $100 per barrel Nymex, based on current quality differentials in the play.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

The low-decline production curves for Uinta oil wells placed on artificial lift is not unexpected and would be familiar to the play's watchers from reports by other operators. The flat production is nonetheless very impressive and presents a striking contrast to steep hyperbolic curves, with 80%-90% effective first year declines, often observed in other resource plays.

Ultra also made effort to demonstrate that strong well performance is reasonably well distributed across its entire acreage block. The slides below show summary production histories and underlying stratigraphy for six wells, A to F, and suggest that essentially all of these wells are highly economic performers. The six-well cross-section shows a "consistent and predictable pattern of sand deposition across the leasehold area," particularly in the important Douglas Creek and Travis members. It is highlighted on the inset map along with the blue and red dots showing the wells that have been drilled to date.

Ultra acknowledged that some geologic differences do exist across the acreage, most notably in the Castle Peak member, and those differences do affect well performance. Management believes however that it has seen enough data to understand the different areas and "build very accurate valuation models."

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

The obvious challenge in evaluating long-term performance and EUR of low-decline oil wells in the Uinta play is the lack of production history. Given that the first wells were drilled on the acquired property less than two years ago, Ultra turned for an analog study to a comparable Lower Green River well drilled by another operator in 2009 in the nearby East Bluebell field, the Rogers 16-43. The well has been on production for ~4.5 years and has cumulatively produced 171,000 barrels of oil. While the well's initial production rate may appear unimpressive - it peaked at less than 130 barrels of oil per day - the well managed to produce >100 barrels of oil per day for 32 continuous months and was still producing at approximately 70 barrels a day most recently.

The Rogers well is located less than 3 miles north of the Three Rivers area and is a valid analog due to its proximity and geological relation. According to Ultra, the Rogers 16-43 well is not an anomaly, with the flat production profile also demonstrated by several other wells in the East Bluebell area as well as in the Three Rivers area. Notably, many of the wells in the Three Rivers area produce at flat rates well above 100 barrels of oil per day.

EUR Uncertainties

The graph below highlights the fact that even with 4.5 years of production history in the Rogers 16-43 well's case, the uncertainty with regard to the well's EUR remains quite significant. Depending on specific model selected for the back end of the production curve, the EUR may range from 300,000 barrels of oil for the exponential model to 560,000 barrels of oil for a high b-factor hyperbolic model.

Ultra is using a hyperbolic decline model and believes that hyperbolic declines in the back portion of the production curve are generally typical for Lower Green River oil wells. Ultra stated that several other wells adjacent to the Rogers have exhibited hyperbolic-type performance and that hyperbolic decline profile is "certainly validated" by the Rogers well's performance over the last two years. For the Rogers well, Ultra is using a b-factor of 1.6 and estimates its EUR to be 530,000 barrels.

It is important to note that due to financial discounting, the uncertainty of economic return is generally less significant than the uncertainty of the EUR estimates. On the other hand, drilling economics are quite sensitive to the assumed shape of the front end of the curve.

Ultra believes it is conservative with its type curves and uses sufficient risking of future development well performance when assessing the Three Rivers asset. Specifically, Ultra mentioned that in its operating model, initial rates were constrained to no more than 200 barrels of oil per day and the flat production period was limited to 4 months or less.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

Well Cost Data

Ultra also provided convincing data confirming the consistently low cost of drilling and completing wells on the property. The slide below shows that well cost has varied insignificantly well to well and has averaged just under $1.5 million for the 20 most recent wells.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

Needless to say, the remarkably low average cost per well results in very compelling drilling economics for the type of well performance discussed above.

Valuation

The slide below shows the resources and value that Ultra has assigned to Three Rivers.

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(Source: Ultra Petroleum's November 1, 2013 Investor Presentation)

The proved developed reserves are estimated at ~10 million barrels, with PV-10 value of $265 million, which equates to just over 40% of the purchase price.

The "bookable offsets" (which must be an equivalent of "PUDs") on 40-acre spacing represent additional 27 million barrels of reserves with a PV-10 value of $470 million. These 130 locations represent the inventory Ultra plans to drill over the next few years and estimates to have an average EUR per well of 258,000 barrels.

On a combined basis, P1 reserves have PV-10 value of ~$735 million.

Additional 40-acre and 20-acre probable and possible locations add incremental 53 million barrels of reserves. With Ultra's current estimates of original oil in place for the Green River formations, the 90 million barrels of 3P reserves represent a recovery factor of 8%.

All valuations are based on a 1-rig development pace (12 years for full development). With an additional 15% to 25% risking applied to future locations, the 3P reserves have a PV-10 value that exceeds $1.1 billion, according to Ultra.

Ultra also highlights additional upside estimated at 83 million barrels from further 10-acre downspacing and water flooding, by analogy with the Monument Butte field.

Conclusions

The flat production profile of Uinta wells is critical to the understanding of the economics of the Three Rivers acquisition. While low decline rate leads to potentially high EURs per well, it also results in significant uncertainties of EUR estimates.

Ultra's presentation indicates that the company paid a price that is just under the PV-10 value of the property's P1 reserves. The relatively high price paid may partially explain the market's less-than-enthusiastic initial response to the transaction (the stock declined by almost 15% during the first week following the announcement, before recovering most of the losses).

Assuming 1-rig development pace, P1 reserves should be fully developed in less than three years. Beyond that point, Ultra will rely mostly on downspacing for future reserves. The effectiveness of downspacing remains to be proven by actual production. Management's commentary sounded confident with regard to 20-acre downspacing potential. Assuming downspacing does not lead to a material deterioration in well productivity, the properties should provide Ultra with running room for several more years of development beyond P1 reserves.

The greatest upside to the acquisition's value, however, is from better than currently estimated well performance. Ultra's current estimate of 258 Boe per well on average is already a fairly tall order. Still, as the example of Rogers 16-43 well shows, even greater EURs cannot be ruled out based on early performance of the most recent wells producing on the property.

The acquisition appears to be a moderately value-accretive event for the stock. Using the company's $1.1 billion PV-10 estimate for 3P reserves and subtracting the acquisition price paid, the transaction may ultimately yield $0.5 billion of full drill-out value (risking and discounting would be appropriate at this point). However, given the company's $5 billion Firm Value, the transaction does not have the scale or resource base to counter-balance trends on the natural gas side of Ultra's portfolio.

While management's clarifications with regard to the Uinta transaction were helpful, the recent recovery in the stock price is most likely driven by a totally different factor - by the rally in natural gas price which continues to be the most important variable for UPL from a valuation perspective.

Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Source: Ultra Petroleum: Additional Data Supports Uinta Acquisition Valuation