4 Stocks Profiting From The Buda Oil Sweet Spot

Includes: MCF, MTDR, USEG, XCO
by: HiddenValueInvestor

The story is finally starting to get out on just how profitable wells are that are being drilled in the Buda oil sweet spot in Zavala and Dimmit counties in south Texas. The oil company that discovered the Buda oil sweet spot is private oil company Dan A. Hughes. The other early leaders in the play are all also non-publicly traded oil companies: Sage Energy, Texas American Resources, and U.S. Enercorp. Because this discovery has been made by private companies the news of the Buda oil sweet spot has not yet rung a bell on Wall Street. But now four publicly traded oil companies that also have acreage in the Buda oil sweet spot are moving forward to tap the Buda. The upside value from the Buda has still not been factored into their stock valuations by Wall Street analysts. That may all change next week when Enercom hosts The Oil & Service Conference 12 on February 18 and 19 for small cap oil and gas companies. Two of the four companies are scheduled to make compelling presentations on the Buda oil discovery.

So far Contango (NYSEMKT:MCF) has been the leader among publicly traded companies to drill into the Buda sweet spot. The Buda is an oil formation that lies around 100 feet below the Eagle Ford. Unlike the Eagle Ford, the Buda has natural fractures and does not require expensive fracture stimulation jobs to complete the well. This lowers both the cost of the well and the time it takes to put a well into production from when it is first spud. The first few Buda wells drilled cost less than $4 million.

So far the best well drilled into the Buda is the Dan A. Hughes oil company Heitz 302 3H well. More information on this well can be found in the article, Some Buda Wells Outperforming Eagle Ford Wells In South Texas. This wells started producing in June of 2012, and according to the Texas Railroad Commission's website, through December of 2013 the Heitz 302 3H well produced 334,114 BOE (82% oil). The well is still going strong, as it produced 11,630 BOE in December of 2013.

The best well to date drilled by Contango is the Beeler #4H well on the Booth-Tortuga lease in which Contango has a 50% working interest. It started producing in mid-October 2013 and by January 31, 2014, the well had already produced 96,997 BOE. Contango has a full time rig drilling on the Booth-Tortuga lease and mentioned possibly bringing in a second rig mid-year. In Contango's operational update it claims to have reduced the costs of drilling Buda wells from just under $4 million on their first three wells to $2.6 million per well on its last three wells. It has also reduced the spud to completion and initial production time to less than a month.

The obvious beneficiary of Contango's work is U.S. Energy (NASDAQ:USEG) with a GAAP equity value of $110 million. The bulk of U.S. Energy's oil assets are in the Bakken. Fortunately, U.S. Energy owns a 30% working interest in all of the wells drilled on the Booth-Tortuga lease with Contango. Both companies also recently added some additional Buda drilling opportunities with private driller U.S. Enercorp on an adjacent lease.

U.S. Energy estimates it could have up to 80 Buda wells to participate in with a PV-10 value of $280 million net to USEG. That makes Contango's share worth over $450 million in future oil production discounted back to a net present value at 10% per year. This estimate is based on an assumption of 400,000 BOE per well. The Heitz 302 3H Buda well drilled by Dan Hughes looks like it could go well beyond that. Also, that PV-10 estimate is using the original $4 million well costs and not the most recent $2.6 million well costs. By plugging in the correct PV-10 costs, the value of the Buda reserves for U.S. Energy rises to over $400 million and the value of Contango's reserves rises to close to $600 million. That would represent $15 per share in upside potential for U.S. Energy and $30 per share in upside potential for Contango. Investors need to be cautioned that these are estimates based on oil staying at $100 per barrel and all of the remaining Buda wells having the same profile as the initial 15 Buda wells drilled by various companies in the sweet spot. There are many things that can go wrong when drilling oil wells, including mechanical difficulties and finding at the bottom of the well there just wasn't as much oil as projected. While so far the oil has been in each well, there have already been a couple of mechanical setbacks leading to extra costs in drilling these Buda wells.

Two other publicly traded operators have significant acreage in the area and plan to test the Buda in 2014. The first one is EXCO Resources (NYSE:XCO), which acquired over 55,000 net acres from Chesapeake (NYSE:CHK) for much less than the acreage is worth with the new Buda discovery. Thousands of these acres are to the west of the Booth-Tortuga lease where Dan A. Hughes oil company says the Buda is even thicker which is detailed in the article EXCO Resources Could Be Sitting In The Buda Sweet Spot. EXCO Resources has been sharing information with Contango on best practices to drill Eagle Ford wells in the area in exchange for information on best practices to drill Buda wells in the area.

The other company is Matador Resources (MTDR), which has almost 9,000 net acres to the north east of the Booth-Tortuga lease. Matador has shot 3D seismic on its lease and plans to drill a Buda well in 2014. Matador believes the whole area could be in the Buda sweet spot due to the location of the Pearsall Arch. If Matador's geologist is correct, then Contango and U.S. Energy could have another 20 gross Buda wells to drill on their joint acreage north east of Matador's acreage and right on top of the Pearsall Arch. The latest information from Matador can be found in its February 2014 Investor Presentation.

Both the Dan Hughes Heitz 302 3H Buda well and the Contango Beeler #4H Buda well reached payback in less than 2 months. Drilling economics this good are hard to find in the lower 48. While the information on the Buda discovery is available to the public on the Texas Railroad Commission online website, it remains obscure and unknown to most investors. Now that the companies are attending conferences and sharing the information it won't take long for Wall Street to look at the valuation of the Buda oil discovery, look at the current valuation of the stocks, and recognize the significant upside the Buda represents to all four companies as long as the results obtained so far continue.

Disclosure: I am long MCF, USEG. 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.