Callon Petroleum (CPE) is a small-cap energy company that has successfully transitioned from a focus on offshore Gulf of Mexico to a pure-play Permian Basin onshore operator. The company now has several positive catalysts going forward:
- Lowered risk profile has reduced debt costs.
- Redeemed half of the 13% Senior Notes due in 2016.
- Pro-forma debt-to-cap ratio of 15% (9/30/13).
- Guidance for 2014 Permian Basin production increase of 120%.
- Undeveloped resource potential >9x current proved reserves
Note: throughout this article, I will refer to slides and information contained in Callon Petroleum's February investor presentation which you can find here. I will also reference material from CEO Fred Callon's recent presentation at the Enercom Oil & Services conference webcast which you can access here.
Beginning in 2009, Callon embarked on a strategic plan to diversify its operations from strictly offshore GoM to a pure-play Permian Basin onshore operator. The move was made to:
- Reduce investment risk.
- Create a strong foundation of visible growth potential.
- Reduce debt, increase liquidity, and enable onshore production growth.
On the last day of 2012, CPE announced it sold its 11.25% stake in the Habenero field to Royal Dutch Shell (RDS.A) for a net cash consideration of $39.5 million. Last December Callon announced the sale of its Medusa field and substantially all of its remaining Gulf of Mexico shelf assets for total net cash consideration of $88 million. For all intents and purposes, the Medusa transaction largely completed CPE's transition from a GoM offshore producer to a pure-play Permian Basin operator.
Financial Benefits Of Strategic Shift
As a result of the GoM divestments, Callon was able to redeem 50% (~$48.5 million) of its 13% Senior Notes due in 2016. Earlier in 2013, CPE raised ~$70 million by issuing non-convertible 10% Series A Cumulative Preferred Stock. As a result, the company has successfully lowered the cost of capital and increased its borrowing base. As of 9/30/13 the company had reduced its pro-forma net debt to capital ratio to a very respectable 15%. CPE can now easily fund on-going development and exploitation costs in the Permian Basin. As can be seen by the company's stock price, the transition was warmly received by the market:
2013 Year-End Reserves
Callon recently issued its year-end 2013 Reserves Update and 2014 guidance. Highlights of the report include:
- 58% increase in total Permian Basin reserves, with 50% proved developed at year-end 2013.
- Permian Basin proved reserves additions were 9.7 million boe with a drill-bit F&D cost of $15.32/bbl
- PV-10 value of Permian operations increased 282% to $301 million - a 20% PV-10 year over year increase.
Year-end 2013 total net proved reserves were 14.9 million boe. This represented a 58% increase over comparable Permian Basin reserves at year-end 2012. Total reserves are 80% oil and are 50% proved developed. The company exited 2013 with an R/P rate = 18.3 years.
As I mentioned earlier, Callon is now focused 100% on its over ~35,000 net acre position in the Permian Basin, more specifically the Midland Basin. CPE roughly doubled its Permian production in 2013. They are currently running two rigs in the region and are primarily implementing pad-based horizontal drilling although some vertical wells are being drilled mainly for lease hold purposes. CPE operates 100% of its production in the Permian.
Callon has grown into a premium operator with their horizontal drilling program in the upper and lower Wolfcamp B zone. The operating team is led by Gary Newberry, a veteran with 32 years of experience at Marathon. The company was recently awarded the 2013 Bruno Hanson Environmental Excellence Award joining previous winners like Devon and Chevron.
Production is growing nicely - specifically in the Southern region of the Midland Basin:
The company is continuing to add additional bolt-on acreage in the region. As a small operator, the company can pick up 1-2 thousand acre parcels that may make no sense for bigger players like Pioneer and Chevron, for example.
Current well costs average in the neighborhood of $6.6 million an estimated EUR of 480,000 boe. Well results from its horizontal development program are shown below:
Upper Wolfcamp B
|Peak 24-Hour Rate||Peak 30-Day Rate|
|Neal 322H (Upton)||8,297'||1,418 (91% oil)**||621 (89% oil)|
|Neal 323H (Upton)||8,205'||1,341 (82% oil)||674 (78% oil)|
|Neal 324H (Upton)||8,277'||1,048 (93% oil)||658 (85% oil)|
|Neal 652H (Upton)||8,592'||Flowing back|
|Neal 653H (Upton)||8,595'||Flowing back|
|Kendra Annie 148 #1H (Midland)||8,088'||Drilling out plugs|
|Kendra Annie 148 #2H (Midland)||8,855'||Drilling out plugs|
|Neal 344H (Upton)||7,917'||Drilled|
|Neal 345H (Upton)||7,500' (plan)||Drilling|
|** Under natural flowing pressure|
|Average peak rate over 26 days|
Lower Wolfcamp B
|Peak 24-Hour Rate|
|Pembrook 10111 #1H (Reagan)||8,261'||768 (96% oil)**|
|Pembrook 10112 #1H (Reagan)||8,240'||716 (90% oil)**|
|Pembrook 10113 #1H (Reagan)||8,250'||1,479 (94% oil)**|
|University 26-35 #1H (Reagan)||4,590'||991 (93% oil)**|
|University 26-35 #2H (Reagan)||8,300'||Drilled|
|University 26-35 #3H (Reagan)||8,207'||Drilled|
|** Under natural flowing pressure|
Callon recently implemented gas lift in the Pembrook wells following weather-related delays in December 2013. Once these wells are optimized, the company will provide longer term production data.
The peak 30-day IP rates on the Neal (Upton) wells (upper Wolfcamp) are averaging ~650 boe with about an 80% oil split. These are excellent results and bode well for the company's future in the play.
As a small oil and gas producer, the primary risk to Callon Petroleum would be significantly lower oil prices. However, as I mentioned before the company has an average well cost of ~$6.5 million on wells yielding an estimated EUR of 480,000 boe. With current a current WTI price north of $100/bbl, the economics equate to an IRR of 55%+ (see chart below). Even if WTI weakened to $80/bbl, CPE will still see IRR's of ~30%. Plus, note these estimates are based on a flat $4/MMBtu nat gas price (which is currently at $6+). With 50% of total proved reserves being "proved developed", the exploitation risks are minimal.
Upside Potential: Undeveloped Resource Potential
The company's current market cap is $274.5 million and compares somewhat favorably with its PV-10 value of $301 million. While the production growth rate, well economics, and drilling results are all impressive, the big upside to Callon Petroleum is the company's undeveloped resource asset base. With its acreage in the lower Spraberry, Wolfcamp A, and Wolfcamp Upper & Lower B, at year-end 2013 the company had an undeveloped net resource potential >140 million boe. That is >9x the company's year-end 2013 total reserves of 14.9 million boe. Since the company hasn't even begun downspacing initiatives yet, this means the possibility the company can keep growing PV-10 value at a 20% clip for sometime into the future is high. The stock price should follow. If CPE can grow PV-10 by 20% just over for the next three years, the PV-10 would equal to over half a billion dollars - or about 2x the company's current market cap. With respect to the current PV-10 analysis, current SEC guidelines for 2013 benchmark prices were $96.78 per barrel of oil and $3.67/MMBtu of natural gas. Both oil and gas prices are currently above these benchmarks.
Callon released Q3 2013 results last November: a net loss of $0.02 per diluted share, or net income of $0.03 per diluted share excluding the impact of unrealized mark-to-market derivative positions on a non-GAAP basis. But there are definite signs of improvement as the company gets down to the business of focusing strictly and 100% on the Permian Basin:
- Average total quarterly production of 4,370 boe/d was a sequential increase of 21%
- Average Permian quarterly production of 2,456 boe/d was a sequential increase of 31%
- Discretionary cash flow of $19.2 million was a sequential increase of 86%
Note the Company's net interest in the Medusa field produced an average net rate of 1,017 boe/d during the three months ended September 30, 2013, ~89% being crude oil. In addition, Gulf of Mexico shelf properties produced at an average net rate of 864 boe/d for Q3. Since the company has closed on the sale of all its GoM properties, this ~1,900 boe/d of GoM production contribution will be partially going away in Q4 results (yet to be announced) and completely gone by Q1. As a result, investors should expect total oil production from Q3 to Q4 to decline.
Also, note the Q3 results reported an agreement to sell CPE's 69% interest in the Swan Lake field for $2 million. This field includes 429 net acres and produced approximately 173,000 cubic feet per day during Q3. This sale means CPE has completely exited its position in the Haynesville shale.
The midpoint of the company's 2014 guidance (4,700-5,100 boe/day) would result in a 120% increase over the company's 2013 Permian Basin production of 2,228 boe/day. CPE plans to spend $210 million of capital for the completion of 26 horizontal wells and 8 vertical wells.
For 2014, the consensus earnings estimates of 13 analysts estimates is for $0.28/share with a low of $0.07 and a high of $0.65. Of course much of the estimate depends on the outlook for oil and gas prices, but at $0.28/share the forward P/E would be ~24.
Summary & Conclusion
Callon Petroleum has successfully transitioned from an offshore GoM company to a pure-play Permian Basin onshore operator. As a result of asset disposition proceeds and the company's new and lower risk profile, the company was able to redeem half its 13% Senior Notes, lower the cost of capital, and increase its borrowing base. As of Q3, the pro-forma net debt-to-capital was only 15%. The company is now well positioned to fund its development and exploitation plans in the Permian Basin where current well economics point to IRR's approaching 60%. While yet to be announced Q4 production results will be negatively affected by recent divestitures, the long term production growth outlook is excellent. Yet the bigger upside is the relatively low-risk undeveloped reserves potential of 140,000,000 boe: >9x more than current total reserves of 14.9 million boe. Therefore there is an excellent chance CPE can continue to grow PV-10 reserves at a 20% clip for the next three years. If so, the PV-10 value would be over $0.5 billion - or ~2x the company's current market cap. As the company executes its 2014 Permian Basin drilling plan, becomes profitable, and grows production, the stock will stand out as a real bargain. Bottom line: Callon Petroleum is a BUY with a 12-month price target of $8.75 (~30% based on the current trading price of $6.79). This estimate is not based on the company's near term earnings, but instead on the relatively low-risk undeveloped resource potential of the company's Permian Basin acreage. Longer-term Callon has the potential to double in price over the next 3 years as it steadily grows production, earnings, and moves its onshore relatively low-risk undeveloped reserves potential over to the "proved" side of the ledger. The stock will appreciate to keep up with its rising PV-10 value.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article was obtained from company documents and/or sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make. Thanks for reading and good luck!