Carrizo Oil & Gas: Sound Plans for Shale and Organic Growth

| About: Carrizo Oil (CRZO)

Shale drilling takes a particular expertise. Recently we have seen companies with this expertise do very well as shales and their millions of barrels are just waiting to be tapped. At first, horizontal drilling was performed on natural gas wells, and recently this was expanded to oil. If we are to use the Bakken shale as an example, where drillers are getting about 95% oil, companies like Brigham Exploration Company (BEXP) or Continental Resources Inc. (NYSE:CLR) are making a mint.

Carrizo Oil and Gas Inc (NASDAQ:CRZO) has this expertise. Carrizo is in a situation that could be something great. They were founded in 2003 and since then they have been busy. As of December 31st of 2009, they had participated in drilling 786 wells. At that time they had a 73% success rate.

Carrizo has a sizeable position in the North Sea. They also have accumulated several shale acreages:

Fort Worth Barnett 47000 acres
Marcellus Shale 111290 acres
Marfa Basin 58000 acres
Fayetteville Shale 26000 acres
Eagle Ford Shale 20000 acres
Niobrara Shale 61000 acres

Carrizo's plan is strong organic growth. To do this they are drilling for gas in the Barnett and Marcellus. The Eagle Ford and Niobrara will be drilled for oil. They plan to drill the low risk Barnett Shale initially. Estimates have this location's proved reserves at 570 Bcfe with potential for an additional 780 Bcfe. There are 470 potential well sites (500 foot spacing) . They are planning on developing their Marcellus Shale position. They are planning on being much more aggressive with respect to their liquids positions. Due to the better margins, the Niobrara and Eagle Ford Shales are a priority. In 2010, Carrizo drilled 5 wells and frac'd 3 in Eagle Ford. Eagle Ford will have up to 2 rigs running this year. The Niobrara had 3 drilled and 1 frac'd, and are expecting at least one rig running. These two areas could add up to 7000 BOED sometime this year. At today's prices this will increase production by one-third and double revenue.

Proved reserves have increased every year from 2003 to 2009, with CAGR of 43%. Average daily production has done the same but at a CAGR of 26%. From 2004 to 2009 this company has maintained a triple reserve replacement ratio. When compared to 21 of their competitors, Carrizo was the second lowest in total finding and development and cash operating costs.

Carrizo is increasing their capex year over year. In 2010 they appropriated most their increase to oily positions in the Niobrara and Eagle Ford. Financially, they have no debt obligations to pay back until June of 2013. In 2018 they have $400 million of senior notes due and in 2018 another $74 million. They have a $350 million credit facility if funds are needed.

When going through their holdings, it seems they have a well balanced portfolio. Their Barnett Shale position has the potential for approximately 470 additional horizontal wells at 500 foot spacing. It has reserve upside of 780 Bcfe. They have already drilled 244 gross (212) net horizontal wells with 100% success. Current net production is 110 Mmcfed. There are an additional 20 net wells waiting on frac/connection. Carrizo's position is in an area that has had very good success with respect to other drillers. Carrizo estimates their Barnett Shale holdings could have a value of $32.16 per share. If a Barnett well cost was $3 million, Carrizo estimates that an undiscounted payback at $5 NYMEX prices would be between 2.1 and 2.9 years.

In the Marcellus Shale holdings Carrizo has a 50/50 joint venture with Avista Capital Partners. They also have a joint venture with Reliance Industries (RIL). In both instances Carrizo remains the operator. Marcellus economics are better than the Barnett's. Carrizo figures, on a $3.6 million dollar well cost, they will have an undiscounted payback at $6 NYMEX of 1.1 years.

The metrics on the Eagle Ford are defined by liquids. With 20,000 thousand acres, and 80% drillable, they will have approximately 114 wells. They estimate target reserves to be 45.6 MMBOE. Carrizo is in process and evaluating further acquisitions in this area. First three wells IP'd at over 1000 bbls/day each. Expectations are wells in this area will be 65% condensate and 35% rich gas. At a $6.5 million well cost at undiscounted payback with $75 NYMEX, wells here will take 1.9 years to recoup cost.

Their Niobrara holdings are 61,000 acres where 50% are drillable. Well spacing of 320 acres could produce 95 wells. They estimate target reserves for this holding to be 28.5 MMBOE. Carrizo is currently pursuing additional areas for purchase here, as it is in Eagle Ford. The Niobrara's average well cost is estimated at $3.5 million. Their undiscounted payback at $70 NYMEX pricing is 1.4 years.

Lastly is the North Sea. They estimate the first production with be in 2012 at 30000 Boed/day gross. Although this area could have significant upside, Carrizo would be willing to part with it at the right price.

In summary, Carrizo is in a very good position for growth. As it is with many oil and gas shale drillers, they have plenty of work looking forward. Their moves into more significant positions with respect to liquids provides for better margins in the short to intermediate terms. Carrizo has the type of growth going forward that is worth the risk.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CRZO over the next 72 hours.