ATP Oil and Gas: Can Gulf of Mexico Permits Be Turned Into Cash?

| About: ATP Oil (ATPAQ)
ATP Oil and Gas (ATPG) is a small-cap oil and gas rework specialist that should be feeling its oats lately. Mainly focused in the Gulf of Mexico (GOM), ATP has been hit hard by the moratorium and permitorium surrounding the oil spill of a year ago. Much maligned by those who hold some of its 32.5% short position and equally touted by those who hold long investments, ATP generates excessive passion from both sides.
ATP, based in Houston, holds leases in the GOM and in the North Sea, along with recently announced negotiations for additional leases off the coast of Israel. Highly leveraged and out of favor with most of Wall Street, ATP is in the most unlikely (according to the shorts) and envious (according to the longs) position, being one of a select few companies to have multiple major permits approved by the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE) since the moratorium was lifted.
The GOM is critical to ATP’s ongoing survival as it represents 62% of potential future production, prior to the Israel announcement of last month. The year-long delay in continuing development of its GOM assets has cost the company about $350 million, and in its leveraged financial condition, has been a very unwelcomed circumstance. However, the company has muddled through the moratorium and is now getting the important life-saving green lights from the Feds to ramp up much needed production.
Investors should be familiar with the drilling permit announced on March 21 for the Titan platform to drill the third of four wells at its Telemark field, and the permit issued last Thursday for completion of the pre-drilled well in its Clipper field. However, many overlook the BOEMRE’s approval issued in January for ATP to resubmit, without an updated SAE, its suspended Canyon Express dry gas well. Management initially commented that drilling of that well will be delayed because the drilling rig left the GOM to find work in Africa after the moratorium was instituted. It could take another year for the rig to return. In addition, with natural gas markets still depressed, there is no real hurry to begin before the contracted rig returns. ATP has also completed a gathering pipeline connection from an existing well since the moratorium has been “lifted”.
Why is small-fry ATP getting the nod from the BOEMRE, while competitors multiple times larger still languish, waiting on their first permits? The answer may partially lie in the company’s infrastructure and the foresight of management concerning safety issues.

Its newest production platform with “Lego” drilling capabilities is state-of-the-art. Designed in 2007 and made in the USA, the Titan’s importance to ATP cannot be understated. More on the Titan can be found in an article here. It’s important to remember officials from the BOMRE visited the Titan last summer to review its safety features.

Much of ATP's business model focuses on lower-risk rework of reserves. In these reservoirs, the geophysics is known and permitting should be a bit easier to obtain. Noteworthy activity by BOEMRE since January, per government and industry press releases, and if the well was in the process of being drilled but was suspended pending resubmission of new, updated drilling application:
ATP (ATPG)– One New Drilling Permit; One Complete or Modify Drilling Permit, Suspended; One Pipeline Connection Approval, Suspended; Notification of One Suspended well not needing updated SAE but contracted rig moved offsite
Chevron (NYSE:CVX)– One New Drilling Permit, Suspended
ENI US – One Sidetrack Drilling Permit, Suspended
Exxon (NYSE:XOM)– One New Drilling Permit
Murphy (NYSE:MUR) – One Sidetrack Drilling Permit, Suspended
Noble Energy (NYSE:NBL)– One Bypass and Complete Drilling Permit, Suspended
Petrobras (NYSE:PBR)– One Floating Storage Facility Permit, Suspended
Statoil (NYSE:STO)– One New Drilling Permit, Suspended; One New Drilling Permit
Shell (NYSE:RDS.B)– One New Drilling Permit; One New Exploration Plan
This increased activity will drive production higher for ATP and will greatly improve cash flow. Currently, production is around 29 mboe/d, with about 39 needed to be operating cash flow less capital expenditure positive. The Telemark and Clipper wells, both of which have been permitted by the BOEMRE, should come close to making up this difference, with completion dates targeted for the 3rd quarter.
With a 30%+ jump in production this year will come the opportunity to potentially hedge at triple digit numbers. Management is also looking to add one more Telemark well and two Gomez wells to the drilling schedule, but these projects have not yet been approved. Combined, these three could add an additional 14 to 20 in production gains.
So why does ATPG trade at only 1.7 times potential cash flow after currently permitted drilling is compete? It’s simple – heavy leverage that grew last year faster than assets, production realization delays, and reliance on GOM assets.
No intelligent investor would argue that ATP is not leveraged to the hilt, but the company has sufficient cash and available lines of credit to bring the permitted projects online. Leverage is expensive, but has allowed management and shareholders to increase their exposure to deepwater oil assets, both reserves and infrastructure. This year’s added production should relieve most of the financial strains of additional over-rides and NPIs. Management has stated that equity dilutions will not be necessary to continue with their 2011 cap ex budget.
Often overlooked by investors is the liquid value of ATP's infrastructure of production platforms and pipelines. Although heavily collateralized or only partially owned, the company’s liquid infrastructure equity could reach well over $500 to $600 million.
Although delayed, the next production platform, the Octobouy, is scheduled to be out in the field in a few years, adding to both production and infrastructure assets. Major North Sea activity has been pushed back as a result of the delay in the Octobouy, which leaves ATP more exposed to GOM for large production gains.
Management is taking its offshore expertise and expanding into a more traditional exploration role with the potential Israeli leases. This added diversification of activity and cash flow should help ATP’s reliance on the GOM. However, both the Octobouy and the Israeli production won’t be achieved for a few more years, making company success still hinged on GOM prospects.
When management delivers the production gains that have been permitted, annualized operating cash flow could be around $10.00 a share, or $500 million. At that time, the investment community should take notice. The overhang of high leverage and missed production projections may prevent realization in its share value until the cash is in the bank. However, by the time the increased cash flow hits the balance sheets, share prices will be substantially above current levels.
ATP is an interesting story of large percentage potential oil and gas production gains, with few wells required, in a high and rising commodity market offset by hefty leverage and GOM exposure.
Just as ATP is leveraged to the success of its oil and gas production levels, so too are long shareholders. The large short exposure could magnify potential stock gains generated from improving fundamentals. Look for more production and financial clarity from management through investor presentations due this week and 1st quarter earning communications due May 2nd.

I think the odds favor the “leveraged exposure to increasing oil prices and production” side of the equation.
As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: I am long ATPG.

Additional disclosure: Author has been a shareholder since 2007