ATP Oil and Gas: The Passionate Tug of War Continues

May. 6.11 | About: ATP Oil (ATPAQ)
ATP Oil and Gas (ATPG) is set to announce earnings next week, Tuesday May 10. More importantly, the short-term future for investors will depend on what is discussed on the conference call. ATP is a small-cap, Gulf of Mexico dependent oil development company that has struggled to fund its aggressive expansion plans. Taking on high cost, low risk projects, historically using leverage as the funding mechanism, ATPG should be on the verge of finally breaking out of its two year funk.
A large percentage of its proven reserves are in the Gulf, with the balance in the gas fields of the North Sea. There is not much question as to the availability of the oil and natural gas; it is just expensive to get from where it is to where it needs to be.
As my grandfather would say, “The road to Hell is paved with good intentions.” ATP has the management ability and the good intensions of turning their oil assets into cash. However, the headwinds have been substantial: lack of debt and equity funding during the credit crisis that coincided with the mid-point in construction of the Titan, an expensive, state of the art infrastructure asset, and then the suspension of new production activity in the Gulf that would earned a return on the same infrastructure.
For the first quarter, the company should be operating cash flow positive, but still negative when factoring in its capital expenditure budgets. Reported earnings per share will be a loss. These are already priced into its current $16.00 share price.
However, the company is working on drilling and completing two new Gulf wells which have been permitted through the new, updated rules. Funding for these projects is in place. With the added production over the next six months, the company should generate sufficient additional cash flow to offset quarterly non-cash charges of depletion, depreciation and amortization, leading to positive reported earnings.
More importantly for small oil companies, ATP’s operating cash flow will exceed capital expenditure needs, pegged at $10 a share. External financing needs become less acute and either debt reduction or asset expansion becomes an option.
The company has plans to drill two additional Gulf wells upon approval of their permits. At that time, the Titan infrastructure could be maxed out in capacity for the next several years. This production facility alone could generate $7.00 a share in cash flow, or double today’s contribution. Completion of these wells is scheduled for 2012.
ATP is in the construction phase of its next large-scale infrastructure asset, the Octobouy deepwater platform. One of the consequences of the lack of Gulf activity for over a year is the delay in Octobouy construction due to financing issues. It would be safe to assume the cash flow from the Gulf allocated to fund the Octobouy has been delayed as well. Although a multi-year project, the Octobouy could cost the company over $500 million before it is deployed, some of which has been paid for. The original design is to deploy this production platform in the gas fields of the North Sea.
Although heavily leveraged, ATP has over $600 million in infrastructure asset equity. Tapping the equity could be used to complete this next phase of infrastructure additions. In addition, the company could bring in equity partners as its overall production increases in the Gulf.
Management recently announced its expansion into the natural gas fields off the coast of Israel. While it is early in the development planning stages and the project is still taking form, the company should reap the benefits from this expansion in about 36 months.
Looking past the quarterly numbers, investors should listen on the conference call for updates on:
  • Progress of the Gulf wells currently permitted
  • Status of additional Gulf permits
  • Status of the construction of the Octobouy and its funding
  • Status of the development plans for Israel
The company has been built on using leverage to acquire and develop their low risk assets. This allows shareholders to leverage themselves as well. However, the company needs to increase production to generate the cash flow to keep the bankers and drillers content, in addition to continuing their expansion. They have the permits and the funding to do so. The timetable to accomplish this should be within the next six months.
There are obvious risks. The credit crisis and moratorium have cost the company dearly in the form of high interest debt due to the financial turmoil of 2008-2009 and $350 million in expenses from the moratorium of 2010. This has fueled the reasoning of those who have shorted the stock, believing the company will run out of cash before the required production growth is achieved. Debt service and mandatory debt reduction in the form of NPI payments continues to be elevated, crimping margins and cash available for cap ex.
The company’s margin of safety lies in its low risk proven oil and natural reserves, low risk probable reserves, and infrastructure. In addition, there is a potential for a high percentage of production growth with a few number of wells in a strong oil market over the short-term. It is critical for management to generate increased production from its current Gulf permits and to acquire the next two permits. If successful, the added operating cash flow from these projects will catapult the company into profitability. If not, the company could be sold.
If successful, the stock could be worth $28 to $32 a share, or 2.3 to 3.0 times operating cash flow, and double its current share price.
Share prices are down 19% since the first of March, when it was trading at about pre-spill levels. ATPG is a high beta stock and with its pending production growth unhedged, investors should anticipate rocky performance if either the stock market or the oil market begins to fall.
It seems with a large short position and the company’s history of struggling with production expansion, investors are waiting for the cash flow to be realized. However like many story stocks, by the time the cash hits the bank and is reported on the next quarterly earnings report the stock should already be on the move.
The passionate tug of war between the shorts and longs continues. However, it should be decided over the next six months - one way or the other. My bet has been, and still is, with the longs.
Previous articles can be found here and here.
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: Long ATPG. Author has been a shareholder since 2007.