I’ve spent a great deal of time this week listening to presentations from the recent Enercom Oil and Gas conference. One nice thing about investing in the oil and gas sector is that most companies provide pretty regular updates at conferences. Now to be sure an investor has to listen to these presentations with a skeptical ear, but it is an easy way to get a look at a lot of stories in a short time period.
For quite a while I’ve been kind of skulking around Venoco Inc (VQ). I kind of knew the story and was kind of interested, but I haven’t quite have a handle on the company or whether or not it is worth pursing further. As I listened to the Venoco presentation I heard something that snapped me to pay closer attention.
First, to make a long story short. Venoco is a fairly small company with a massive land position in the California Monterey shale. The question so far has been whether or not the industry is going to be able to crack the code and figure out how economically extract oil from the Monterey.
Why do I care ? Because Chesapeake is the 800 pound gorilla in the unconventional resource game. Chesapeake has at top 3 position in virtually every unconventional play in the United States other than the Bakken. With the technological experience Chesapeake has I figure that the fact that they are now amassing land in the Monterey means they believe the play will be economically viable.
And more than that, the unconventional production experience Chesapeake will bring to the play will benefit all of the players as the industry will adopt best practices. All we need is one company to figure out how to get this done economically. Then anyone else with land in the play will benefit.
The Monterey Shale
The Monterey is not a new play, in fact far from it. The major oil companies have produced from the Monterey heavy oil pools since the 1900s. Most of the acreage in the Monterey in California has long been controlled by the major oil companies. This has meant that the smaller independents have not had much of a presence.
What not having that independent presence has likely done is delay the application of new technologies to the Monterey shale. The shale is the zone much deeper than where the majors have produced from conventionally. The majors have been slow to embrace the unconventional oil and gas revolution which has been led by independent producers like Chesapeake and XTO.
The Monterey Shale Play is enormous. The EIA (numbers taken from the Venoco presentation linked earlier) estimated in its report the following numbers with respect to technically recoverable reserves:
- The Bakken 3.6 billion barrels
- The Eagle Ford 3.4 billion barrels
- The Monterey 15.4 billion barrels
How is that you say? More than four times the size of the Bakken ?
Don’t get too excited. So far drilling results being reported by the two main land holders Oxy and Venoco are mixed. So this is going to take some more time. But the Bakken was exactly the same. We always knew the oil was there, and through trial and error over a five year period the industry figured it out. The first few wells were disastrous, but a necessary part of the learning process.
I think the industry likely will figure out the Monterey as well, and with Chesapeake moving in I feel like that might be sooner than later. One thing though is for certain, and that is that there is no more leveraged way to play the Monterey than through Venoco Inc.
Over the past five years Venoco has been busily identifying and then leasing prospective Monterey acreage. The best way to get a land position in a resource play is before anyone else wants it and it is still cheap. In total Venoco has amassed 214,000 acres with their leasing activity starting way back in 2006.
The potential amount of oil recoverable from this acreage is described by Venoco as being multi-hundred million barrels. If you use a rule of thumb of $20 per barrel in the ground and assume 200 million barrels recoverable the amount of value could easily be several billion dollars. With an enterprise value that today isn’t much over $1 billion the Monterey could clearly turn Venoco into a multi-bagger.
But as an investor you can’t just take a flier on the Monterey, you need some downside protection for your investment. And Venoco does offer that as it has other assets in the Sacramento Basin, Southern California and Texas. In total the numbers on these non-Monterey properties are:
- 18,000 barrels of oil equivalent of production in H1 2011
- Year end 2010 85.1 million BOE of proved reserves
- Year end 2010 PV10 reserve value of $1.1 billion
- Year end 2010 PV10 reserve value using strip pricing of $1.6 billion
To simplify, the existing booked reserves have a present value using 5 year strip pricing of $1.6 billion which is more than the current enterprise value of Venoco. That basically means that all of that Monterey upside, which could be a few hundred million barrels of recoverable oil is being valued at zero by the stock market. That is clearly interesting, although there is reason for caution.
If you have a look at Venoco today one thing that you shouldn’t be too fussed on is the company debt level. The company currently has a debt to EBITA ratio of about 2.6 to 1. Venoco plans next year to sell its Hastings Texas field (which has no booked reserves but considerable value) and get this ratio closer to 1 to 1. The Hastings field currently has no booked reserves because it is currently not producing. Also in the Hastings field is a Denbury Resources initiated CO2 flooding project in December 2010. When that production recommences interest in the Venoco position in the field should increase and a deal to reduce Venoco’s debt transpire.
An investment in Venoco at current prices will likely have one of two outcomes:
- Venoco, Occidental (OXY) or someone else (maybe Chesapeake) crack the code and unlock the Monterey oil for economic production. That happens and Venoco is a multi-bagger
- Cracking the Monterey remains a mystery and all of the value in Venoco lies in the non-Monterey assets. Since these assets basically support the current share price an investor likely shouldn’t lose much.
I’d prefer to wait until Venoco sells the Hastings field and reduces the debt to more reasonable levels before investing. The company seems to have enough value in the non-Monterey assets to support the current share price, but a high debt load can of course quickly turn any asset value to zero. A more reasonable debt level would greatly reduce the risk profile of Venoco as an investment. Of course the debt reduction might also result in a much higher share price.
An investor can be a little more aggressive and buy Venoco now, or wait for the debt reduction and risk paying a higher price later. Either way, for Venoco to turn into a great investment someone like Chesapeake needs to figure out how to unlock the Monterey.