Oil and gas plays are usually not my thing but I think I have found a small play that is substantially undervalued with hidden assets to boot that could provide dramatic upside next year.
The introduction of fracking & horizontal drilling technology in shale rock formations to the oil and gas industry several years ago has turned this country from a region almost devoid of oil and gas into a gas rich country with well over 50 years (some estimates are as many as 100 years) of supply. Recent improvements in technology have also enabled the country's oil supply to grow to supply this country with as much as 25 years of oil.
As the technology to get the oil and gas out of shale has improved, enabling the extraction to be less costly and more productive, the value of acreage in these areas like North Dakota's Bakken shale Texas's Eagle Ford Shale and the massive Marcellus Shale in Pennsylvania, West Virginia, New York, and Ohio, have skyrockted . As a general rule, the more oily plays like the Eagle Ford are most valuable, followed by the more liquid natural gas areas like Marcellus. Recent purchases by big oil companies in the Eagle Ford shale have valued the land at up to $20,000 per acre.
Magnum Hunter's (MHR) management realized the massive opportunity in shale oil and gas and took over a sleepy small oil company in early 2009 and aggressively began purchasing properties and small oil companies with valuable assets . The first purchase was Sharon Resources, which brought them valuable acreage in the Eagle Ford shale, followed by the purchase of Triad out of bankruptcy in 2009, and the purchase of NGAS last year. The NGAS and Triad acquisitions brought to the company a huge piece of the Marcellus and related shale plays such as the Utica shale for a relatively low price. The company has also been active in the Bakken shale in North Dakota, and southern Canada, buying several small companies with a total of 80,000 acres in the Williston Basin, one of its best pieces of property .
In total the company now has proved reserves of 32 million barrels of oil, which should increase at the next update in January. The company believes it is sitting on more than 400 million barrels of supply and has identified more than 1350 drilling locations.
Now that the company has spent more than two years buying property it is now time to substantially increase production.
At the start of the year production was at 2,500 boe (barrels of oil equivalent) per day and it has doubled to more than 5,000 barrels by the end of the second quarter. By year's end the company hopes to double production again to 10,000 barrels.
This morning the company announced that the production rate at Eagle Ford is progressing ahead of schedule with better than expected flow rates on two wells. One well has an initial flow rate of 2,044 boe per day and the other at 1,017 boe per day. The company plans on spudding an additional eight wells in the area by the end of 2011, ending the year with nineteen wells.
With the land purchases behind it the company is decreasing its cap-ex next year to $200 million from this year's $255 million . The company's stock has gotten hit this year as there has been concern that funding would dry up for small-cap companies like MHR. That plus the decline in the price of oil plus the overall market sell-off has caused the stock to drop more than 50% from its spring high to the recent low.
However the company recently obtained bank credit lines to cover the entire 2012 cap-ex budget, which means it will not have to come to either the equity or high yield market and issue more debt. Furthermore the combination of decreased cap-ex plus increased production should lead MHR to turn profitable next year.
Additional upside for MHR should come next year when the massive pipeline the company is developing in the Marcellus shale called the Eureka Hunter is completed. At completion the pipeline will cover an area of over 1000 square miles and be able to process 200-300 million cubic feet of gas per day. The company's plan is to spin off the pipeline as a master limited partnership next spring or summer. I believe the value of the Eureka Hunter asset is well over $500 million. Considering that the entire market cap of MHR currently is only $550 million, one can see what a valuable hidden asset is.
The CEO of MHR, Gary Evans, has already sold two energy companies in the last six years so it would not surprise me if he sells MHR in the not-so-distant future. One thing I am pretty certain of is that the price if it sold will be at a much higher price than the stock is currently traded at today. Meanwhile I am looking forward to the company reaching profitability next year and the spin-off of the Eureka Hunter pipeline asset. Disclosure: I am long MHR.