From when I started buying shares in the fall of 2008 through when I sold this spring, I rode the roller coaster ride that is ATP Oil and Gas (ATPG). As an investor I’ve never had an experience like ATP before, and I can’t say I’m looking for a similar experience in the future.
When I bought my ticket to the roller coaster in the fall of 2008, shares of ATP were somewhere around $16. This was already a long drop from a high of $50 earlier in the year. The plunge in the share price was not over however as the stock didn’t bottom until it hit $2.78 in March of 2009. I remember that $2.78 share price vividly, because I watched it in real time from under my desk in the fetal position.
Shortly after the share price hit bottom, ATP managed to complete an asset monetization of a key piece of Gulf of Mexico infrastructure, which raised much needed cash. I thought this asset monetization was a rousing success given that the world was falling apart at the time. Feeling more optimistic, I sucked up my courage and bought some more shares. A few months later ATP arranged for vendor financing on some Gulf of Mexico drilling further easing their funding concerns and I was feeling even better about their prospects I bought again.
The next year or so the ATP roller coaster continued mainly upwards touching $23 in the fall of 2009 and by the spring of 2010 was hovering around $20. At this point I felt like a genius as ATP was about to bring its first well on production from its Gulf of Mexico Telemark project, and the company’s prospects looked bright.
But as you know roller coasters go up and down, and it was time for another plunge. Very soon after ATP was bringing on production from its first Telemark well, BP (NYSE:BP) blew their Macondo well. Every stock tied to the Gulf of Mexico plunged, ATP worse than most.
It wasn’t just the stock price that was impacted by the BP spill, so were ATP’s operations. Original plans were to bring on 3 or 4 additional wells in 2010. Instead because of the drilling moratorium ATP had to wait almost a full year after the BP spill before they could resume normal drilling operations.
When you are battling a ticking clock in the form of a large debt load, a one year delay in a step change in production and cash flow is not very helpful.
Macondo was a real problem, but the rollercoaster in ATP shares bottomed in June of 2010 and climbed steadily through the spring of 2011. Immediately after ATP received their first post Macondo drilling permit early in 2011, I jumped off the ride -- dizzy, nauseous and relieved.
When I sold I certainly thought ATP had better days ahead of it, and that I was leaving upside on the table. I was ok with that as the Macondo incident really drove home to me how this company with such a large debt load was not necessarily in control of its own destiny.
A lesson I needed to learn about leveraged companies.
The Rollercoaster Has Turned Back Down
As it turns out I got off the ride at a good time. ATP’s share price bobbed up and down over the summer of 2011 and into the fall, mostly on the news out of Europe. Recently, shares have plunged well under $10 on more company specific details.
My exit timing this spring was pure luck because I now believe my entire investment thesis here was flawed right from the beginning.
I saw ATP as a company with two distinct aspects, one risky, one conservative:
- The first part is an incredibly aggressive (risky) financing strategy that involves taking on huge amounts of debt to build out key deepwater hubs in the Gulf of Mexico
- The second part is that this risky financing strategy is possible because it is combined with a low risk operational strategy carried out by a first class operational team. The operational strategy involves a narrow focus on the low risk development of proven oil and gas reserves. In other words ATP can take on a lot of debt because they know what their drilling is going to result in with respect to cash flow (other operators are more exploration in nature).
I thought the operational excellence of ATP would result in a fast ramp up of cash flow, deleveraging the balance sheet and removing the large discount the stock market was assigning to the value of ATP’s reserves.
I greatly underestimated the operational risk.
During the conference call last week ATP shares sold off hard. This week I had a chance to listen to the call and the reason for the sell-off became pretty clear. Company production, which exceeded 31,000 boe/day in August, is now down to 25,000 boe/day.
Most of the debt ATP has taken on was to finance the development of its Deepwater hub at Telemark. At Telemark, ATP has production capacity of somewhere around 25,000 barrels of oil per day. The original thinking was that the first four wells would easily allow ATP to reach full capacity.
The production decline mentioned above relates to the Telemark property which is crucial to ATP.
The conference call revealed the following:
- The first Telemark well which was at the Atwater 63 block was originally advertised by ATP as the one well that would be the most prolific producer. Original estimates revealed in the 2008 Q4 conference call were for the Atwater 63 well to produce at 7,000 to 10,000 boe/day. In early 2010 after drilling this well tested at 10,700 barrels of oil equivalent a day which sounded great. Through 2010 however it became evident that there was a problem with the well at Atwater 63, with production rates only in the 2,000 to 3,000 boe/day range. In the conference call last week ATP disclosed that the well is being produced only every other month for pressurization reasons and at a rate of only 1,000 boe/day. ATP expects that ultimately the reserves recovered here will be 90% of what was originally expected. 1,000 boe/day versus expectations of 7,000 boe/day.
- The second Telemark well which was at Mississippi Canyon 941 has performed much better. Original production rates from the well which commenced late in 2010 were for rates in excess of the expected 7,000 boe/day. There is one minor problem which was revealed in last week’s conference call which is that sleeve has been closed on the lower zone in the well in order to reduce the amount of water being produced. Closing this sleeve has resulted in the shut in of 1,500 boe/day of production. ATP believes they can get this production back at relatively low cost.
- The third Telemark well also at Mississippi Canyon 941 also initially looked great with initial rates in excess of 7,000 boe/day. However the conference call last week revealed that because of concerns over damaging the gravel pack ATP is only going to be able to produce the well at rates of 3,500 boe/day. There will not be any reserve implications of the lower rate, but there will be considerably less cash flow as a result of production being half of what was expected.
Hearing what all of these wells are currently producing at rattled me. Three wells that were expected to produce at 7,000 boe/day each or 21,000 boe/day combined are currently producing at roughly (1,000 + 7,000 + 3,500) = 11,500 boe/day (the 7,000boe/day for the first MC941 well is an estimate, it could be slightly higher).
Well over a billion dollars of debt has been taken on by this company to get at these reserves and the first three wells are producing at barely more than half of what was expected. My investment thesis on ATP was that the danger was on the balance sheet, not in what was going to come out of the ground. I had assumed that a company would not debt finance such a project without being virtually certain that they had a handle on what their reserves were capable of producing.
I thought the main risk was the company running out of cash before the Telemark wells were producing, not that the Telemark wells would not produce enough.
There Are Some Positive Items as Well
These well results are very concerning obviously, but I’m not ready to give up on ATP. There have also been some recent unexpected positive developments:
1) The drilling of the fourth Telemark well found a nice surprise:
“ATP encountered 167 feet of additional net pay sands above pre-drill estimates. These sands are in addition to the 72 feet of logged net oil pay seen in the original target sand at the Morgus well located at MC 942 #2. Because of the considerable additional hydrocarbon-bearing sands, ATP is adjusting its completion plan to include two new gravel packs which will extend the projected completion time to late January 2012, and ATP expects a positive effect on production by extending the production life and third-party reserve estimates associated with MC 942.”
2) ATP’s Clipper property is much more significant than expected:
“The second Clipper well, located at Green Canyon (GC) 300 #4, in approximately 3,450 feet of water, encountered 56 feet of logged net oil pay confirming reserves previously booked. The 9-5/8 inch casing has been set at 15,778 feet measured depth through the pay intervals. The well will now be completed and tested. In July 2011, ATP successfully completed and flow tested the first Clipper well, GC 300 #2 ST #1, at a rate of 45.6 MMcf per day and 4,656 Bbls per day.”
I don’t own any shares and have no plans to buy any. The debt load was always frightening and the results from the Telemark wells leave me with no idea what I can count on in terms of production going forward.
I am however rooting for ATP management, ATP employees and ATP shareholders. Hopefully high oil prices can make up for the disappointments in production.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.