An investment approach that I try to embrace is the concept of finding free options. When the stock market has no idea how to value an asset it often assigns very little if any value to it. And that can create opportunity. Sometimes these free options can turn out to be more valuable than the entire market capitalization of the company in question.
Rosetta Resources (ROSE) is a company that I have thought for quite a while might offer such an opportunity.
Rosetta has had phenomenal success with its venture into the Eagle Ford Shale Play in Texas. In its most recent presentation Rosetta details how the company’s proven and probable reserves had doubled as of July to 970 BCFE since year end 2010. This is mainly because of wells outperforming initial assumptions. Ultimate estimated recovery for each Eagle Ford well increased from 7 BCFE to 10 BCFE.
I believe that the value of the Eagle Ford property alone based recent transaction multiples is in excess of the current enterprise value of Rosetta Resources. So the Eagle Ford alone makes Rosetta an attractive investment.
But there is also a free option that shares in Rosetta offers.
That option is in the form of 300,000 acres in the “Alberta Bakken” resource play in Montana and Southern Alberta. If this acreage turns out to contain oil that can be produced at commercial rates it could represent value that creates a step change in asset value for Rosetta.
So far the value of this free option is questionable.
The recent sell off in the shares of Rosetta are the result of some disappointing production numbers form exploratory wells drilled on this Alberta Bakken acreage:
Regarding our plans in the Southern Alberta Basin, Rosetta's exploration program is a complex play with limited service infrastructure that will take time for the industry to completely understand and develop. We will complete our current horizontal drilling program and adjust our exploratory efforts and spending to reflect those results and hold our position for future optionality.
“he 2012 budget allocates approximately five percent of funds for evaluation of the Southern Alberta Basin. Rosetta continues to implement the previously announced seven-well horizontal drilling program to test the economic potential in the Banff, Bakken, and Three Forks reservoirs across its approximately 300,000 net acre position in northwestern Montana. To date, the Company has successfully drilled four of the seven horizontal wells with the remaining three scheduled to be drilled in early 2012. Two of the four wells drilled to date have been completed in the Middle Bakken and have tested at stabilized rates of 154 barrels of oil equivalent per day ("BOE/d") and 104 BOE/d. Completion operations continue on the third well. The remaining four horizontal completions will be tested during the first half of 2012.
These production rates were not what the stock market or Rosetta hoped to see. In the presentation linked above Rosetta details some facts about the Alberta Bakken acreage:
- Rosetta has confirmed that the acreage has a large resource in place (6 billion BOE)
- Rosetta has advanced the science work needed for wells to crack the code on this complex play
- Rosetta has set assumptions for well commerciality at Initial production of 250 Boe/d, EUR of 185 MBOE, 160 acre spacing and $4 million wells costs (these will achieve a 21% ROR at $85 WTI)
The announced production rates of 154 and 104 BOE/day are clearly well below the rates that Rosetta believes are need to make this play work. They have advanced the science, but not far enough. So for now, we know there is lots of oil and gas in the ground on Rosetta’s acreage in the Alberta Bakken, but someone still needs to figure out a way to get it out at rates that make production economic.
Investors who were hoping that the initial wells in the Alberta Bakken would meet the 250 barrel per day figure have sold Rosetta as they are disappointed in the 150 and 100 barrel per day results.
And this disappointment might spell opportunity for the rest of us. Since there really wasn’t much priced into Rosetta for the Alberta Bakken acreage this selloff may not be merited.
The good thing about this Alberta Bakken play is that there are lots of companies working on cracking the code. Rosetta itself doesn’t have to figure out how to best configure these wells. All Rosetta needs is for one of the many companies who are working on this play to do so. Then all companies can adopt best practices.
Other companies with large positions in the Alberta Bakken include:
I don’t have any insight into when or if the Alberta Bakken will prove to be a commercially viable play. I would never make a direct bet on it because of that. However, if I can buy Rosetta at a discount to the value of its Eagle Ford property and get 300,000 Alberta Bakken acres for free then that is another story entirely.
I’m going to be watching Rosetta over the next few weeks. If investors disappointment over the low announced Alberta Bakken production rates continues to push the share price down I may start buying a few shares.
I liken it to a coin flip. Heads I make out ok investing in Rosetta because of the value of the Eagle Ford. Tails I hit a home run because I get the Eagle Ford and the industry cracks the code in the Alberta Bakken.