Marathon Oil: Increasing The STACK Bet

| About: Marathon Oil (MRO)


Marathon is buying 61,000 net acres from PayRock Energy Holdings, an EnCap portfolio company, for $888 million in cash.

Strategically, the acquisition appears to make sense as it increases Marathon’s existing position in the Anadarko Basin to a critical mass level.

However, taking in consideration the geological risk, the acquisition is not inexpensive and sets the bar high for both well performance and commodity prices.

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Important note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.

Acquisition Metrics

In the STACK acquisition announced on June 20, 2016, Marathon Oil Corporation (NYSE:MRO) attributed ~$11,800 per acre valuation to the undeveloped acreage, which implies that the existing production, 9,000 Boe/d net, was valued at ~$170 million. The per-acre valuation may appear materially below what Devon Energy (NYSE:DVN) paid to Felix Energy in its recent STACK acquisition and slightly above the per-acre price Newfield Exploration (NYSE:NFX) paid to Chesapeake Energy (NYSE:CHK). It should be noted, however, that a significant portion of the acreage being acquired by Marathon is less proven than the core acreage acquired by Devon. In the context of the geological risk and lease retention deadlines, I view the price being paid by Marathon as not dissimilar to the valuation in Devon's acquisition.

The acreage being acquired by Marathon is located in the oil window (the acquisition acreage is color-coded in yellow on the map below) and is ~60% operated. According to Marathon, approximately half of the acreage is currently held by production and a 1.5-rig program would be required to meet lease expirations on the remaining acreage.

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(Source: Marathon Oil, June 2016)

The above map seems to suggest that the northern and southern portions of the acreage - which represent the lion's share of the properties - have been less delineated than the central portion of the acreage (which is also the area where significant offset operator activity in the Meramec has taken place). While the map shows that at least four wells have been drilled in the southeastern portion of the acreage in Canadian County, Marathon highlighted results for just two wells, the Porter 1307 1-22MH and the Moffat 1406 1-2MH. The IP-30 rates for these wells, 603 Boe/d (51% oil) and 378 Boe/d (87% oil), look substantially below the average rate for the best wells drilled in the central portion of the acreage. On the other hand, in the northern portion of the acreage, Marathon highlighted a step-out delineation well, the Deep River 30-1MH, which delivered an encouraging IP-30 rate of 956 Boe/d from a ~5,100-foot lateral.

The delineation of a new play, particularly of a geologically complex one, is inevitably a gradual process and the STACK is no exception in this regard. It is no surprise that drilling activity in the STACK has been concentrated in the area where success has already been established, with step-out activity progressing cautiously at the flanks. Therefore, there are no reasons at this point to believe that the southern and northern portions of the acreage package being acquired by Marathon are of an inferior quality. Importantly, the moderate price paid for the acreage effectively reflects the lack of sufficient well control in certain portions of the acreage. However, it would be equally premature to extrapolate the results of the select best wells drilled in the central portion of the acreage onto the less delineated flanks.

Drilling Returns

Marathon highlighted that it expects to generate 60%-80% before-tax IRRs at $50 per barrel WTI in the Meramec. The return metrics are very impressive, even though Marathon did not specify whether the estimates are burdened with the facilities and artificial lift cost and whether any impact on the EUR from potential well interference in full-field development mode has been factored in.

Marathon's presentation indicates that the company's IRR estimates are based on a 940 Mboe type curve for a one-section (5,000-feet) lateral. The presentation does not specify the oil EUR embedded into this estimate and the assumed trajectory of the gas-oil ratio. To gain full confidence in these estimates, one needs at least few years of production history over a substantial well sample, in my opinion. However, Marathon's indication that the wells reach full payout in just 1.5 years at $50 per barrel WTI suggests very strong drilling economics, regardless of the EURs assumed.

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(Source: Marathon Oil, June 2016)

In Conclusion…

Marathon's move to increase its footprint in the STACK is not unexpected. A month ago, I discussed Marathon's increasing focus on the Anadarko Basin plays in "Marathon Oil: STACK Moves Higher On The Operational Priority List."

Marathon is an experienced operator in the Anadarko Basin and its acquisition decision must be well-informed. However, Marathon is acquiring the acreage in a highly competitive play from a highly sophisticated seller. It would be naive to expect that a premium-quality package could be won without paying a premium.

Marathon's EUR estimates for the acreage appear to be at the high end of peer estimates for the oil window. The IRR metrics advertised by the company are extraordinary and raise a question if the type curve its "risked" with sufficient degree of conservatism. Of note, to date Marathon has brought on production less than a dozen Meramec wells in the STACK, out of close to 200 Meramec wells drilled by the industry.

If Marathon delivers on its promise, the acquisition would likely prove to be a "steal," even assuming that only a portion of the acquired acreage falls within the play's sweet spot. However, given the STACK's early-stage status, I view type curve indications by operators as inevitably preliminary and believe that additional production history is required for validation. I must reiterate that the trajectory of the gas-oil ratio over time is the key metric to watch.

The acquisition by Marathon continues the consolidation trend in the STACK, with private equity investors transferring acreage to operators with deeper technical capabilities and capital resources sufficient to carry the play through the delineation and optimization stage towards full-field development. Five leading operators in the STACK have emerged:

  • Devon Energy
  • Newfield Exploration
  • Continental Resources (NYSE:CLR)
  • Marathon Oil
  • Cimarex Energy (NYSE:XEC)

The delineation in the play is progressing at a brisk pace. From a news flow perspective, the STACK and the Permian Basin are likely to remain the most active areas for the remainder of this year.

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Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.