Abraxas Petroleum Doubles Down On Expected Austin Chalk Bonanza

| About: Abraxas Petroleum (AXAS)

Summary

The Austin Chalk well now drilling, if successful, promises a quick payback and may result in the development of the leases from sales proceeds of the previous wells.

The Delaware Basin test wells also offer a speculative opportunity for growth even though the leases cover mostly moderate thickness of the prospective zone.

Costs to complete the Bakken wells dropped 50% and other costs dropped as well resulting in a drop in the capital budget to $24 million from $40 million.

The resumption of drilling will help the company lower average costs.

The Austin Chalk is well surveyed and delineated by decades of production, lessening the risk or failure or an unfavorable result for the exploration well.

The last article found Abraxas Petroleum (NASDAQ:AXAS) negotiating a joint venture to drill an Austin Chalk well. Usually joint ventures are used to spread the risk among several parties and reduce the overall risk of one project failing to one party. However, management has been watching neighboring operators, plus a successful equity raise (nearly 29 million shares at $1 per share), and a commodity price rally has emboldened the management. The situation has really changed in the last few months enough that management has felt confident about drilling the well themselves.

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Source: Abraxas Petroleum June, 2016, Corporate Update Slides

The attractiveness of the project is shown in the slides above. Clearly the operators are drilling wells that will pay back in a year given the cost of $5.7 million in the first slide. Since it is still early in the development part of the Austin Chalk, using the latest methods, these results could still improve considerably. Given the company's lackluster Bakken results (shown below) these preliminary results are a very welcome change. However, the company now needs to duplicate the results of the neighboring operators on its leases. Since smaller companies often are at a significant disadvantage in competing for leases, conservative investors may want to wait for the results on the first well before investing.

A successful result of the test well could result in the company earning its money back fast enough to drill a second well from the profit proceeds of the first well. Then the industry dream of a group of leases that can be developed from the cash flow of the previous wells drilled would be realized. Since there are possibly 90 potential well spots, this could be very significant for a company of this size.

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Source: Abraxas Petroleum June, 2016, Corporate Update

Industry conditions are changing so fast that the budget in this slide is already out of date. Costs were rising because the company was not drilling new wells. However, there are now several significant projects using the latest technology that should lower various costs. That could result in lower LOE and other operating costs if the company is successful.

Lower oil prices could cause the company to slow down and attempt the wait out the price decrease. With so many competitors going bankrupt or cutting back their operations, it seems hard to imagine a sustained decrease in oil prices. However, a sustained decrease could hurt this company badly. So from a financial viewpoint, the company has a speculative financial structure. Some moderate speculative success and some increased hedging could reduce the risk of lower commodity pricing considerably.

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Source: Abraxas Petroleum June, 2016, Corporate Update

Management put out bids for completing the Bakken wells awaiting completion and the bids came in about 50% lower than just a few months back. The commodity price rally and the lower bids meant that the wells would be completed as producers. The return on the money invested to finish the wells was considered excellent by management and it may be over 100% IRR. However, the flow rates listed by management on the last set of wells may not justify drilling any more Bakken wells in the current environment. Those reserves listed above per well are actually low, so at least so far, these leases are not really worth further investment. Not only do drilling and completion rates need to decrease but resource recovery may need to improve to make the leases viable in the current low pricing commodity environment. Most oil companies like to see a payback within two years and these wells do not appear to meet that constraint. With the improvements noted by other operators, the IRR may be more adequate for drilling to resume on the leases in the future. The completion final costs and results of the six wells will also be a key indicator to further development of the Bakken.

Plus the Bakken has had a lack of infrastructure that resulted in the producers receiving an unfavorable differential for their oil. That differential at times has been more than a third of the selling price lately. When oil prices were much higher, the differential was far less punishing (as a percentage of the selling price) than it is in the current low commodity price environment. The lower industry activity is allowing pipelines and other infrastructure to catch up with falling demand, so the resulting lower differential may also make the Bakken more attractive in the future.

The decrease in costs for all of the projects has enabled the company to lower its capital budget from $40 million to $24 million and use the extra money to target small working interest owners on its leases. The purchase of small working interests can often decrease record keeping and other costs. Done properly, these purchases also increase profitability of projects and corresponding lease value. Should that Austin Chalk well fail or need some more trials, there is now room in the capital budget for those contingencies. Previously, the $40 million budget was taking advantage of cash flows and spread out enough to make the budget viable. The rapidly decreasing capital budget costs has created room to do many unanticipated capital projects and left room for additional drilling. Expect company activity to continue to rise as the latest commodity price increases are sustained. Management has indicated that they intend to keep the capital budget within a $30 million to $40 million range.

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Source: Abraxas Petroleum June, 2016, Corporate Update Slides

The second slide shows the relative value of the company leases. Very few of the company leases are in the best (purple) area but many are in the moderate areas (green). So the company may well have significant viable options after the current commodity price rally, although some hedging may be needed to guarantee a reasonable profit on wells drilled in the green. Investors should not expect flow rates as good as the ones shown on the slide when the company drills as the wells shown on the slide were drilled in better areas with thicker desirable intervals. But with the area in the early development stage, its possible that all the relevant costs and resource recovery could improve to make the company's acreage a very profitable play. There are no guarantees that the favorable future result would happen though.

In the meantime, this play appears to be a lower cost play than the Bakken acreage and gives the company another speculative alternative to drilling more Bakken wells with fairly long payback periods. So part of the budget (two wells) is allocated to this acreage with more money possible should a successful first well dictate more development. There are other prospects on these leases that the industry has not yet fully explored that may offer an attractive potential in the future. But right now the current proposal appears to be the most profitable.

The actions of management seem to indicate that they expect a successful Austin Chalk well that will pay back in less than a year. If that is the case, then expect some of the capital budget money to move in the direction of drilling another Austin Chalk well before year end. The Delaware Basin wells are getting less attention but could be a very profitable growth avenue also. The Bakken leases do not appear all that profitable right now, although they could be in the near future, so the place to drill is where the money pays back the fastest. That appears to be the Austin Chalk and the Delaware Basin. Plus if there is a differential for the resources sold from the Austin Chalk, it would not be nearly as significant as the Bakken differential. There is far more infrastructure available to producers in the Austin Chalk areas.

So the company has several speculative ways to grow. The future of these leases could be far better defined over the next few months. However, at this stage, with the beginning of drilling of the first well announced, the stock is definitely a speculative investment. Management can afford a failure here (however unlikely) because they raised money by selling equity rather than borrowing money and bumping up against the new recently redetermined debt limit. Plus there will be a production increase in the second half from the completed Bakken wells even if the Austin Chalk well is a total flop. Therefore the bank line redetermination in the fall will likely be a lot easier just including the production from the Bakken wells into the total production. The recent commodity price rally and any exploration success will also help the redetermination process. So the credit line is unlikely to be cut further and will probably increase. Management has kept the long term debt-to-cash flow ratio conservative and will undoubtedly do so in the future.

A successful Austin Chalk result could cause the common stock to more than double from its present levels, as could any one of the other exploration wells. The downside risk is fairly minimal, as recent losses appear to be fully priced into the stock and the stock has not advanced that much on the news of the commencement of drilling the Austin Chalk well. Such a small advancement on this news is a sign of market pessimism at a market bottom. The market does not appear to have considered that management has done what it can to reduce the risks of this exploration well and that the Austin Chalk is one of the oldest producing intervals in the country. As such, the Austin Chalk is very well surveyed and the target is more certain than with a lot of other plays. A successful Austin Chalk well (similar to neighboring operators) could be producing as much as 400 BOE a year later, which is far more (and much cheaper to operate) than the Bakken wells. There could be a lot of downside to the other 90 potential wells that would still generate a return (and lower costs) acceptable to management. As a speculative investment, an investor could do far worse than this company.

Disclaimer: I am not a registered investment advisor and this article is not advice to buy or sell stock in any company. The investor needs to do his own independent investigation that includes reading the company governmental filings and press releases, as well as anything else relevant to determining if this company fits the investor's risk profile.

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.