Abraxas Petroleum Company Transformation Is On Schedule

| About: Abraxas Petroleum (AXAS)

Summary

6 Bakken wells are being completed and will start the flow-back process soon..

The Austin Chalk well has been drilled with some encouraging shows along the way and has the possibility of being extremely profitable..

The Wolfcamp well also has the potential to point the company towards a very profitable future..

Both the Austin Chalk and Wolfcamp leases have several years of potential profitable locations.

The next bank credit line redetermination process could go far better than the last one.

This company has been aiming for a production and cash flow growth spurt for awhile. Abraxas Petroleum (NASDAQ:AXAS) had sold shares to the public successfully a little while back. The main premise of the sale was that the money would eventually be used to fund some well placed bets to transform the company into a much larger company and revive the stock price despite the current hostile industry environment. At first the company management was looking at joint ventures but later, after the offering, decided to drill the prospects by itself in the hopes of making a killing. The safety cushion was supposed to be the stock sale because debt has to be repaid whether or not the gamble succeeds whereas equity does not.

So the latest quarterly report is far more important as it relates to the promise of future successes, than the current attainment of previously set revenue and earnings targets. Since management has dangled that wonderful future in front of the market, it is time to see exactly how much progress has been made towards that wonderful future. Long term debt was reduced to about $99 million at the end of the second quarter, primarily as a result of the stock offering. Though management has indicated that the proceeds will be redrawn from the bank line as needed for the coming significant production increases. If the strategy is successful, the increasing production could allow for a bank line increase at the next re-determination. In fact, the process could be delayed to assess any material production increase effects. Shareholders hope that the creditors will be very favorably impressed.

Up in the Bakken, management has several wells that were drilled but not completed. Management was hoping for better commodity pricing before completing the wells. The second quarter rally appeared to be just what management was looking for. Even though prices have since retreated from the second quarter highs, the wells are being fracked, and the rest of the completion process will soon follow. Six of these wells are company operated and should be producing by or during the fourth quarter. The flow back process will begin soon. The last well is not company operated and is scheduled to come online in the beginning of 2017. Other wells that were shut-in to aid in the completion process will be returned to production.

Since management has waited to complete the wells, the completion technology has advanced significantly. At the time of the previous article, management had reported a steep decrease in completion costs that enabled considerable savings to be reported for the capital budget. But there have also been some completion improvements that are economical even if the well costs are higher. It will be interesting to hear what completion management chose and the reported improvement in results over the previous wells. In the current environment, large tracts of the Bakken are not economical, but these wells were probably economical to complete rather than remain idle much longer. Future activity on these Bakken leases will depend upon the IRR of future wells using the latest technology and costs. Other company leases could easily offer superior results next year.

"Austin Chalk

At Abraxas' Jourdanton prospect in Atascosa County, Texas, the Company successfully drilled the Bulls Eye 101H to a total depth of 14,365 feet with a 5,865 foot effective lateral. Abraxas plans to complete this well with a 27 stage fracture stimulation in the coming weeks. Approximately 90% of the horizontal wellbore was in the Company's 20 foot target zone while drilling. Abraxas owns a 100% working interest in the Bulls Eye 101H.

Permian

In Ward County Texas, Abraxas plans to spud the Company's first well targeting the Wolfcamp A, the Caprito 99-101H, on August 13, 2016. Abraxas anticipates completing the 4,800 foot lateral horizontal well in September and bringing the well to sales shortly after.

Abraxas successfully acquired 21.3 net acres with associated production of 4.5 Boepd for approximately$130,000. Abraxas has approximately $4.5 million of offers outstanding with other parties in and around the Company's existing Delaware Basin position."

But the real news that will far more likely influence the success of the company in the future lies with the Texas leases. The company touts the Austin Chalk well as a very significant and potentially very profitable well. However, as has been noted several times in the past, that Austin Chalk wells in the area using "modern completion techniques" do not have much of a history. The Austin Chalk itself has a long history with a very different type of well. The Austin Chalk history for vertical wells goes back decades at least in many places. So investor caution may be called for here. While preliminary results on neighboring leases are very encouraging, the lack of the multi-year production history makes well profit predictions a speculation. Plus competitors are experimenting with more stages and longer laterals (up to 10,000 ft laterals!), so there are some good chances to enhance profitability of future wells in the Austin Chalk.

Now if this first well has a break-even projection of less than a year, the company may decide to "go for it" and develop the leases on the theory that management can get its money back and the profits are a gamble. A two year or longer pay-back could give management a reason to slow down the development or even abandon the planned development. Oil well accounting is such that profits can be reported in the beginning and write-downs come later, with time to take advantage of a potentially higher stock price in between. Preliminary drilling results are encouraging but the well must be completed and a track record of profitability obtained over some time. Oil industry history is littered with "hot plays" that were abandoned within a year. Let us hope this is not one of them.

The Wolfcamp is another area that gives the company a chance to make some unusually large profits. Both of these lottery tickets are well placed bets that have a better chance than average of succeeding, though success is by no means guaranteed.

For a company with less than 5,000 BOED, all of this testing is very material. Investors could see quite a cash flow spurt from all of this activity in the fourth quarter, and then a decreasing cash flow trend that is typical for alternative oil wells until management thoroughly assesses the results of these two new wells as well as future Bakken possibilities (if any). If enough of these projects assess very well, the company could be on a very significant growth spurt before next summer.

As noted before, with the deposit of the proceeds into the bank to reduce the company debt on the credit line, the company has considerably more flexibility than it did before the stock offering. The previous credit line redetermination had tightened things up quite a bit and the company management scrambled to increase the breathing room. Now any increase in the bank credit line (back to the old levels??) will be met with more production and increased collateral that should make the creditors more comfortable than before. Success could enable the company to comfortably fund its growth with cash flow and debt. This would limit future shareholder dilution. Really significant success would enable the company to fund all of its growth with cash flow. Of all the projects, the Austin Chalk well is probably the most speculative of the group, and the Bakken wells, the least speculative.

A higher stock price as a result of the above activity is very likely. The stock could easily double on the success of the Austin Chalk well alone. Wolfcamp results will probably push the stock price higher as well. After that hopefully will be increasing future production guidance. But then the challenge becomes one of continually increasing production. The new Austin chalk wells will probably now have a higher decline rate. So while the company will get its money back fast, the challenge will steadily increase to re-invest the money to keep the company growing. U. S. Energy (NASDAQ:USEG), a company I have followed for years had a big initial success with the BUDA wells in Texas, but the company failed to follow that initial success with more success, so when the commodity price decline started, the company production fell, and the company has struggled as a result. Maybe commodity prices won't decline again as they did in the recent past, but management will have to find new profitable ways to grow. That success is not guaranteed. So how long the growth spurt will last will depend upon management. The initial results that will soon be reported look good right now. It is the results after those 90 proposed locations for Austin Chalk wells are accounted for that will determine the long term success of the company and the long term investment success.

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 am/we are long USEG.

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.

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