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Summary

Newfield Exploration (NYSE:NFX) reported strong well results in its new South Cana focus area. IP rates and liquids yields are impressive and in line with the very best wells in the original core of the play in Canadian county. Newfield estimates that its six reported wells have EURs in the 6.6-10.2 Bcfe range with high oil and NGLs cuts which should translate into solid economic returns. The report reconfirms earlier South Cana successes by Continental Resources (NYSE:CLR) and Marathon Oil (NYSE:MRO). With five rigs already running, Newfield is putting high stakes on the Cana play. However, several questions remain open: the size of the South Cana's "sweet spot"; well costs; expected rates of return; and the scalability of the play for Newfield. This note briefly addresses these topics and discusses potential implications for the stock. Exact well locations and test results are provided.

The Cana Woodford is Newfield's Second Most Active Drilling Area after Uinta

On July 19, Newfield provided, as anticipated, an operating update on its Cana Woodford shale play in Oklahoma (also known as Anadarko Woodford). This is the first release of well results by the Company since its announcement earlier this year that it had quietly accumulated a sizable lease position in the Anadarko Woodford and had ramped up an active drilling program.

Newfield has allocated significant resources to the Cana in the hope of developing a new core operating area. In late 2010, the Company began to aggressively lease acreage in the play targeting both the oil and the condensate windows in the eastern and southern extension areas that previously had been viewed as marginal or uneconomic. As of July 19, Newfield has accumulated over 135,000 net acres, including 80,000 net acres in the southern extension, and is continuing active leasing. The leasehold cost has averaged around $1,000 per acre (the royalty burden has not been disclosed but I estimate it to be slightly above 3/16, on average). In addition to the estimated $150 million that NFX invested in the project in 2010-2011, the Company is budgeting $300 million for 2012. NFX has been running five rigs since January and has indicated that it may further increase its activity in 2013 if drilling results continue strong. For comparison, in its established and proven core operating area in the Bakken, NFX currently has a total of three rigs.

Newfield's South Cana Well Results Impress

The Cana operating update pertains primarily to the Company's activity in a compact area at the southern-most frontier of the play (the South Cana). The six wells that NFX reported are concentrated in what appears to be the South Cana's sweet spot, a narrow (6-10 miles wide) condensate-prone section of the play's fairway that trends diagonally from north-west to south-east across several townships in the vicinity of the Grady-Stephens-Garvin tri-county point (the lower right corner of the map below).

Anadarko Woodford Play Map

(click to enlarge)

Source: Marathon Oil April 27, 2012 Slide Presentation.

Several operators including Continental, Marathon, Newfield, Eagle Rock Energy Partners (NASDAQ:EROC), and others, are actively assessing the South Cana potential. As many as 15 rigs are currently drilling in the area compared to just three nine months ago. Based on a detailed analysis of the public well data and the information available from Oklahoma Corporation Commission, I estimate that as much as 100 square miles (64,000 acres) of the sweet spot have been de-risked. However, the ultimate size of the condensate window's most productive core may prove to be modest in size. In a follow up note, I will provide a discussion of this portion of the play including the results to date and the latest focus of operating activity.

Newfield's press release extends the progression of recent very strong well results by Continental and Marathon in the South Cana core. Four of the six wells reported are located in close proximity (one to three miles) of the wells previously drilled by CLR and MRO and have very similar IP rates. This proves the consistency of strong flow rates in the two townships, 3N-5W in Grady county and 2N-4W in Stephens county, where the best wells have been drilled so far. The four wells had an average IP rate of 1,437 boepd (24% oil) with high-Btu gas and were drilled to the vertical depth of 15,000-16,000 ft. The EURs for these four wells are likely to be at the higher end of the Company-provided range of 6.6-10.2 Bcfe which imply robust well economics at current forward strip prices and $10 million well cost assumption. The EUR estimates appear conservative in comparison to the 9 Bcfe of reserves assigned by Continental to its Lambakis 1-14H well that tested with 1,060 boepd (15% oil) in 2011.

Below are the well locations and summary results for the four NFX-operated wells drilled along the centerline of the South Cana condensate window:

  • Wright 1H-9 - Location: Stephens county 16-2N-4W. WI: 74%. IP: 1,900 boepd (27% oil). 7-day average production: 1,450 boepd. Lateral length: 4,730'.
  • Branch 1H-16 - Location: Stephens county 21-2N-4W. WI: 100%. IP: 1,850 boepd (27% oil). 7-day average production: 1,550 boepd. Lateral length: 4,950'.
  • Faith 1H-12 - Location: Grady county 13-3N-5W. WI: 52%. IP: 1,000 boepd (22% oil). 30-day average production: 900 boepd. Lateral length: 4,200'.
  • Greenwood 1H-4 - Location: Grady county 4-3N-5W. WI: 63%. IP: 1,000 boepd (16% oil). 7-day average production: 930 boepd. Lateral length: 4,900'.

Perhaps more interesting are the results of the two wells, the Whitt 1H-25 and the Williams 1H-19, that NFX drilled on the eastern flank of the condensate window, approximately 3-4 miles from the centerline. The reported IPs and strong oil yields are very encouraging given the early stage of the assessment program targeting the oil window:

  • Whitt 1H-25 - Location: Garvin county 25-3N-4W. WI: 93%. IP: 1,050 boepd (50% oil). 7-day average production: 900 boepd. Lateral length: 4,900'.
  • Williams1H-19 - Location: Garvin county 19-2N-4W. WI: 94%. IP: 650 boepd (69% oil). 30-day average production: 430 boepd. Lateral length: 4,900'.

Uncertainties Remain

The size of the core productive area. The combined results from Newfield, Continental and Marathon give confidence that at least a portion of the South Cana acreage is highly productive and should be solidly economic once the development phase is reached. The eventual size of the core however remains the big risk. If the results of the delineation drilling disappoint, the high-return segment of the South Cana's condensate window may end up too small to make strategic significance for large players like Marathon, Newfield and Continental (these three operators will likely control the majority of the leases in this small area). In addition to the assessment of the condensate window which has already shown success, big hopes are on a breakthrough in the oil window. There, conclusive results are yet to be reported.

Well Costs. The expected high well costs are the obvious issue for this part of the Cana Woodford. With 15,000'-16,000' typical vertical depths, wells in the South Cana condensate window are likely to cost substantially more than those in the original core of the play in Canadian county where the Woodford tends to be 2,000-3,000 ft shallower. Devon Energy (NYSE:DVN), Cimarex Energy (NYSE:XEC) and QEP Resources (NYSE:QEP), the three largest operators within the original core, have reported typical EURs of 6-9 Bfce and costs in the $7.5-9.0 million range for wells drilled in a pad development mode. Expected returns for those development programs are solid but not extraordinary: 20%-50%. in order to attain similar returns, the EURs in the South Cana will need to be higher.

Infrastructure. In the event of continued success, the NGL processing capacity and water access/treatment issues would need to be addressed. South Cana will compete for pipeline access, services and processing infrastructure with the primary development area to the north which is now in its infill drilling phase and faces its own processing and water infrastructure shortages due to the continued production ramp up.

Implications for the NFX Stock

While NFX's initial well results are encouraging, it is too early to conclude that the Company's Cana initiative is value-accretive to the stock. Even within the sweet spot in the condensate window, the economics of the play cannot be taken for granted. Wells are deep and expensive, natural gas remains the largest component of the production mix by volume, and infrastructure development may mean additional costs and time. The $8 million cost target per well indicated by the Company during their conference call seems to be overly optimistic.

Newfield is investing a substantial amount of capital and organizational resource in the play. I estimate that the Company will need to deliver as many as fifty strong wells, similar to the ones discussed above, just to break even on its initial investment. With five rigs running, that may take two years, and some operating luck. Only after that point the play will begin to generate a positive NPV. In order to ultimately return a strong profit, NFX's Cana assets will need to have the productive quality and scale so that an active drilling program can be sustained for many years. It is important therefore, that Newfield either be able to capture a sufficiently large acreage position within the sweet spot of South Cana condensate window (which of course may already be the case but not communicated for competitive reasons) or show strong success in the oil window. And preferably, both. The stock should begin to recognize value once these critical components become more visible.

In conclusion, I should note that Newfield is not alone in its excitement about the South Cana. Marathon and Continental have been equally aggressive in pursuing this opportunity. All three companies are experienced shale operators. Chances are that more good news is on its way.

Source: Newfield: South Cana Wells Shine, But The Play's Scalability Remains To Be Proven