Plains Exploration: Value Destruction In The Haynesville Shale

| About: Plains Exploration (PXP)

"Buy low and sell high." I was reading an investing book on an airplane about ten years ago and that is what the gentleman beside leaned over and said to me with a smirk on his face. He clearly thought that I was wasting my time with my reading. He already knew the answer I was searching for.

Of course he was correct, buy low and sell high is a simple concept. It is simple as a concept, far more difficult to put into practice.

I've made my share of mistakes that resulted in buying high and selling low. Investors in the natural gas space know what I'm talking about, including producers who jumped on board the shale gas boom.

One particular case of buying high and selling low really stands out.

In the spring of 2008 Chesapeake Energy (NYSE:CHK) dropped a bomb on the North American energy industry with its unveiling of a huge acreage position in the previously unknown Haynesville Shale natural gas play. Off the radar, Chesapeake had amassed at very low prices hundreds of thousands of acres in the prolific Haynesville Shale. Chesapeake built such a large position that it needed a partner to help develop it.

Chesapeake found a partner in the form of Plains Exploration (NYSE:PXP). PXP acquired a 20% interest in Chesapeake's Haynesville Shale leasehold for $1.65 billion and additionally agreed to fund 80% of the cost of drilling in the Haynesville Play up to another $1.65 billion. That amounted to a $3.3 billion investment by PXP and implied a $16.5 billion valuation of Chesapeake's Haynesville holdings.

It was a big win for Chesapeake shareholders. The $3.3 billion that Plains paid covered all that Chesapeake had paid for securing the acreage in the first place and meant that Chesapeake retained an 80% interest in this Haynesville acreage at a net cost of zero dollars.

Plains was also very happy about the deal as well as evidenced by these comments from CEO Jim Flores immediately after the deal was announced:

We will always and continue to measure our direct capital expenditures against the dollar per boe valuation of our stock. Therefore we have not participated in the latest hot play, and instead elected to repurchase our stock and while we were constantly reviewing the landscape for opportunities that provided superior returns of significant positive impact to our company.

We believe the Haynesville Shale is one of those unique opportunities. The Haynesville Shale impact we think will be no less than the San Juan Basin coal seam gas impact of the late '80s and early '90s. The reservoir here at the Haynesville is beautiful in its simplicity, the massive gas in place, produces -- produced also with dynamic volumes much like the San Juan gas Basin volumes came in everybody in '80s and '90s.

Our current financing plans are to borrow the necessary funds for the acquisition under our recently enlarged revolver with JPMorgan and Bank of America. And we plan to reduce that revolver by $1 billion over time using the excess cash flow of high commodity prices and non-revenue asset sales like real estate and frontier deepwater Gulf of Mexico fields.

Plains weighed the decision to purchase this Haynesville property against the opportunity to repurchase shares that management believed were attractively valued. Plains was very proud of its disciplined approach in the past and its avoidance of chasing the latest hot play. And after deciding to go forward with this acquisition Plains funded it by borrowing money.

As it turns out it was a decision to make a major purchase of natural gas assets at the very top of the market for the hot new Haynesville play.

Fast forward four plus years and we find Plains entering into another large and company changing transaction:

Plains Exploration & Production Company ("PXP" or the "Company") today announces it has entered into a definitive agreement to acquire from BP Exploration & Production Inc. and BP America Production Company ("BP") all of their interests in certain deepwater Gulf of Mexico oil and gas properties for $5.55 billion. The properties include the BP-Operated Marlin, Dorado and King Fields (collectively the Marlin Hub, 100% working interest), BP-Operated Horn Mountain Field (working interest 100%), BP-Operated Holstein Field (working interest 50%), BP non-operated Diana-Hoover Field (33.33% working interest, operated by ExxonMobil) and BP non-operated Ram Powell Field (31% working interest, operated by Shell Offshore Inc.).

This $5.5 billion acquisition from BP (NYSE:BP) ($6.1 billion when another deal with Shell (NYSE:RDS.A) is included) is being made by Plains which is a company that has a market capitalization smaller than the size of the deal.

This a deal that is being funded with debt and planned proceeds from the sale of certain assets that Plains owns. Which assets? You guessed it. The assets are those Haynesville acres that Plains purchased four years ago from Chesapeake.

Four years ago Plains paid $3.3 billion for its Haynesville property. Plains now plans to divest those same properties as well as another natural gas property (Madden Deep) for anticipated total proceeds of $1.5 billion to $2 billion.

Plains invested $3.3 billion in the Haynesville at the pinnacle of the natural gas prices and the Haynesville land rush. Plains is now selling these properties for little over $1 billion as the market for natural gas and the Haynesville is likely near a bottom.

Given how this Haynesville investment worked out for Plains shareholders I would be very nervous about the size of this recent Gulf of Mexico investment and the debt involved.

Buy high. Sell low. It is only a good combination if you are a short seller.

Disclosure: I 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.

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