Resolute Energy Corporation (NYSE:REN) is an independent oil and gas company engaged in the exploration, exploitation, and development of its oil and gas properties located in Utah (Paradox Basin/Aneth Field), Wyoming (Powder River Basin/Hilight Field and Big Horn Basin), North Dakota (Williston Basin/Baaken Field), and Texas (Permian Basin). From inception in 2004 as a private company, Resolute's goal has been to grow its reserve base and production through acquisitions of domestic onshore properties. Per the 10-K, REN completed the acquisitions of its Aneth Field Properties in 2004 and 2006, its Wyoming Properties in 2008, its North Dakota Properties in 2010 and 2011 and its Texas Properties in 2011. While a primary business strategy is the continued development of these properties, Resolute will pursue opportunities to acquire, explore and develop properties that are oil- and NGL-rich.
Oil sales comprised approximately 90% of revenue during 2011. As of 12/31/11, Resolute's estimated net proved reserves were approximately 64.8MMBoe, of which approximately 82% of REN's estimated net proved reserves were oil, about 9% were NGLs, and the remaining 9% consisted of gas.
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As with all oil and gas E&Ps, the focus is on proved reserves and production. Below is a snapshot of REN's proved reserves as of 12/31/10 and 12/31/11. Note the history of public information is limited in this case; while REN began operations as a private company in 2004, its IPO was filed in September 2009.
A significant portion of the reserves is oil- and NGL-based, a positive factor in an environment that favors oil prices over gas. More than 86% of reserves are concentrated in the Aneth Field in Utah. The Aneth Field was first discovered for its uranium deposits and subsequently for its oil reserves in 1953 as Humble Oil and Shell Oil initiated agreements with the Navajo Tribe and the state of Utah to produce oil. Drilling began as early as February 1956 producing more than 1,700 bbls/d per Utah.gov. The initial production brought increased attention to the area as several other oil producers followed, negotiating additional leases throughout the northern part of the reservation in what was known as the Four Corners Oil Field.
As is typical with mature oil fields, the major oil exploration companies that first explored the area have since sold the mature properties in search for higher risk and higher growth properties. An area once owned by several E&P producers is now under one company's ownership and management for the first time as noted on REN's website. REN maintains a Cooperative Agreement with the Navajo Nation Oil & Gas Company, Inc, which represents the interest of the Navajo Nation. As the majors shed these assets, smaller E&P companies like REN acquired land rights with the intent of more efficiently producing the remaining oil reserves. Since the low hanging fruit was picked decades ago by the big oil companies, REN relies on secondary and tertiary oil recovery methods.
Side note: When I first started in the oil and gas industry, I wondered why larger oil companies would opt out of fields that still contained valuable reserves. The head of the strategy team told me that getting oil via secondary and tertiary methods of recovery is similar to recovering as much milk as possible from a carton. There is the easy stuff that pours freely and then there is the milk that’s trapped in the carton’s corners or coats the inside lining. While spending the extra time to access that oil may not be worth it to a major oil company that has a significant cost structure, it may very well be worth it to smaller and more nimble E&P companies that have lower cost structures and have the time, dedicated resources, and secondary and tertiary recovery expertise to recover the volume in a profitable manner.
In 2Q12, REN's Aneth Field produced 6,650 boe/d compared to 5,990 boe/d a year ago, an 11.0% increase. The recent acquisition of the additional Denbury Resources' interest in Aneth contributed to about 420 boe/d to the 2Q12 production. REN continues to increase its Aneth production primarily through CO2 flooding. What is CO2 flooding (aka enhanced recovery and tertiary recovery)? Per Denbury, it is a process used to recover more oil than would otherwise be recoverable using conventional methods by injecting CO2 into a well. The CO2 "dissolves into the oil causing the oil to swell. This reduces the surface tension between the oil and the formation and allows the oil to be extracted through producing wells." According to Denbury, these efforts allow recovery of an additional 17% of oil in place.
Since REN acquired the Field in 2004, the daily oil production has increased by about 26.5%, or a seven year CAGR of about 3.4%. This type of growth is far from remarkable but extraordinary growth is not expected from such a mature field. The value of the basin is derived from the steady nature of cash flows generated over a long period of time (the reserve to production ratio for the Field is about 26 years) needed to finance the acquisitions of higher growth potential properties, such as those REN acquired in the Permian and Bakken.
In the 2Q12, the Hilight Field produced an average of 1,565 Boe/d, down from 1,830 boe/d for 2Q11. The lower production is due to normal production declines. Per management, decisions about initiating new activity in the area, including drilling in the Turner and Niobrara formations will depend on evaluation of results from wells drilled by other operators in the area and final interpretation of its own seismic data. In the Big Horn Basin, a single horizontal well was completed in March 2012 and was non-commercial. Based on the YOY proved reserves and production decline, management seems more focused on the other three plays than the Hilight Field. Although currently the second largest play by proved reserves, I expect the Texas and North Dakota combined production to eclipse the Wyoming properties' production within the next year.
In 2Q12, the Permian Basin produced 430 boe/d, up from 330 boe/d produced in 1Q12. REN did not have acreage in the Permian Basin a year ago. Land acquisition, drilling, and infrastructure construction is taking place in the Delaware and Midland basins and the company seeks opportunity to grow acreage in both regions. In the Delaware basin, the focus is in Reeves County where REN has 23,000 gross (8,500 net) acres and is drilling in the Wolfbone formation. Infrastructure including gas lines with compression facilities, power infrastructure to bring electricity to pumping and compression units, and a SWD well which came online in August 2012 has been or is being constructed in the area. The SWD well should have a favorable impact to the lease operating expenses although the impact was not quantified by management.
In North Dakota, production averaged 765 boe/d net to REN during the 2Q12, up from 195 boe/d produced in the same quarter last year. In the New Home project area in Williams County, leasehold interests are owned in approximately 23,500 net acres. In the Paris project area in McKenzie County, REN assumed operations of 19,000 gross (8,500 net) acres in January 2012. REN management has noted that announced data from several nearby wells has helped to lower the risk assessment for the remaining Paris acreage.
So what's the score so far?
REN issued its IPO in September of 2009 and the closing price after the first day of trading on 9/28/12 was $10.45 per share. Since the IPO close price on 9/28/09 and through the close date on 10/23/12, REN has decreased by 20.2%, the price of oil has increased by 29.9%, the price of natural gas has decreased by 5.6%, and IEO (the iShares Dow Jones US Oil & Gas Exploration ETF ) has increased by 22.2%. REN's security price has moved in the opposite direction of the price of oil and IEO and has declined significantly more than the price of natural gas.
Source: finance.google.com, eia.gov, cmegroup.com
What's the cause for the company's underperformance? Although there is no obvious cause or event that explains the sub par performance relative to the products it sells and a benchmark index, there are a couple of theories that may partially explain the underperformance.
Theory 1: The oil and gas industry has been running hot with a capital spending frenzy in a rush to grab land now known to contain several decades' worth of oil and gas reserves made possible with improved land surveying technology and extraction techniques. As the IHS article dated 4/30/12 notes, "global upstream capital and operating expenditures (CAPEX and OPEX) are set to reach a combined record of $1.23 trillion for 2012." Of that amount, the article notes $392B of the spending will occur in North America. While unable to find spend by N.A. basin or play, much of the media focus, based on personal experience, has been on the Marcellus, Eagle Ford, Haynesville, Fayetteville, Permian, and Bakken plays. The bulk of REN's reserves are in the Aneth Field, a Field that is not nearly as widely covered in the media. In fact, when I Google "Aneth Field capital spend for 2012", the first ten results involve Resolute and Resolute's recent acquisition of Denbury's interests in the Aneth Field. REN's 2012 Aneth capital spending is expected to be about $100MM, including the $35MM acquisition from Denbury. For those doing the math, that is 0.03% of the N.A. 2012 capital spend. Knowing the Field is under common ownership and management per REN, it's logical to deduct that total capital spend for the entire area isn't be much more than $100MM for the year.
Rebuttal: The company continues to explore and increase production in the Permian, Bakken, and potentially the Turner and Niobrara fields, all of which are rich in oil and NGLs. And while the Aneth Field is not as widely known, it does offer a stable and long-term source of cash flows needed as REN expands its presence in other more widely covered and higher growth areas. And while 0.03% of the current year's investment is a very small percentage, it is greater than $1.0B NPV10 of proved reserves for a company with a market value of more than $500MM.
Theory 2: The company's two year CAGR (REN's IPO in 2009 allows for only three years of information) in the proved reserves YE balance is only 2.7%. This growth rate is unimpressive when compared to its peers' reserve growth rates during a time of historically record-setting investment (see point #1). Companies are spending aggressively so the investment community expects proved reserves to grow faster than about 3%, even for an industry that has a naturally declining asset base.
REN is not short on its proved reserves balance with a R/P ratio of 22.2 years. In contrast, its peers R/P ratios are 11.8, 12.5, 8.8, 8.8, and 3.3 for CWEI, GDP, PQ, SJT, and EGY, respectively (these five companies were listed as REN's peers per cnbc.com). What's more important is that REN continues to increase production in a favorable price environment while continually increasing positions in oil- and NGL-rich plays like the Permian and Bakken. The three year average daily production CAGR (from 2009 to 2012E) is 12.1% for oil and 5.7% for gas and NGLs and a total Boe/d CAGR is equal to 8.5%. The 2Q12 vs. 2Q11 growth rate by play is 292% in the Bakken (195 Boe/d to 765 Boe/d), N/A for the Permian (0 to 430), 11% for Aneth (5,550 to 6,650), and (15%) for the Hilight Field (1,830 to 1,565). The company isn't desperate to increase its reserve base given the existing inventory.
There is nothing all that flashy or eye-catching about where Resolute operates the majority of its business. While the company expands its presence in some of the higher growth basins, about 86% of proved reserves at FYE11 are in the Aneth Field. Yet management has been able to increase daily average production by a three year CAGR of 8.5%, including 12.1% for oil and production growth contributes to revenue growth.
REN has been able to fund much of its growth and maintenance capital expenditures through operating cash flow which I have forecasted to generate about $100MM for the FY12. That has allowed the company to keep its debt relatively low relative to its peers in a capital intensive industry in historically capital intensive times. REN's total debt to equity, capital, and assets is 0.52, 0.34, and 0.26, respectively and these ratios are lower than three of its five peers. SJT is actually and oil and gas royalty and therefore reports no debt. I disagree that it's a "peer" since the business operates so differently. EGY did not carry debt on its balance sheet as of the MRQ. Additionally, REN's interest coverage ratio is above 13.5x, more than two times higher than the next best ratio reported among its peers.
I estimate REN's value to be about $14 per diluted share based on free cash flows available to the firm. Many in the industry use the NAV method of valuing E&P companies to calculate the value of the company with the assumptions that all future capex is halted and the remaining production is produced. The reason for the NAV argument is the calculation does not involve a continuing value calculation which requires a terminal value and an associated long-term growth rate, often viewed as a flaw for a company producing finite resources not able to grow indefinitely. The NAV I calculated is $14 per diluted share. Based on my analysis, REN is undervalued with a target price of $14 per diluted share.
For more detail regarding REN, click here to see the report's accompanying data.
Please note that REN's 3Q12 earnings call is on November 5th.
Disclosure: I do not currently have a position in REN or any other 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. I have no business relationship with any company whose stock is mentioned in this article.