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U.S. Energy (USEG) Is By Far The Most Levered Way To Play The Buda Oil Discovery In South Texas

Below this paragraph is the text of an article I wrote about new information uncovered on the Dan Hughes Buda discovery in south Texas. U.S. Energy (NASDAQ:USEG) is by far the most highly levered way for investors to play the Buda. U.S. energy has an enterprise value of $55 million and is the small oil company with a 30% working interest in the Booth-Tortuga lease mentioned below. Because Seeking Alpha uses a $100 million market cap to distinguish between small caps and micro caps U.S. Energy cannot be mentioned in one of their articles that is sent to their partners like Yahoo. After Contango's merger with Crimson Exploration it now has an enterprise value of approximately $950 million. The difference between the enterprise values and the working interests means a share of U.S. Energy gets around 10 times the amount of oil from the Buda as a share of Contango. And Contango is sitting on enough oil in the Buda to potentially have a PV-10 value of $800 million if they decide to run two full time rigs, go for the maximum number of infill wells, and assuming oil stays at an average price of $100. Noel Parks with Ladenburg Thalmann has a $2 price target on U.S. Energy. He stated he is waiting on results from the second well, and maybe the third well, to confirm the discovery before he upgrades the stock. He was unaware of the Dan Hughes wells before it was pointed out to him. The rest of the analysts are also waiting. Because of the Geology the second well is almost certain to be a success. And production from the first well has held up as the Beeler 2H reached full pay-out after three months in the middle of August. The third well which steps out to the west has a very good chance of being a success as well. U.S. Energy is sitting on 2 to 10 times their market cap in PV-10 oil just in the Buda. The 2 times is if the third well is a dud, because they have multiple wells to drill between their successful Beeler #2H well and the Dan Hughes wells. They will get a nice bump in PV-10 value from their petroleum reserve engineers based on the Buda wells they have participated in and the additional surrounding wells drilled by others by the end of the year. Their enterprise value is currently a few million below their existing PV-10 value without the Buda discovery. Those interested should read the links on Dan Hughes filing with the Texas Railroad Commission and the academic paper on the geology. Remember (this is my disclaimer), advice is worth what you paid for it and this advice comes to you for free.

Excitement has been building in the oil patch in South Texas surrounding the recent Buda oil discovery by private oil company Dan A. Hughes. They discovered major natural fractures in the Buda oil formation along the Zavala and Dimmit County line in Texas. The Hughes Heitz 302 3H well has produced almost 300,000 barrels of light sweet crude oil in a little over a year and is still producing. Unlike Eagle Ford wells, Buda wells do not require fracture stimulation and the wells cost less than $4 million to drill and complete. In addition, the Heitz 3H well is producing fairly large quantities of very liquids rich natural gas.

What makes this discovery so important for Contango Oil & Gas (NYSEMKT:MCF) is that they have a large lease bordering the western side of the Hughes lease called the Booth-Tortuga lease. This is because of Contango's recent acquisition of Crimson Exploration.

Key information on this particular Buda sweet-spot is revealed by Dan A. Hughes Oil Company's filing with the Texas Railroad Commission at a hearing to observe field rules for the Buda formation in Zavala and Frio Counties in Texas. The hearing was observed by Black Brush O&G, LLC. In the filing, Dan A. Hughes reveals that "in support of its position it submitted a structural map for the Buda formation for the area surrounding its Heitz lease in Zavala County, Texas. The structural map indicates the Buda formation is contiguous throughout the region. It also shows that the Buda formation is thicker to the west of its lease."

Contango Oil & Gas has a 50% working interest in 10,140 gross acres on the Booth-Tortuga lease, which neighbors the western side of the Hughes Oil Heitz lease. A small oil company has a 30% working interest in the Booth-Tortuga lease and the rest of the working interests are broken up amongst various entities.

The real secret to unveiling Buda sweet-spots is unlocked in the hearing when Dan A. Hughes Company testifies that "faulting is present near the eastern boundary of the Zavala and Dimmit County line. Hughes seeks to drill wells near fault lines which create natural fractures due to faulting." Basically, the reason natural fractures occur in the Buda oil formation is because ancient earthquakes split the rocks and allow oil to flow naturally. The way to find natural fractures is to find fault lines. The bigger the better.

It just so happens that the area Hughes and Contango are drilling in sits on top of ancient underground volcanoes with multiple fault lines. An academic paper by Truitt F. Mathews details the geology of the area. One aspect is a major fault line, known as the Zavala Syncline, runs very close to and potentially right under the Booth-Tortuga lease. The Zavala Syncline splits like a wishbone starting about 10 miles west of Frio County near the border of Zavala and Dimmit Counties. One leg runs due west just south of the Zavala County line and the other leg heads northwest up through Zavala County.

Based on the well spacing information filed by Dan A. Hughes Oil Company, Contango could have approximately 40 to 80 horizontal drilling locations in the Buda formation due to the natural fractures created by the nearby fault lines. Hughes estimates there are 715,000 barrels of oil in place for every 152 net acres. Their current estimated recovery factor of 15% is for just one vertical well drilled on 152 net acres. But Hughes estimates three more in-fill wells can be drilled for a total of four vertical wells per 152 acres. This would significantly increase the recovery factor. Cotango could be sitting on top of 40 million to 50 million gross barrels of oil in the Buda formation on its Booth-Tortuga lease with a total recovery factor of potentially 30% to 50%.

The opportunity for investors comes from the fact the information on the geology of Zavala county is obscure. And the documents on the Dan Hughes hearing in front of the Texas Railroad Commission are even more obscure. Contango has already drilled one Buda well that began producing in May and fully paid for itself during August. They have completed the second well and are currently drilling the third well. Right now the analysts following the companies near the Buda discovery are waiting for additional wells to confirm the discovery. They are unaware of the obscure geological information, or of the Dan Hughes filings with the Texas Railroad Commission. If they knew about this they wouldn't be waiting for more results because the first Contango well has been very successful. Results for the second Contango well could be out before the end of October. thirty day production results on the third well could be reported before the end of November.

There are other publicly traded companies with acreage in the area. Matador Resources (NYSE:MTDR) is shooting 3D seismic and expects results in October. Chesapeake (NYSE:CHK) was the largest leaseholder in the area, but recently sold a lot of acreage to EXCO Resources (NYSE:XCO). Newfield Exploration (NYSE:NFX) owns a large portion of the leases on the western half of the Zavala and Dimmit County line right on top of one of the legs of the Zavala Syncline. Anadarko Petroleum (NYSE:APC) and Sanchez Energy (NYSE:SN) also lease acreage in the area.

Most investors and oil people know a good Buda well requires finding an area with natural fractures. But they don't know where they occur, or why. They are waiting on someone else to drill near them to take the risk. This is how Contango stumbled into a fortune in the Buda thanks to Dan Hughes. What they should be doing is shooting 3D Seismic like Dan Hughes and Matador and looking for the fault lines. Finding the fault lines is the secret to a good Buda well. Because naturally fractured Buda wells recover their EUR's so quickly, Contango should put out a second full time rig and turn the Buda discovery into a windfall rather than an annuity.

Disclosure: I am long USEG.