Yesterday, Goodrich Petroleum (NYSEMKT:GDP) delivered two important announcements related to its Tuscaloosa Marine Shale ("TMS") operation. First, the company posted yet another very impressive production test result achieved at a reasonable well cost. Second, Goodrich emerged as the acquirer of Devon's (NYSE:DVN) 185,000 net acres in the TMS. Quite notable is the price tag of the acquisition: $26.7 million, which includes 750 boe/d of existing production. While lease expirations and quality of some of Devon's acreage may partially explain the strikingly low purchase price (undeveloped acreage appears to come essentially for free), the transaction looks like a remarkable bargain for Goodrich.
The absence of a meaningful stock price reaction during yesterday's trading session may reflect possible investor concerns over Goodrich's likely need to raise equity capital to help capture the remarkable development opportunity that the company has staked in the TMS play.
Well Results At A High End of Expectation
Goodrich posted what appears to be a second in a row outstanding drilling result in the challenging Tuscaloosa Marine Shale formation. Its recently completed well, the Smith 5-29H-1, tested with a strong 24-hour rate of ~1,045 boe/d (96% oil), on a tight 14/64" choke. The well has approximately 5,400 feet of usable lateral and was fracture stimulated with 20 stages. The well is in the early stage of flowback, with only 3% of the frac fluid recovered after six days on production. If the flow pattern of Goodrich's another recent well, the Crosby 12H-1, repeats itself, production rate from the Smith 5-29H-1 may increase further before achieving hyperbolic decline.
Quite notable is the Smith well's design: the lateral was placed above the difficult to drill "rubble" zone, similar to the well design strategy used by Encana (NYSE:ECA) in its Ash well. The Smith well was drilled at an estimated cost of approximately $13 million, a reasonable amount by the TMS standards.
The Smith 5-29H-1 adds yet another highly encouraging data point to the list of TMS drilling results and supports the thesis that the play has high productivity potential over a significant area: the Smith well is located approximately 36 miles east of the Crosby well.
As a reminder, the Crosby well was completed in early February and tested with a 24-hour rate of 1,130 boe/d (93% oil), on a 15/64" choke with 2,700 psi flowing pressure. [Flow rate continued to increase] The Crosby had approximately 6,700 feet of usable lateral and was fracked with 25 stages. With over 80,000 barrels of oil produced in the first 100 days, the Crosby remains the strongest producer in the Tuscaloosa Shale and is tracking substantially above Goodrich's 800 Mboe "High Case" type curve. Given that the Smith well is 20% "shorter" than the Crosby well (20 stages vs. 25 stages), the Smith has initial test metrics at least as good as the Crosby.
Goodrich estimates that even before further well cost reductions, wells such as the Crosby could have rates of return of over 70%, assuming $100/barrel WTI. Strong off-LLS price realizations and relatively low royalty burdens in the play contribute meaningfully to the play's economics.
Following the success of the Crosby well, Goodrich substantially increased its capital allocation to its Tuscaloosa Marine Shale program earlier this year. The company is currently running one rig in the play and plans to keep that pace through the end of the year. Quite important is Goodrich's comment in the press release:
With continued success, the Company will likely accelerate development of the play with a substantial increase in capital allocation in 2014.
The statement signals the company's increasing confidence in the play.
Several Additional TMS Well Announcements Are Imminent
Next few months may bring several significant catalysts to the Tuscaloosa Marine Shale play.
Goodrich is currently drilling the CMR/Foster Creek 20-7H-1 (98.5% WI) well. Results may be announced within the next two months. In addition, Goodrich is participating in Encana-operated Anderson 17H-2 (7% WI) and Anderson 17H-3 (7% WI) wells. According to Goodrich, test results from these two wells are expected within two to three weeks.
Goodrich is purchasing a 66.7% working interest in producing assets and approximately 277,000 gross acres in the Tuscaloosa Shale for $26.7 million, with an effective date of March 1, 2013. While the seller's name was not disclosed, it is quite obvious that it is Devon Energy. The remaining 33.3% working interest owner, Sinopec, has elected to retain its interest, which is not surprising given the very low price of the transaction.
Devon has struggled in the Tuscaloosa, with only few of its several tests showing commercial-type flow rates. Devon's decision to sell its acreage in the Tuscaloosa and Utica shales came public when Scotia Waterous announced the two divestiture mandates earlier this year.
Devon's acreage is located predominantly in the southern portion of the play on the Louisiana side. A significant portion of Devon's leasehold appears to be outside of the TMS's thickest section located to the north (the isopach map of the play shown below). This suggests that only a relatively small percentage of the acreage being sold represents "core of the core" acreage.
The gross oil production associated with the properties averaged approximately 750 barrels of oil per day for March 2013. The transaction also adds facilities and operating infrastructure. The purchase price appears to reflect the value of existing production, with very little value, if any, attributable to undeveloped acreage. Goodrich's comment that it "will prioritize the acreage" reflects the obvious reality that the play's high well costs and long time required to drill each well limit the amount of acreage that can be realistically retained by production before expiration deadlines. Goodrich added:
...the ultimate number of retained acreage [will] be based on geologic location, timing and amount of lease extension payments, and future rate of development of the play.
Implications for the Stock
- With equity market capitalization of less than $0.6 billion, Goodrich represents a high-impact bet on potential success of the Tuscaloosa Marine Shale play.
- While resolving the funding issue without equity dilution will be a major challenge for the company, the second in a row strong drilling result is very encouraging and may indicate that the leading operators in the play (Encana, Goodrich) have finally been able to identify an optimal well design.
- Recent drilling success - which will be put to the test during the next two-three months by several anticipated well announcements - may open a line of sight towards the play's commerciality.
- A positive read-across from Goodrich's announcement goes to Encana and Contango Oil & Gas (NYSEMKT:MCF).
Disclaimer: Opinions expressed in this article by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of Goodrich Petroleum or other companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the company's SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.
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.