Contango Is Sitting On A Buda Oil Bonanza In South Texas

| About: Contango Oil (MCF)
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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 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.