With Apache's emphasis on the western Anadarko basin through its acquisition of Cordillera offset by BP's announcement that it is selling its Anadarko gas properties, a look at Jones Energy (NYSE:JONE) is timely. Jones has been public less than a year: its initial public offering occurred in July, 2013. This oil and gas company focuses narrowly on producing from the western Anadarko and Arkoma basins.
A gas/natural gas liquid-weighted reserves and production profile is now worth more on the back of near-term higher gas prices. Jones Energy's recent presentation in which it emphasized barrels of oil equivalent instead of oil, gas liquids, and gas separately served to obscure its value as a natural gas producer. According to Jones' fourth quarter earnings press release, oil is 25% of its production; the rest is natural gas liquids and natural gas. So with current daily production of 20,400 barrels of oil equivalent per day, only about 5,000 barrels per day are oil.
A 6:1 oil:gas heat content basis for pricing would put oil at $27.18/barrel or gas at $17.31/million British Thermal Units. Clearly the heat content ratio does not determine relative prices: with West Texas Intermediate oil at $104.30/barrel and natural gas at $4.74/million British Thermal Units the oil-to-gas price ratio now is 22. However, the biggest natural gas drawdown due to the coldest US winter in recent years has depleted US stocks of natural gas so refill demand over the next several months will be high. A glance at the Ukrainian conflict with Russia over gas prices--as well as sovereignty--highlights the importance of natural gas. Any company resilient enough to still be in the natural gas business after $2.00/million British Thermal Unit prices of a few years ago should benefit from prices now more than twice that level.
The Wall Street Journal's Liam Denning has noted that private equity interest in buying natural gas rather than oil suggests overlooked value.
Operational Areas (Map)
Jones Energy's activity focuses on the Arkoma/Woodford (southern Oklahoma) and Anadarko/Cleveland (western Oklahoma and northeast Texas Panhandle.) In the Anadarko, a 3300-square-mile play, Jones Energy has drilled about 500 horizontal wells in nine target formations and estimates over 2500 drilling locations remain, including 1731-several years' worth--in the Cleveland formation alone. It has another 811 drilling locations in the southern Oklahoma Woodford formation.
Of Jones' 89 million barrels of oil equivalent of proved reserves, 63% are in the Cleveland, and 29% are in the Woodford.
An advantage of the Anadarko play is that like in the Permian and Bakken, the Anadarko is a stacked play, with several horizontal producing zones accessible from a single well.
Jones Energy's reserves at year-end 2013 were 89.0 million barrels, of which 56% were proved developed.
|Proved Reserves as of December 31, 2013|
Jones Energy, like all producers, is highly sensitive to its realized prices for its oil, gas, and natural gas liquids. The company says that rather than strip and sell ethane, it "rejects" ethane, which means ethane stays with natural gas (methane) and is sold for gas heating value. Thus, because ethane is the biggest portion of natural gas liquids production, it is important to note that Jones Energy's liquids should be valued more like natural gas than oil. With the current high prices for natural gas, ethylene plant expansions to consume additional ethane not yet online, and the remoteness of Jones' production from petrochemical plants compared to natural gas liquids produced in the Eagle Ford or Bakken, ethane rejection is a good decision.
The short-term strip for West Texas Intermediate is over $100/barrel. Just as important, the short-term strip for natural gas is over $4.50/million British Thermal Units. While the value of light, sweet oil is considerable, it is piling up in Houston storage because of increased US production in the Permian, Eagle Ford, and Bakken plays.
Note that Jones Energy has locked in the value of most of its oil for this year-and declining amounts in future years-with swaps at $91.12/barrel. It has similarly locked in a majority of its 2014 gas production at $4.87/million British Thermal Units. Its price for natural gas liquids-the largest part of which is ethane--is less compelling with an ethane swap price of only $0.24/gallon.
Operations, Revenues, and Earnings
The company's most recent guidance in February, 2014 was for 22-23,000 barrels of oil equivalent of production average per day in 2014, a 30% increase from its 18,200 barrels of oil equivalent production at year-end 2013. Its operating loss applicable to common shares for the quarter ending 12/31/2013 was $-34.4 million.
The company plans to invest $350 million in capital expenditures for 2014, including $310 million for drilling and completion and$40 million for leasing, workovers, and efficiency projects. It is running eight rigs in the Cleveland/Western Anadarko and 2 rigs in southern Oklahoma (the Woodford.)
Jones Energy expects to drill 139 gross wells and 86 net wells in 2014. While its average drilling and completion costs have been $3.1 million, per-well costs during the enhanced frack trial phase approached $5 million. A $3.1 million average for drilling mixed oil and gas wells is less-and has to be-than the $7-$10 million/well companies report for drilling in the Bakken and other oil-prone fields.
According to the company, its average internal rate of return is 60% in the Cleveland play and 49% in the Woodford play. These compare favorably to industry averages of 25% for the Cleveland play and 15% for the Woodford play. Its oil initial production rates increased from 240 barrels per day to 270 barrels per day between 2012 and 2013. Its 3-year 30-day initial production average is 504 barrels of oil equivalent/day.
According to Hart Energy, since so much of the western Anadarko is already leased or held by production, the only way to enter it is through acquisition. This gives Jones Energy an advantage since it is firmly positioned in the Anadarko. Of its 115,000 net acres, 80% are held by production. The management of Jones Energy has been operating in the Mid-Continent for more than 25 years, history which the company claims gives it a competitive advantage in terms of local knowledge and relationships.
Although other companies such as Apache and Newfield also explore and produce in the Anadarko basin, few have so much of the company value concentrated in it as Jones. Apache has the largest number of rigs drilling in the western Anadarko. MidStates Petroleum is another competitor in the basin, but it is now debt-burdened without the same significant private equity backing as Jones.
According to Jones Energy, management owns 28% of the company and its financial sponsors own another 47%; thus, three-quarters is in non-public hands. The primary financial sponsor is Metalmark Capital, a private equity firm with several energy company investments. Metalmark owns 23.2 million shares of Jones.
Jones Energy's market capitalization is $193.4 million, or 12,530,000 public shares at an April 17, 2014 close of $15.44/share. Given the above management and private equity ownership, this represents a quarter of the value of the company. Yahoo!Finance estimates Jones Energy's enterprise value to be $821 million.
Jones just sold 6.75% notes due 2022 and upsized the offering from $300 million to $500 million. The company "intends to use the net proceeds of the offering to repay all outstanding borrowings under the Company's existing second lien term loan facility and pay down borrowings under its senior secured revolving credit facility." So this exchange of lower-priced for higher-priced debt will not affect the company's debt-to-asset ratio. That ratio already stands at a high 88%.
Oklahoma Operational Issues
Another issue for Oklahoma drillers is the recent news about earthquakes. As with earlier studies the earthquake increase appears to be correlated with the deep disposal wells used for produced water rather than fracking itself. While the increase in earthquakes is unlikely to stop fracking operations, determining and addressing its cause is key.
Water and Well Costs
At a recent Hart Energy conference, keynote speaker Rob Johnston of Apache discussed the importance of water. Unconventional drilling uses lots of water, over three million gallons for a horizontal oil well and nearly five million gallons for a horizontal gas well. In the dry western MidContinent and west Texas, new sources of non-potable (non-drinkable) water, including recycling produced water, are needed for fracking. Johnston noted that recycling water costs an additional $2/barrel compared to fresh water. For a horizontal natural gas well, this adds about $240,000/well to the cost of drilling
Gas Pipeline Infrastructure Advantage
What is often mentioned about Oklahoma and Texas in comparison to North Dakota and Pennsylvania is that the Oklahoma-Texas long experience of production gives these states, and companies operating within them, an infrastructure advantage.
Indeed, there are six major legacy gas pipelines in the Anadarko area. Four run from the Southwest to the Midwest, one runs within the MidContinent and one runs from the Southwest to the West Coast. They are:
ANR (TransCanada) 2 billion cubic feet/day;
NGPL (KinderMorgan) 3.4 billion cubic feet/day;
Panhandle Eastern (Energy Transfer Partners) 2.8 billion cubic feet/day;
Northern Natural Gas (Mid American Energy Holdings) 2.0 billion cubic feet/day;
Transwestern (Energy Transfer Partners) 2.0 billion cubic feet/day (goes to the US west coast);
Southern Star Central Gas Pipeline 0.8 billion cubic feet/day throughput with 2.4 billion cubic feet/day design capacity. On April 9, 2014, Southern Star began an open season for its MidContinent expansion.
Gas from these pipelines competes in the Midwest with natural gas from Canada and the Rockies, with gas from eastern Texas and Louisiana, and eventually with gas from Pennsylvania and Ohio, particularly the massive Marcellus field. Although natural gas is still being flared from the Bakken field in North Dakota, when it is captured and transported it will compete in the Midwest market also.
Other Financial Information
The mean Yahoo!Finance analyst rating for Jones Energy from the eight analysts following it is 1.5 on a 1-5 scale, with 1 being the best.
However, Zack's recently recommended selling Jones Energy based on the company's pattern of downward earnings estimate revisions.
To repeat two important points, Jones Energy's major holder is Metalmark Management II, LLC, with 23.2 million shares, or 47% of the company. Company management owns another 28%. Jones Energy's closing price on April 17, 2014 was $15.44/share with 12.5 million shares publicly outstanding.
An investor's concern may be that so many others have first claim on the capital. With a debt-to-asset ratio of 88% the bondholders, followed by the private equity owners and the managers, appear to have more influence than the public stockholders. However, the private equity holders and the managers have the same incentive for a higher stock price as do public stockholders.
The key to the company's growth will be the hydrocarbon prices it realizes, its ability to increase production, and its ability to control expenses.
What appears to be somewhat under the radar is that Jones Energy's high proportion of gas production, a little less than half of its total, is an advantage in this time of higher gas prices. A second advantage is Jones' existing position in the Anadarko Basin: others cannot readily enter without buying assets or companies because the basin is fully leased. A third advantage is that Jones Energy is well-positioned to sell its Anadarko natural gas production due to proximity of six major legacy natural gas trunklines. Unlike the continuing conflict over Keystone XL, these pipelines have been in the ground and operational for decades.
So Jones Energy is a company investors may want to consider depending on each investor's assessment of a) Jones' ability to operate economically to grow production, b) the likelihood of earnings improvements, c) expectations about the continued higher price of natural gas, d) the value assigned to the Oklahoma-Texas advantage of existing midstream infrastructure, e) the probability of Jones Energy being acquired at a premium from its management and major private equity holder, and f) the contrarian approach embraced by private equity firms of valuing natural gas prospects over oil prospects.
Disclosure: I am long JONE. 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.