ATP Oil & Gas: Above Average Risk, Controversy and Potential Reward, Part II

| About: ATP Oil (ATPAQ)
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Last Nov, I penned Part I of this title, suggesting that ATP Oil and Gas (ATPG $16.60) is a speculative and highly leveraged play on rising oil prices, based on acquiring GOM drilling permits that will increase production and cash flow.
The thesis has not changed. ATPG is a small-cap oil and gas development and production company, rather than a true exploration company, that generates excessive passion from both long and short investors. ATPG is a speculative investment not well suited for investors seeking a steady 9% annual return on a relatively risk-free selection. Some claim the stock is best used as a trading vehicle, some believe its volatility is options nirvana, some believe it on the verge of a huge decline and financial ruin, while still others are convinced the company is on the cusp of finding its own stash of gold.
Yearend 2010 and 4th qtr results were released this week. Production was up and revenues were up. Operating cash flow was negative for the year and earnings both before and after one-time items was in the red. Total liabilities grew by around $800 million. Most importantly, ATPG is still waiting on GOM deepwater permits.
If you fall on the side of the optimists, there are plenty of reasons to be encouraged. In addition, there is just as much fodder for those who are betting on ATPG’s demise. But still no final resolution in the tug of war between ATPG bulls and bears as there is still a huge short position outstanding.
Production averaged 24.9 mboe/d in the 4th qtr, up from 23.1 in both the 3rd qtr and 2nd qtr, and 15.4 in the 1st qtr. Current production is reported at 29 mboe/d. About three quarters (3094 mbbls) of 2010 oil production run rate (4471 mbbls) is hedged in 2011 at $86.63 and a bit more than half (2402 mbbls) is hedged in 2012 at $89.83. This leaves a nice cushion of existing production, in addition to 2011 production increases, to offer at potentially higher rates.
The 2010 production increase was across its asset base – 2 new wells at Telemark, re-completion at Gomez, new wells at Canyon Express and Tors in the North Sea. Since Jan, well MC754 has been completed along with additional production at Tors.
Management announced a new international venture, taking its expertise to the gas fields off the coast of Israel. While it is billed as a low capital endeavor for ATPG, it is intriguing that at this point in time, management is acting on a belief that there are better opportunities in non-USA waters. In a few years, the Israel venture may add a bit more potential and value to ATPG, along with further diversification of assets.
Operating cash flow for the year was negative -$37 million, while at the end of the 3rd qtr ytd, it stood at a positive $2.3 million. Production was up, but ocf was down - not a good 4th quarter.
There was an item listed under operating lease expenses that is described as a "one-time" expense of $20 million for pipeline hydrate remediation and new inspections per the improved GOM requirements recently issued by the BOEM. This doubled the lease expense budget. This one-time expense item constitutes 55% of 2010’s annual ocf shortfall. With higher anticipated production in 2011, lease expenses are expected to increase, along with potential additional expenses for pipeline hydrate remediation.
The balance sheet remains highly leveraged. Debt continues to grow at a faster rate than shareholder assets. Total liabilities grew from $2.0 billion in 2009 to $2.8 billion in 2010 while total assets grew from $2.8 billion in 2009 to $3.2 billion in 2010. On the flip side, management has negotiated a reduction in the interest rate of its high-yield debt.
This is a strong sign of support from ATPG’s financial backers. In addition, proven reserves only were valued at a PV-10 rate of $2.6 billion as of yearend. There is plenty of hidden value in its state-of-the-art production platforms, pipeline infrastructure, and potential for reserve additions.
While liquidity remains an overhanging issue, ATPG has in place the funding necessary for the development of its next set of GOM production wells. ATPG also has sufficient cash on hand.
The key for ATPG remains acquiring their next four deep-water permits from the feds. These permits have been tossed around more than a football on a fall day at the Kennedy Compound in Hyannisport. Management commented on their conference call that 3600 pages of documents have been filed, or twice the length of War and Peace.
Production needs to be at 42 mboe/d for ATPG to be ocf minus cap ex positive, at $80 oil and $5 gas. With current production at 29 and the two wells at Telemark potentially producing 5 to 7 each, followed by two wells at Gomez potentially producing 3.5 to 5 each, it’s not hard to visualize reaching this goal. Current hedges and unhedged sales are comfortably above the $80/$5 threshold.
ATP will move forward in steps: its current production profile; when permits are received; 90 and 180 days later when the cash flow from the next 2 Telemark wells hits the bank; then 90 and 180 days after that when the next two Gomez wells are adding to cash flow as well. The intriguing part of being a long investor in ATP is determining these values and a reasonable timetable.
Due to their multi-layered debt, and the accompanying risk, ATPG is an interesting leveraged play on the oil markets, based on a short-term, large percentage production growth spurt, which is unhedged, from a few number of new wells. Funding is in place, the assets are in the ground, and all that is needed is the blessing of the US government and our elected officials. Until that happens, ATPG cannot move forward, at least here in the US.
I think ATPG is worth $15 to $18 before permits are received; $20 to $22 when they arrive; $28 to $32 when the cash hits the bank; and higher after that. If you can tell me when the proverbial "check is in the mail" arrives, I can tell you when these production levels and share prices may be achievable.

3 yr stock chart with 200 day and 50 day moving averages:

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: I am long ATPG. Author has been a shareholder since 2007