For most exploration and production companies, discovering the oil is the challenge. Not so for Nighthawk Energy (AIM:HAWK). The company already has a report by leading consultants Schlumberger that their Jolly Ranch asset, jointly owned with their US partner Running Foxes, most likely contains some 1.5 billion barrels of oil-in-place.
Nighthawk’s goal is to demonstrate that its oil at Jolly Ranch, which is partially held within extensive ‘unconventional’ shale formations rather than conventional sandstone and limestone reservoirs, can be economically extracted. This work is currently at a key stage: an extensive drilling and testing programme has been taking place at Jolly Ranch, and Schlumberger is currently conducting a second report which will be used as the basis of an independent reserves assessment.
FROM UNCONVENTIONAL TO CONVENTIONAL
However, oil and gas can also be generated in source rocks – but remain there. Such formations do not have high permeability; as a consequence, the hydrocarbons do not readily escape or ‘flow’ from the rock. But they can nevertheless support commercial production, given suitable technology and a sufficiently high oil and gas price to support investment in their extraction. Such investment can include methods to mitigate the low permeability, by exposing more of the reservoir for extraction or by fracturing the rock so as to artificially make it much more permeable, thus allowing the trapped hydrocarbons to flow.
Today’s oil price supports production from fields which, in the past, were commercially unattractive including those containing thick or ‘heavy’ oil. The higher the oil price, the more attractive these become as a source of oil and gas.
In the US, the advantages of home-produced oil and gas, which reduce dependency upon overseas supplies, are considerable. These factors have been creating a great deal of interest in the so-called ‘unconventional’ shale reservoirs such as those being explored, appraised and developed by Nighthawk Energy.
Nighthawk Energy is, first and foremost, an explorer. It is seeking to demonstrate the commerciality of some very extensive acreage, principally its Jolly Ranch asset which it holds jointly with its American partner Running Foxes Petroleum. Assuming that this can be done, the assets would potentially be of interest to various oil producers. Whilst the cost of individual wells in Nighthawk’s acreage is not high by industry standards, the number of wells required to develop oilfields of this type is large, and the total capital cost is therefore quite substantial. That said, initial flow rates can typically be relatively good, and can allow the capital cost of a well to be recovered relatively quickly, after which a lower but relatively steady income stream is typical.
It would be possible for Nighthawk, in the success case, to gradually develop its assets using a “bootstrap” model, in which income is steadily re-invested in further wells, and so on. However, specialist producers who like the zero exploration risk of proven reserves might well consider purchasing the assets; there is currently considerable activity of this type in the US with other shale acreage.
CISCO SPRINGS - UTAH
Nighthawk acquired an initial 25% working interest in some 8000 acres of the Cisco Springs natural gas production and development project in 2006. The working interest has since been increased to 50% of some 24,000 acres.
There are approximately 70 historic wells on the originally acquired acreage which Nighthawk and Running Foxes have successfully re-entered and logged, and a further 32 new wells have been drilled which have given 30 natural gas appraisal discoveries. Net deterministic Proven and Probable reserves for Nighthawk Energy have been independently assessed at 121 billion cubic feet of gas and 3.8 million barrels of oil. This represents 24 million barrels of oil and equivalent; Cisco Springs represented a headline asset in the company’s portfolio prior to other subsequent acquisitions.
Comprehensive infrastructure and full production facilities are in place for both oil and gas production; in 2007 using rather lower volumes, Oilfield Production Consultants (OPC) estimated the NPV10 net value to Nighthawk of these assets at $192.3m. Low regional gas prices have curtailed the current monetisation of these assets, and production is consequently at a low level. But the company describes Cisco Springs as “an important and valuable element of the overall portfolio” (David Bramhill, Managing Director, 25 March 2010)
REVERE - KANSAS AND MISSOURI
The Revere project is a consolidation of three individual assets: the Devon Oilfield (80% Nighthawk), Buchanan (50% Nighthawk) and Xenia (50% Nighthawk). These fields total some 40,000 acres and are located on or around the state border of Kansas and Missouri. The remaining interest is held by Nighthawk’s partner, Running Foxes.
Investor attention given to Jolly Ranch tends to overshadow Nighthawk’s other operations including Revere. The company’s most recent production figure for Revere is “over 200 barrels of oil equivalent per day” and it is planned to increase this to at least 500 barrels equivalent per day by the end of 2010.
The company describe it as a “low cost, high upside development project” and actively progresses the operations. Currently there are 157 production wells, a further 69 wells drilled and awaiting completion, with a further 107 wells permitted. Investors used to high production rates per well from fields in other countries might perceive such numbers of wells as rather high for the volume of oil produced, but the US combination of high netback per barrel and low production levels per well can be attractive; the Revere reservoirs are typically just 350 to 800 feet below surface, so drilling costs are modest.
The oil assets are in Barlesville and McClouth reservoirs which have low reservoir pressure and a lack of gas drive which inhibits them from readily producing naturally; waterflood, which involves injecting water into the reservoir to flush the oil out, is a standard technique used on similar fields in the US and elsewhere. Some 15% to 25% of the oil can potentially be extracted using this approach. There are currently 47 water injection wells at Revere. OPC believe that production rates of some 5-20 barrels of oil per day are possible from each production well, using these methods. If this is correct, then some 250 wells (see above) might potentially give production levels some way in excess of the year-end target, once the project is fully on-stream.
A 13-well drilling programme is underway at Xenia, and instead of OPC issuing an estimate for the gas in place as was intended, recent drilling results will instead support a Proven, Probable and Possible reserves statement. This is currently awaited. Gas production is currently varying from 0.5 million to 0.75 million cubic feet per day, plus some associated oil. Whilst current gas prices are not strong, Nighthawk’s enthusiasm for this asset is noted, and the operational plan is to increase output to some 1.5 million cubic feet per day during 2010. Further increases, probably involving infrastructure expansion, are possible in the longer-term. The 26km Xenia gas pipeline, completed in late 2009 with a capacity of 5 million cubic feet per day, possibly gives some broad indication of upside potential. Nighthawk also owns a 50% interest in the 39km Bourbon County Pipeline.
A proven and probable reserves figure for the Revere oil is similarly not yet available. OPC have given an original oil-in-place estimate of some 217 million barrels, but this does not cover all of Revere. If one were to assume 15% recoverability (see above), the theoretically recoverable volume would be some 32 million barrels, giving perhaps 20 million barrels to Nighthawk (having 50% to 80% of the asset, see above). However, the percentage of the oil that has already been recovered would need to be subtracted.
JOLLY RANCH - COLORADO
Nighthawk Energy acquired a 50% interest in some 40,000 acres at Jolly Ranch in June 2007. This acreage position has subsequently been substantially increased, now covering approximately 370,000 gross acres in Lincoln, Elbert and Washington Counties, Colorado. The other 50% is held by their US partner Running Foxes, who are the operator.
This asset is located within the Denver Basin which has supported significant hydrocarbon production from Pennsylvanian sandstones and carbonates. Jolly Ranch contains multiple conventional and unconventional oil producing horizons; the primary targets are the Marmaton carbonate and the Cherokee and Atoka shales, which are located above each other in the Pennsylvanian, the Marmaton being above the Cherokee, with the Atoka at the bottom.
The sedimentary layers below the city of Denver are 15,000 feet thick and the Pennsylvanian formations are between 6,100 and 7,800 feet below surface. The sources of the hydrocarbons are the black shales which are laterally continuous throughout the area studied by Schlumberger (see below). These are rich in the ancient organic material from which the oil forms.
During the three years since the initial assets were acquired, the building-up of the acreage has been accompanied by exploration drilling and the associated establishment of resource estimates. By March 2010, 13 deep wells had been drilled on the acreage, classified as appraisal successes and cased and completed as producers; three shallower wells and two salt water disposal wells had also been drilled.
During the course of this work, Schlumberger Data & Consulting Services were commissioned to report on the acreage. In July 2009 thee P50 (‘most likely’) estimate of the oil-in-place in the Marmaton, Cherokee and Atoka were assessed by Schlumberger at 1.462 billion barrels gross. However, this assessment did not cover all of the Jolly Ranch acreage, about one-third of it being excluded from their study. Schlumberger stated that there is a reasonable chance of reservoir and source rock continuity over both the project area and the surrounding acreage.
It is inevitable that this assessment of gross oil-in-place becomes the realm of speculation by investors; until the entire area of Jolly Ranch has been studied and the Proved and Probable reserves established (assuming of course that the acreage is demonstrated to be commercial) it is up to investors to decide what to make of such numbers.
Some will no doubt scale-up the Schlumberger figure, assuming for example that the one-third which was excluded is broadly similar to the area studied. That would give a speculative 2.2 billion barrels oil-in-place. The percentage of the oil which is potentially recoverable is a key issue; the company has given guidance that their internal estimate of recovery factors ranges from 10% to 20%. Assuming something of the order of 15%, the recoverable barrels would then be some 220m barrels on two-thirds of the acreage, or some 330 million barrels on the extrapolated figure for the entire acreage. The further work currently being done by Schlumberger (see below) will include consideration of such issues.
Subsequent to the assessment of the above independent estimate, more recent drilling and development work has confirmed continuity of the shales over an expanding core area. Log analysis of wells also confirms or exceeds the figures in the report; Nighthawk also believe that what are known within the industry as ‘sweet spots’ probably exist at Jolly Ranch; these are areas where the formations are significantly better than average, and hence potentially represent attractive prioritised targets. Whilst consideration of such matters inevitably takes one into the realms of speculation, they appear at this stage to be positives rather than negatives. Such sweet spots can be much larger than their name might suggest, potentially extending over large areas.
The oil from the Jolly Ranch wells during testing and production is good quality, of 32 to 41 degrees API, as independently assessed by Weatherford laboratories; such oil commands a good price. The most recent production figure (March 2010) from the company was that four wells were on production, and were producing between 150 and 200 barrels of oil per day. This production is from the shales.
The commercial development of Jolly Ranch involves determining the optimum well completion arrangements, particularly for the shales. The Marmaton, which is located above the Cherokee and Atoka, is a conventional reservoir with known production profiles and completion methods. Producing from the Marmaton would be relatively simple - but in order to release the value of all three formations, the lowest must be produced first, allowing water to move upward as the oil is extracted. Nighthawk and Running Foxes are therefore currently focussed on the more challenging ‘unconventional’ Cherokee and Atoka, which contain significantly less oil than does the Marmaton. As a consequence, the commercial production level at the present time is relatively modest, though the Running Foxes production target is 1000 barrels of oil per day by the end of 2010.
The Jolly Ranch drilling programme for the second quarter of 2010 has seen the drilling of two development wells within the core development area, and a third well some 14 miles to the north of the core project location in a previously undrilled area. This latter well, the John Craig 7-2 wildcat, targeted a structural closure defined by recent 3D seismic, four miles from the Great Plains field which was recently discovered by another operator with two high-rate production wells currently producing some 300-600 barrels of oil per day from the Excello shale of the Cherokee formation. It is also some two miles west of the Riverbend field discovery made by Weipking-Fullerton Energy which also produces from the Cherokee.
The results are clearly encouraging, with the two development wells having encountered significant hydrocarbons in several horizons, including the Cherokee and Atoka primary targets; both wells have been cased and completion processes are being undertaken at the time of writing. The John Craig 7-2 well was targeting several conventional zones as well as unconventional zones, and has encountered significant hydrocarbons in the Marmaton, Cherokee, Atoka and Morrow formations; at the time of writing the casing has been run and well completion operations will commence in the near future.
The results from the wildcat well appear significant, because they give new evidence of the geology in the Jolly Ranch acreage. Nighthawk Energy has commented: “The John Craig 7-2 well opens up development significantly north of the current Jolly Ranch area. These preliminary results confirm to the extent of the area drilled so far, the conclusion of the Schlumberger study which indicated that the Cherokee and Atoka shales extend throughout the entire Nighthawk/Running Foxes area” – David Bramhill, Managing Director, 2 June 2010.
Nighthawk have engaged Schlumberger to complete an extended modelling and reservoir simulation to allow development of production and recovery profiles, with the results to be used as the basis of an independent reserves assessment.
Unlike many other small to medium exploration and production companies, Nighthawk is debt-free and some three months ago had $18.3m in cash and liquid investments to fund its operations.
Revenues were $1.01 million for the six months ending 31 December 2009, but the potential value of the company is better assessed by reference to its assets.
Currently, there are some 330m shares in issue. Taking account of the various reserves and resources estimates figures outlined above, the estimated BPS for the Nighthawk portfolio appears to be somewhere around 0.5 recoverable barrels per share. Taking account of the estimated netback of some $28 per barrel assessed by Benavides Petroleum Engineering for commercial production at Jolly Ranch, based on $70 per barrel oil, there would appear to be some degree of headroom from the current share price of about 22p.
An alternative assessment of the potential value of Nighthawk Energy uses broad-brush assessments of what purchasers are prepared to pay for good shale acreage. Taking this at a minimum of $5000 per acre, and assuming that Nighthawk received payment for at least 100,000 acres of Jolly Ranch at that price, the resultant figure would be $500m, which would be substantially above the current market capitalisation of some £75m. That the company appears underpriced seems to be generally agreed by analysts, but this is also the case for many other natural resources companies.
The key issue is whether or not Jolly Ranch is attractively economic. If the operational work which is currently being done at Jolly Ranch, together with the associated studies by Schlumberger referred to above confirm that this is the case, then investors might indeed be jolly before too much longer.
The author holds shares in Nighthawk Energy