Company Analysis-Petroquest Energy
PETROQUEST ENERGY (PQ) May 2007
Key Investment/Trade Positives:
1) Petroquest Energy (PQ) has been undergoing a longer term transformation from a Gulf Coast exploration company to one with significant longer life development in East Texas and the Arkoma Basin. A continuation of the improved stability and an “optimal” mix (as per discussion in our Newfield Exploration analysis) of exploration and development should lead to multiple expansion.
2) The company is highly leveraged to progress at the Woodford Shale (located within 20 miles of Newfield Exploration’s activity). Progress in the area has potential for significant upside for the stock (estimated $5-10 per share based on a break up analysis using conservative comparable valuation metrics). However, particularly based on the smaller size of the company, the costs involved are also substantial (estimated at $5MM per well and more than originally budgeted). Based on our analysis, the project has not been over hyped by management and expectations of positive developments (which are looking fairly positive based on Newfield exploration’s work and initial drillings) have not been incorporated into the price of the stock.
3) Petroquest Energy has had consistent operating success and strong price momentum.
Key Investment Risks
1) Despite diversification efforts Petroquest Energy has a heavy reliance on riskier Gulf Coast exploration outcome (its properties are still highly concentrated relative to peers). Riskier short-lived reserves still disproportionately represent volume and production growth.
2) Petroquest Energy has had significant operational success since its turn around in 2002 and has a history of meeting or beating expectations. Any major setbacks (which are not uncommon given industry/business dynamics) could have a disproportionate negative impact on the stock.
3) Exploration risk (concentrated/heavier reliance on riskier short life reserves), flattening production growth, miscalculated assumptions regarding volume, and exploration cost variables.
4) Commodity pricing risk.
Bullet Point Description/Presentation:
*Petroquest is a purely domestic independent oil and gas company with operations in Oklahoma, Texas and the Gulf Coast Basin. The company seeks to grow production, proved reserves, cash flow and earnings at low finding and development costs through a balanced mix of exploration, development and acquisition activities.
*Current domestic oil and natural gas focus is on: 1) East Texas; 2) Arkoma Basin; 3) South Louisiana; and 4) Shallow Gulf.
*The company has a five step growth strategy by way of: 1) optimizing existing production; 2) development drilling; 3) resource play development; 4) strategic acquisitions; and 5) exploration program.
*From 1985 through 2002, PQ focused exclusively in the Gulf Coast Basin with onshore properties principally in southern Louisiana and offshore properties in the shallow waters of the Gulf of Mexico shelf. During 2003 (the “turnaround” period for the company), PQ began implementing its strategic goal of diversifying reserves and production into longer life and lower risk onshore properties in Texas and Oklahoma. PQ also refocused selection processes to reduce average working interest in higher risk projects, shift capital to higher probability onshore wells and mitigate the risks associated with individual wells by expanding drilling programs across multiple basins.
*During the past 2 years, the company has achieved record production, estimated proved reserves, cash flow from operating activities and net income.
*Historical growth for the company has come through drill bit and strategic acquisitions, with an 89% historical drill success rate over an 8 year period.
*The company has had considerable operating success and is considered a top quartile operator among peers. During 8 years it has increased :1) Reserves +33% CAGR; 2) Production +41% CAGR; and 3) Cash Flow +125% CAGR.
Growth Strategy for 2007/2008/Q&A Discussion
*During the Q&A, questions focused on specific projects (see below for factual background) and particularly on the status of the Woodford Shale. It was highlighted that progress at the Woodford Shale represents a key part of the company’s upside potential.
*Management highlighted an emphasis and goal of focusing its reserve base to longer life onshore plays (focusing on Woodford and Cotton Valley) and ultimately reducing the shorter life/riskier Gulf Coast region reserve base to about 25%.
*Sequential emphasis towards the longer reserve life strategy. In Year End 2006, approximately 52% estimated proved reserves were located in longer life basins in Oklahoma and Texas and 48% were located in the shorter life. This compares to 35% of proved reserves in longer life basins in 2003, 45% in 2004 and 50% in 2005. In terms of production diversification, during 2006, 29% of our production was derived from longer life basins versus 30% in 2005, 16% during 2004 and virtually none in 2003.
*PQ continues to seek opportunities to increase its longer life onshore reserves while maintaining some exposure to shorter life, but potentially higher impact Gulf Coast reserves with an ultimate goal of having longer life reserves represent approximately 75% of total estimated proved reserves.
*The company plans to continue several strategies designed to mitigate operating risks. Since 2003, PQ adjusted the working interest it is willing to hold based on the risk level and cost exposure of each project. For example, the company typically reduces working interests in higher risk exploration projects while retaining greater working interests in lower risk development projects. Also, partners agree to pay a disproportionate share of drilling costs relative to their interests.
*PQ expects to continue to actively hedge a portion of our future planned production to mitigate the impact of commodity price fluctuations and achieve more predictable cash flows (approximately 36% currently production currently hedged and targeting 40-50%)
2007 Focus Projects discussed/highlighted during Q&A
*PQ plans to continue focusing on Oklahoma, Texas and the Gulf Coast Basin, and to continue to build scale, particularly in the longer life onshore regions, through drilling and complementary acquisition activities.
*PQ plans to diversify by focusing on striking a balance between lower risk development and exploitation activities and higher risk and higher impact exploration activities. The company also plans to continue to pursue strategic acquisitions aimed at geographically and operationally diversifying its asset base and increasing its inventory of drilling projects.
Gulf Coast Basin/Turtle Bayou Field. During 2006, PQ invested $6.5 million in this field on the drilling of one exploratory well. As a result of this discovery, production from the field averaged over 4 MMcfe per day during 2006, a significant increase from 2005 average daily production. In addition, this discovery added approximately 15 Bcfe of net proved reserves representing a nearly four-fold increase in proved reserves in the field from the beginning of 2006. PQ is evaluating future opportunities, but at present, does not plan to drill any wells in this field during 2007.
Main Pass Block 74. During January 2006, production was restored at this field after being shut-in since September 2004 in order to complete extensive repairs to third party pipelines damaged by Hurricane Ivan. Production from this field averaged 12.6 MMcfe per day during 2006 and represented approximately 18% of our total 2006 production.
Oklahoma/Arkoma Basin/Woodford Shale. During 2006, PQ drilled 77 wells on Oklahoma properties achieving a 92% success rate. PQ invested $33 million in Oklahoma during 2006 or 19% of total 2006 capital expenditures. PQ grew average daily production in 2006 from Oklahoma properties to 9.1 MMcfe, a 98% increase from 2005 average daily production. During late 2006, PQ began initial drilling program to evaluate the Woodford Shale formation on portions of our Oklahoma acreage. During 2007, PQ expects to spend approximately approximately $30++ million in this region on the drilling of a combination of vertical and horizontal wells and the acquisition of 3-D seismic data to target this potentially significant formation.
Texas/Cotton Valley/SE Carthage. During December 2003, PQ acquired working interests in approximately 41,000 acres in this field, which had approximately 80 producing wells. During 2006, PQ invested $38 million on the successful drilling of 13 wells in this field. Net production from this field averaged 11 MMcfe per day during 2006, an approximate 36% increase from 2005 average daily production. During 2007, PQ expects to invest approximately $40 million and drill 15 wells in this field.
Management
Charles Goodson---Chairman, CEO, and President
Michael O. Aldridge---Chief Financial Officer
Daniel G. Fournerate---General Counsel
Institutional Holders Structure
Ingalls & Snyder $47.131Million (7.7%) NYSE
Independence Investment $29.93 Million (6.55%) Shares Outstanding 47.82 Million
Freiss Associates $25.48 Million (4.18%) Float: 39.47 Million
Barclays $24.25 Million (3.98%) Market Cap $555.61 Million
Mellon $23.74 Million (3.90%) Avg Volume: 393,2000
Wellington Management $20.69 Million (3.40%)
Key Investment/Trade Positives:
1) Petroquest Energy (PQ) has been undergoing a longer term transformation from a Gulf Coast exploration company to one with significant longer life development in East Texas and the Arkoma Basin. A continuation of the improved stability and an “optimal” mix (as per discussion in our Newfield Exploration analysis) of exploration and development should lead to multiple expansion.
2) The company is highly leveraged to progress at the Woodford Shale (located within 20 miles of Newfield Exploration’s activity). Progress in the area has potential for significant upside for the stock (estimated $5-10 per share based on a break up analysis using conservative comparable valuation metrics). However, particularly based on the smaller size of the company, the costs involved are also substantial (estimated at $5MM per well and more than originally budgeted). Based on our analysis, the project has not been over hyped by management and expectations of positive developments (which are looking fairly positive based on Newfield exploration’s work and initial drillings) have not been incorporated into the price of the stock.
3) Petroquest Energy has had consistent operating success and strong price momentum.
Key Investment Risks
1) Despite diversification efforts Petroquest Energy has a heavy reliance on riskier Gulf Coast exploration outcome (its properties are still highly concentrated relative to peers). Riskier short-lived reserves still disproportionately represent volume and production growth.
2) Petroquest Energy has had significant operational success since its turn around in 2002 and has a history of meeting or beating expectations. Any major setbacks (which are not uncommon given industry/business dynamics) could have a disproportionate negative impact on the stock.
3) Exploration risk (concentrated/heavier reliance on riskier short life reserves), flattening production growth, miscalculated assumptions regarding volume, and exploration cost variables.
4) Commodity pricing risk.
Bullet Point Description/Presentation:
*Petroquest is a purely domestic independent oil and gas company with operations in Oklahoma, Texas and the Gulf Coast Basin. The company seeks to grow production, proved reserves, cash flow and earnings at low finding and development costs through a balanced mix of exploration, development and acquisition activities.
*Current domestic oil and natural gas focus is on: 1) East Texas; 2) Arkoma Basin; 3) South Louisiana; and 4) Shallow Gulf.
*The company has a five step growth strategy by way of: 1) optimizing existing production; 2) development drilling; 3) resource play development; 4) strategic acquisitions; and 5) exploration program.
*From 1985 through 2002, PQ focused exclusively in the Gulf Coast Basin with onshore properties principally in southern Louisiana and offshore properties in the shallow waters of the Gulf of Mexico shelf. During 2003 (the “turnaround” period for the company), PQ began implementing its strategic goal of diversifying reserves and production into longer life and lower risk onshore properties in Texas and Oklahoma. PQ also refocused selection processes to reduce average working interest in higher risk projects, shift capital to higher probability onshore wells and mitigate the risks associated with individual wells by expanding drilling programs across multiple basins.
*During the past 2 years, the company has achieved record production, estimated proved reserves, cash flow from operating activities and net income.
*Historical growth for the company has come through drill bit and strategic acquisitions, with an 89% historical drill success rate over an 8 year period.
*The company has had considerable operating success and is considered a top quartile operator among peers. During 8 years it has increased :1) Reserves +33% CAGR; 2) Production +41% CAGR; and 3) Cash Flow +125% CAGR.
Growth Strategy for 2007/2008/Q&A Discussion
*During the Q&A, questions focused on specific projects (see below for factual background) and particularly on the status of the Woodford Shale. It was highlighted that progress at the Woodford Shale represents a key part of the company’s upside potential.
*Management highlighted an emphasis and goal of focusing its reserve base to longer life onshore plays (focusing on Woodford and Cotton Valley) and ultimately reducing the shorter life/riskier Gulf Coast region reserve base to about 25%.
*Sequential emphasis towards the longer reserve life strategy. In Year End 2006, approximately 52% estimated proved reserves were located in longer life basins in Oklahoma and Texas and 48% were located in the shorter life. This compares to 35% of proved reserves in longer life basins in 2003, 45% in 2004 and 50% in 2005. In terms of production diversification, during 2006, 29% of our production was derived from longer life basins versus 30% in 2005, 16% during 2004 and virtually none in 2003.
*PQ continues to seek opportunities to increase its longer life onshore reserves while maintaining some exposure to shorter life, but potentially higher impact Gulf Coast reserves with an ultimate goal of having longer life reserves represent approximately 75% of total estimated proved reserves.
*The company plans to continue several strategies designed to mitigate operating risks. Since 2003, PQ adjusted the working interest it is willing to hold based on the risk level and cost exposure of each project. For example, the company typically reduces working interests in higher risk exploration projects while retaining greater working interests in lower risk development projects. Also, partners agree to pay a disproportionate share of drilling costs relative to their interests.
*PQ expects to continue to actively hedge a portion of our future planned production to mitigate the impact of commodity price fluctuations and achieve more predictable cash flows (approximately 36% currently production currently hedged and targeting 40-50%)
2007 Focus Projects discussed/highlighted during Q&A
*PQ plans to continue focusing on Oklahoma, Texas and the Gulf Coast Basin, and to continue to build scale, particularly in the longer life onshore regions, through drilling and complementary acquisition activities.
*PQ plans to diversify by focusing on striking a balance between lower risk development and exploitation activities and higher risk and higher impact exploration activities. The company also plans to continue to pursue strategic acquisitions aimed at geographically and operationally diversifying its asset base and increasing its inventory of drilling projects.
Gulf Coast Basin/Turtle Bayou Field. During 2006, PQ invested $6.5 million in this field on the drilling of one exploratory well. As a result of this discovery, production from the field averaged over 4 MMcfe per day during 2006, a significant increase from 2005 average daily production. In addition, this discovery added approximately 15 Bcfe of net proved reserves representing a nearly four-fold increase in proved reserves in the field from the beginning of 2006. PQ is evaluating future opportunities, but at present, does not plan to drill any wells in this field during 2007.
Main Pass Block 74. During January 2006, production was restored at this field after being shut-in since September 2004 in order to complete extensive repairs to third party pipelines damaged by Hurricane Ivan. Production from this field averaged 12.6 MMcfe per day during 2006 and represented approximately 18% of our total 2006 production.
Oklahoma/Arkoma Basin/Woodford Shale. During 2006, PQ drilled 77 wells on Oklahoma properties achieving a 92% success rate. PQ invested $33 million in Oklahoma during 2006 or 19% of total 2006 capital expenditures. PQ grew average daily production in 2006 from Oklahoma properties to 9.1 MMcfe, a 98% increase from 2005 average daily production. During late 2006, PQ began initial drilling program to evaluate the Woodford Shale formation on portions of our Oklahoma acreage. During 2007, PQ expects to spend approximately approximately $30++ million in this region on the drilling of a combination of vertical and horizontal wells and the acquisition of 3-D seismic data to target this potentially significant formation.
Texas/Cotton Valley/SE Carthage. During December 2003, PQ acquired working interests in approximately 41,000 acres in this field, which had approximately 80 producing wells. During 2006, PQ invested $38 million on the successful drilling of 13 wells in this field. Net production from this field averaged 11 MMcfe per day during 2006, an approximate 36% increase from 2005 average daily production. During 2007, PQ expects to invest approximately $40 million and drill 15 wells in this field.
Management
Charles Goodson---Chairman, CEO, and President
Michael O. Aldridge---Chief Financial Officer
Daniel G. Fournerate---General Counsel
Institutional Holders Structure
Ingalls & Snyder $47.131Million (7.7%) NYSE
Independence Investment $29.93 Million (6.55%) Shares Outstanding 47.82 Million
Freiss Associates $25.48 Million (4.18%) Float: 39.47 Million
Barclays $24.25 Million (3.98%) Market Cap $555.61 Million
Mellon $23.74 Million (3.90%) Avg Volume: 393,2000
Wellington Management $20.69 Million (3.40%)
