Zman’s Energy Brain ~ oil, gas, stocks, etc…

Have a great and safe 4th of July and remember not to hold, light, and throw explosives unless that is your day job and then by all means, have at it!

Here's the weekly wrap along with the gas storage review since Thursday was a half day.

Holdings Watch: Closed Positions for the week ended 7/3/08.

• (HK) - Exited the July (HK) Calls for $4.00 (HKGJ), up 90% since entry on 6/30. Will be looking to add more longer dated calls on bouts of profit taking.

• (QBIK) - Sold the Cubic common share position for $4.89, up 64% since entry one month ago. I simply can’t come close to defending the price up here. I will revisit if it comes in some but the (CHK) well rate news was the driver I saw eventually moving it higher and we got that in spades on the JV call.

We spent the latter part of the week adding near and longer dated calls into sector weakness. 

Holdings Watch For The Month of June:

On to the Wrap

ZComments:

1) Energy Sectors Sport Across The Board Decline. It's been a long time since I've had to write that. Blame sector rotation at the beginning of the new quarter, blame a shabby and teetering broad market, blame thin holiday volumes, or even the intra-day switch from extreme "buy, buy, buy" to "sell, sell, sell" on the gassy stocks by a media personality (from here on to be known as a Crameroo) for the dip. The reason behind the late week dip is probably a combination of all of the above. It certainly was not commodity related as they continued to advance to the bitter end. 

So Where Does That Leave The Energy Sectors? In a nutshell, fine. Unless you are talking about the independent refiners in which that is an entirely different ball of black wax. 

2) Commodity Watch: Onward and Upward For Oil and Natural Gas.

• Natural Gas continue to seek levels that will entice imports to arrive at U.S. regas facilities. Summer heat and the more active portion of the Atlantic Basin hurricane season may conspire to get it over the $15 which my sense is would be enough to get noticed. Of course, Europe in the low $20s still takes precedence but perhaps some more shorter haul shipments (from the likes of Trinidad) could begin heading northwest.  

3) Rig Counts. Another new high for gas-directed rigs. Horizontal rigs may have inched lower this week but the outlook for increases in their deployment only improved with news items this week. We increased our exposure to the land drillers (again) this week. The second half of 2008 is likely to resemble the end of the hockey stick for activity and onshore dayrate pressures are mounting for both rigs, OCTG, completion services, etc. 

The Natural Gas Storage Review 

The EIA reported an injection of 85 Bcf into storage, I was at 80 to 85 Bcf, the Street was looking for 88 Bcf. Gas reacted somewhat positively to the news. 

Potential End Of Storage Season Outcomes. At present my back of the envelope math is leading me to think storage will end up in the 3.2 to 3.3 Tcfe range which is fairly bullish. We are passing the peak of injection season so unless a significantly cooler than expected Summer develops I'm not looking for a quick reduction to the YoY storage deficit. Not a lot more to add that I didn't already write in comments during the week. I may add a study or two as the weekend progresses.

Have A Great And Safe Fourth Of July Weekend! 

CHK & PXP Announce Haynesville JV

Anatomy of the deal:

Plains Exploration (PXP) Pays Chesapeake (CHK) $1.65 billion for 20% of CHK's Haynesville Shale (H.S.) leasehold.

• This amounts to 110,000 acres of CHK's now 550,000 acre H.S. position,
• On the surface this equates to $15,000 per acre,
• But PXP is carrying 50% of CHK's drilling and completion costs up to an additional $1.65 billion,
• This carry boosts the per acre value to $30,000 per acre.
• CHK's average acreage cost so far in the H.S. has been recently estimated to be about $10,000 with recent buys landing in $20,000+ territory. 
• CHesapeake goes on to point out for the mathematically challenged that this transaction establishes a value of $16.5 billion for their H.S. leasehold.
• CHK's TEV as of the close (7/1) was $49.6 B. Back out the check from (PXP) of $1.65 B and that leaves Total Enterprise Value of just under $48 billion. Take out the H.S. piece and you are under $32 B. $32 billion for the most active driller and third largest gas producer in the U.S. with #2 positions in the Barnett and Fayetteville Shales, yada, yada, yada.
• Nice trade Aubrey.

A Look At Their Reserve Comments:

• Well spacing: 80 acres. I've been assuming 60s. This leads to a slightly smaller bump to the well inventory but the 6,875 horizontal locations is nothing to sneeze at.
• EUR's of 4.5 to 8.5 Bcfe. I've been using an average of 5.5 Bcfe recoverable per well. They comment that they are comfortable with the 6.5 Bcfe for the core area which means the wells are bigger than that. 
• But this is the kicker. CWC (Completed well cost) of $6.5 mm now with the assumption that costs fall 10% when they get the process down to a more routine nature.  Put that number up against the mid point of the recovery range and you've got $1/Mcfe development costs. That's world beater. IRR's should be in the high double digit range if you assume CHK's hedge levels and at the strip they would be well into the triple digits. But when you take into account the carried interest, well, the IRR just goes ballistic as F&D falls through a $1/Mcfe.

The Plan: Drill fast, drill deep.

• at least 12 rigs by YE08
• at least 30 rigs by YE09
• up to 60 rigs by YE10
• wells here take about 60 days to drill down over 10,000 feet and then across another 3 to 4,000 of lateral section implying each rig could drill up to 6 wells per year although it will probably be a hair under that in the earlier periods. The exit rate rig count for 2010 would imply over 360 wells per year, adding net reserves to CHK in excess of 1.3 Tcf (per year). 
• if anyone can get the rigs its (CHK). Good news for (NBR), (UNT), (UDRL) and probably the rest of the onshore land drillers and completion companies. Where the manpower and steel for this will come from (as CHK and PXP are certainly not alone (read on) is hard to say. 

What This Does For Other H.S. Play Valuations. The Top 15 looked at from the perspective of acreage positions valued at $30,000 per acre and divided by the outstanding share counts relative to current stock prices. At these valuations you are almost getting the rest of HK for free! Personally I think this yard stick is overzealous but it does serve to point out another angle on the Haynesville leverage story. See Tuesday's post for a look at H.S. leverage to current reserve size. 

In a nutshell this deal will lead to another round of gains for the Haynesville levered and even those more speculative names like (QBIK) that we continue to hold (although this news may provide a nice exit point as that position out paces reality). CHK gets to de-lever both from a financial as well as a risk stand point and receives a source of funds obviating the need for further near term capital market transactions. We continue to hold calls and the common for (CHK) and (HK) as well as a number of related players (see the Holdings Wiki Tab for a full list).

Joint Company Conference Call: Wednesday, 9 am EST.  

Raw Notes From The Conference Call:

Aubrey Comments: What is becoming "America's largest gas field, and 4th largest gas field in the world" 

$2.5 billion invested here; worth $16.5 billion

Think 250 Tcfe in place in the H.S., 5x the Barnett Shale

Formation present over 3.5 mm acres defined in the core most likely

This is from 70 penetrations evaluated by their core center

Homogenous, thick, over pressured

8 horizontal with IP 5 to 15 mm/d on very restricted chokes with high pressures (6,500 psi)

6.5 Bcfe for now but that will go up 

Pursuing similar strategic partnerships in the Marcellus and Fayetteville. Think Fayetteville shale assets are worth $15 billion or $30 per share.

Marcellus - 2 Horizontal - 9 mmcfgpd combined . Holy Smokes.  See proving up $15 billion and $30 value per share here later this will with another monetization deal like yesterday's

Will not do a minority interest in the Barnett (where they are #2)

Aubrey outlined $150 per share of value. Saying the PXP deal is the first step in highlighting this value.

Last 2 Words on the Haynesville: 

• Chose PXP due to their knowledge and trust of each other and PXP's deep roots in LA. They have over > 4,000 landmen in the field.
• HS will develop much more quickly and easily. Their will be a core area and a non-core area.   CHK is in the core like they were in Johnson and Tarrant County.

PXP Comments:

Consistent high porosity throughout, overpressured, excellent recovery factors in all the wells they have seen to date.

See doubling their reserves in the next three years at $1.85 / Mcfe. 

Production growth rate at 5-8%. This HS JV is expected to send their production growth rate > 20% per year beginning in 2009 for the next several years. 

Capex increasing in 2008 to 1.5 b and to 1.75 b in 2009.

Q&A 

Joe Alman @ JPM - question defining the H.S. - the deal covers zones below the cotton valley.

8 horizontal wells - all 8 in LA, won't be drilling any in Tx for 90 days.

80 acre spacing? - could go to a closer spacing over time.  

Tudor Pickering - capital allocation for PXP

Completion methodology - laterals from 2,900 feet to 4,000 feet, 5 or 6 stage fracs, thinking 1 stage every 650 feet.

Production Growth: chance they will ratchet up guidance,

wells will be drilled on 640 acre units to hold acreage

PXP has no plans to issue equity.

It's good to be back! Flew in just after midnight so forgive the short post. I thought I'd do the wrap and comments in my new fangled Spanglish but lack of sleep kills my sense of innovation. So here's the wrap table followed by an abridged Monday post. Look for me to be back to my overly verbose self tomorrow.

In Today's Post:

1. Commodity Watch
2. Holdings Watch
3. Stocks We Care About Today - (SD), (HK), the refiners
4. Analyst Watch  

Commodity Watch:

• Crude Oil. Holy smokes, oil through $140 last week despite the Saudi's wet blanket party and a MEND "unilateral ceasefire". Blame a weak dollar if you want but growing fear on the Street is that the Saudi's simply don't have the spare capacity. This morning crude is up $1.50 to $2 having breached $143 in the early morning hours as tensions between the Israel (the U.S.) and Iran escalate.

• Iran Watch #1: The head of Iran's Revolutionary Guard threatened to "impose control on the Persian Gulf and Strait of Hormuz" if attacked and threatened neighbor states with reprisals if the cooperate in any U.S. or Israeli operations against Iran's nuclear facilities. Ah, summer in the Middle East.

• Iran Watch #2: Iranian oil production reached 4.23 mm bopd, it's highest level since the overthrow of the Shah in 1979. They plan to take production to 4.28 mm bopd by year and with volumes like that, don't look for them to smoke a peace hookah anytime soon.

• Natural Gas closed up less than a percent at $13.19 last week as another sub par injection was recorded. Imports remained down nearly 3 Bcfgpd in the preceding week and I don't see any near term help from the LNG side of the equation which is 2/3rds of the YoY deficit.  This morning gas is trading up a dime plus with the rally in oil

• Weather Watch: Cooling degree days came in at 65 up from 54 in the prior and even with year ago levels when we saw an injection into storage of 84 Bcf. My early read having not yet seen imports would be for a similar number or slightly larger number to be released this Thursday. 
• Tropics Watch: Four tropical waves are making their way across the Atlantic but no near term development is expected.

Holdings Watch: I was up very slightly in my absence last week as I sat on a larger than normal cash and stock position (59% cash, 23% stocks, 18% long options). I'll be slowly wading back into greater oil service call exposure this week as the evidence of a resurgence in North American drilling continues to mount (that's a new record for gas directed and horizontal rigs in the table above). On the E&P front, there wasn't a lot of news out of the trendy Haynesville players last week and the Bakken's too appear to have been rather quiet as we approach 2Q earnings season. I will be slowly moving back into some of my favorite names in this space as well as mark to market earnings adjustment season is now in full swing and I expect further runs in many of our favorite names as we approach catalytic news items before and during their 2Q calls.  To see my current option holdings click the ZEB Holdings Wiki tab at upper left.    

Stocks We Care About Today:

(SD) CO2 Deal With (OXY). Oxy will fund a CO2 removal plant in West Texas that keeps (SD) on the path to producing 350 MMcfgpd by 2011 from its high CO2 content gas reserves in the western side of the West Texas Overthrust. In exchange for the $1.1 billion price tag Oxy keeps the CO2 for its own W. Texas tertiary recovery efforts while SD nets out the methane. They also announced a fire at their Grey plant occurred on Friday which is expected to result in the loss of 16.5 MMcfgpd (or about 6% of 1Q volumes) for 90 days. A non-event in my book and both news items leave my thoughts unchanged on the common, still long, but am looking for a re-entry point on calls prior to earnings.

Refiners Continue To Wither. I can't say enough "sometimes the best trade you make is the one you avoid". Bottom fishing this group has been the equivalent of financial hari kari. Look for an update on the space tomorrow.   

(HK) - Announces Biggest Haynesville Result To Date & Updates Leasehold.

• First horizontal well (Elm Grove Plantation #63, Bossier Parish) completed at a whopping 16.8 MMcfgpd choked down to 24/64"" with an 11 stage frac. Looking at the chart it looks like the news started to leak last week prompting the PR which given the high level of activity and rising head counts in the region is going to be increasingly the case.
• 3 horizontals drilling at present
• leasehold now at 275,000 net Haynesville acres.
• Plan to have 6 rigs running by mid September and 10 by year end.
• Glad I hold the common and the September $40s as well as positions in (CHK)
• Should see across the board buying in the Haynesville names (CHK), (GMXR), (GDP), (PVA), (CRK) etc (see fully list on the E&P tab and even tiny (QBIK). 

Odds & Ends

Analyst Watch: FBR hikes its pt for (DVN) from $125 to $140.

Housekeeping Watch: Glad to see how active the site was last week. The number of emails I received while away was shocking and will take awhile to go through. If you have anything pressing shoot me a note at zmanalpha@gmail.com

I'm off to Honduras in the morning and will be out all of next week. I will not respond to emails and there will be no new posts for the site after this one until Monday, June 30. If you're reading this free weekend wrap post and have not subscribed by now why not wait until I have something new to say. If you just can't wait to get access to the site please know that while PayPal subscriptions are automated, Google Checkout subscriptions require activation by me and I will get to that July 1.   

Subscribers Say The Nicest Things Watch: These were some of my favorites this week. 

"Zman - HK June 40s in at .75 out at 1.20. First Ztrade and enough to re-up for a year. I have learned more about short term interactions in the past 1/2 month as a subscriber than in a year of haphazard independent study. While i’ll never post another trade, i hope to contribute to the discussion in the future though my ocupation is far from the oil/gas patch." ~Italyinvestor

"italy he has been so good for 6 months its unbelieveable. i rarely trade options like he does, but often trade the underlying stock and option spreads, and while i have made an astounding amount of money the option boys have made that much more. he also has a real reason for the stocks he buys. am one happy subscriber!!! (plus i now know about horizontal drilling, oil shales , and a lot more!)" ~ KA

"My finance and I thank you all for our new Harley Softtail Custom" ~ JR

Holdings Watch:  Look ma, no Scuds! We usually have 3 to 5 complete losses or scuds in the portfolio each month. Despite a last minute valiant effort to create one via an ill-conceived (CHK) day trade I'm happy to say I failed. Here are the Trades Closed And/Or Expired To Date In June: 

Asset Balance at Day's End:

• Cash: 59%
• Equities: 24%
• Equity Options: 17% 

On To The Wrap… 

Have a great week gang, I know I will.  

Housekeeping Item: Inquiring Minds Want To Know. Click here for the Bio Tab. Note that it is not very full. Please send Petra any details about what it is you do at zmanadmin@gmail.com. I know it's a strange request coming from a guy who goes by Zman however it's not me but your fellow subscribers who want to know. For the most part, I already know who you are and I'm flattered that you're here. 

In Today's Post:

1. Holdings Watch
2. Commodity Watch - including gas storage wrap as I was lazy and did not publish it last night.
3. Stocks We Care About Today
4. Odds & Ends

Holdings Watch:

• (NBR) - Entered (NBR) September $47.50 calls (NBRIW) for $4 with the stock at $47.30.

• (CHK) - Wildztrade gone bad. Entered the June $65 calls (again) for $0.94 average. Last bid $0.30. This is why you don't see a lot of WildZ's.

• (CHK) - Entered (CHK) July $65 calls (CHKGM) for $3.50.

Commodity Watch:

Crude Oil: tumbled with the prospect that China would curb demand by boosting gasoline  prices. Crude ended down $4.75 per barrel at $131.93. just below conveniently looking round dollar support at $132. This morning oil is trading up $2.

• China Watch: Price Hikes To Cut Demand or Not. China effectively hiked gasoline and diesel prices 16% and 18% respectively yesterday. The fear in the oil markets yesterday was that this would lead to a demand response and and last night the bulge bracket firms were out defending global demand:

• Goldman Says Oil Drop An Overreaction: Which is what I'd say too had made a major upgrade call on the producers and oil service the same day most of them ended down 3 to 5%. But their points are valid:
• there are currently product shortages (gasoline, diesel, jet fuel, you name it) in China,
• the price hikes will prompt local refiners big and small (the so called "teapot refineries") to produce more product increasing demand for crude in the near term.
• Many of the teapots are shuttered at this time but could re-open with higher selling prices (they account for 15% of local market production)
• GS notes that following a 10% price rise in November 2007, crude imports increased by 500,000 bopd or about 14%.
• in the medium term they see insignificant demand destruction from this move

• Morgan Stanley - China Fuel Price Hike Will Not Cut Demand. -Morgan described the hikes as more designed to help financial difficulties of refiners (and it certainly propped shares of (PTR) and (SNP)) rather than as a curb for demand. 

Natural Gas: softened with crude despite a smaller than expected gas storage injection of 57 Bcf (which came within a hair of the record low for this week in history).   Gas fell $0.35 to $12.86 but was well off its low of the day. You don't even start to think of the uptrend in gas prices as being in jeopardy unless you strike through $12.50 and then quickly through $12. This morning gas is trading slightly with crude.

Quick Review of the EIA Storage Report

Short Position Still SIZE and Got To Be More Worried Than Ever As Storage Comps Toughen. The spec net short position was at record levels last week and the trends in storage data are setting more of the same short, cover and re short action we've seen all year. 

One Last Chart For The Road. Note the change in slope of the green wedge (2008 cumulative injections); that's not what the bears want to see.  

Stocks We Care About Today

(RIG) 5 Year Ultra Deep Capable Contract Exceeds $1 Billion. $1.06 billion to be exact for the GSF Development Driller II to (BP). The raw math works out to a $580,000 day rate proving that recent cherry picked high rates are not flukes and that we can expect to see more contracts for 7,500 foot water depth capable semi-subs in this new $550,000 to $600,000 per day range in the near future.  

• this rig is currently under contract to BP at $208,000 per day and was set to come off contract in November so look for a small bump in EPS '09 and '10 as this extension is probably higher than most analysts were guessing as most rigs in this class have been coming in mid $400s to low $500s on 3 to 5 year extensions.
• the contract probably is a minor buoyancy point for the group (RIG, DO, NE, and maybe ATW)  

Odds & Ends

Analyst Watch: Broadpoint ups (NFX) pt from $80 to $88, UBS ups (ECA) from $120 to $130.

Honduras Watch: Not to beat a dead horse but some of you don't read every day and so that you don't keep just refreshing your screens in vain next week for a new post know that their won't be one. Comments will be open on the weekly wrap page but I will not post, comment, or likely be aware of the price of oil, natural gas or the stocks next week.