Sometimes, following in the footsteps of the big guys is just
what a company needs to strike gold. In the case of Bonanza Creek
Energy, we're talking black gold.
The Denver-based small-cap oil and gas exploration and
production company is operating in one of the most significant
oil fields in the U.S., the Niobrara oil shale in the Wattenberg
field located in the Rocky Mountain area of Colorado. The company
also has a presence in southern Arkansas, focusing on the oily
Cotton Valley sands.
"Their acreage (in the Wattenberg field) really looks to be in
one of the sweet spots of that play," said Chad Mabry, senior
research analyst at KLR Group. "And that's going to be their
primary growth driver in the quarters ahead."
Two major players are also present in that area:Anadarko
Petroleum (
APC
) andNoble Energy (
NBL
).
Bonanza 's (
BCEI
) shares have been surging since Anadarko proclaimed the area to
be the biggest near-term value driver in its portfolio with rates
of return in excess of 100%, writes Mabry in his research report.
Anadarko also noted that it is just now starting to see the
potential of that area via horizontal development.
"You've got two great operators in the same ZIP code, and this
gives Bonanza Creek extra role models to follow," said Andrew
Coleman, managing director of E&P research at Raymond James
& Associates.
Looking For A Double
"From a production standpoint, we think they are going to
double this year," noted Coleman. "We've got that being as much
as 70% higher for 2013."
Bonanza started operating in the Wattenberg field in 1999 as a
private company. After a corporate restructuring in 2006, it
received additional institutional funding from D.E. Shaw &
Co. and completed 15 oil and gas property transactions in three
main areas: the Rocky Mountains, Arkansas and California.
In 2010, the company received additional institutional funding
and was recapitalized and consolidated under its current name. It
went public in December 2011.
"Horizontal drilling really came of age in Wattenberg around
2010. Nobel and Anadarko took the lead and did a lot of drilling
in the horizontal wells," said Bonanza's CEO Mike Starzer. "We
applied that same technology to the Niobrara with tremendous
success."
When Bonanza first entered the Wattenberg area, it was
applying vertical drilling technology.
"Now, we take those vertical wells and we drill out 4,000 feet
in a lateral section, staying in the zone. That's called
horizontal drilling," Starzer noted. "Currently, we're fracking
18 stages in that lateral."
Fracking, or hydraulic fracturing, uses water, sand and
chemicals to crack underground rock and release previously
hard-to-get reserves of oil and natural gas.
"The wells produce on a much stronger rate than they did
vertically," Starzer said. "We're going to get a much more
efficient depletion of the reservoir, less surface impact, and we
end up lowering our development cost.
"The U.S. is by far the world's leader in horizontal drilling
and multistage frack. That application will eventually migrate
all around the world."
Bonanza has proved reserves of 43.7 million barrels of oil
equivalent. It produces about 60% from the Rockies and 40% from
the Arkansas field. It also has a small interest in California,
but the company is in the process of divesting these assets.
The Wattenberg field comprises 72% crude oil and 28%
liquid-rich natural gas. Since the beginning of its horizontal
Niobrara development in mid-2011, the company has spud, or begun,
31 wells and completed 25 as of the end of last quarter. Its
upward revised plans called for the completion of 36 wells in
2012.
Bonanza also identified 360 net horizontal locations on its
acreage, which could provide it with a 10-year drilling
inventory, writes Mabry.
The second area of Bonanza's focus is the Cotton Valley Sands
in Arkansas. About 60% is crude oil, 30% natural gas and 20%
natural gas liquids.
"When you look at the Wattenberg field, it's like a layer
cake. It's just very consistent, east to west, north to south,
and all the layers are exactly the same," said Starzer. "When we
look down at Arkansas, it's more like a marble cake, where you
have different lenses. The sands come and go, but you'll have 25
to 30 of them in every well and they'll be full of gas and
oil."
Here, the company uses pinpoint fracturing, which is applied
to vertical wells.
"We go down and open up just the zones we want, that are not
depleted and produce predominantly oil," explained Starzer. This
technology was pioneered 10 years ago and applied at another
field.
A major risk to a production and exploration company is the
level of oil and gas prices. While gas prices were depressed in
the last five years, they are now finally recovering.
Oil Price Risk
As Bonanza's production is more focused on oil, fluctuation in
oil prices poses a more significant risk to the company. While
some analysts have a bearish outlook for oil prices, Bonanza is
bullish in the long run. However, Starzer says that in the short
term, it's important to be cautious.
To address this risk, the company hedges about half of its
crude oil production at a price of $90 per barrel or above. It
also has one of the strongest balance sheets among its peers. The
company has very little debt while producing substantial amounts
of cash.
However, oil and gas development can be very capital
intensive, and analysts expect the company to outspend its cash
flow next year. As a result, Mabry believes that Bonanza will
likely need to raise more capital in 2013. He estimates that the
company may look at the high-yield market to fuel future
investments.
Management has a long track record in the oil and gas industry
and is well regarded by the analyst community. Some 62% of the
company is owned by the top three institutional investors, while
management owns 3%.
"As far as technical acumen, these guys bring a lot of
horsepower to the equation," said Coleman.
"The fact that we've seen the same financial partners come
back to the table a few times now to essentially back the same
management team, it certainly speaks well of management," said
Mabry.