By
Oil & Gas
360
:
Callon Petroleum company (
CPE
) is an independent oil and gas exploration & production
[E&P] company operating both offshore and onshore in the United
States. The company generates the majority of its free cash flow
from its offshore fields in the U.S. Gulf of Mexico, both on the
shelf and in the deepwater regions. Callon has a non-operated
interest in two deepwater fields - Medusa and Habanero, which
produce the majority of the company's cash flow that Callon is
reinvesting onshore into the Permian Basin for growing oil
production and reserves.
A short history lesson is helpful in understanding Callon's
position today. In 2009, management and the Board decided to
reinvest the free cash flow generated from its offshore producing
fields into onshore assets. The move onshore was intended to reduce
reinvestment risk, increase visible growth potential and increase
exposure to crude oil. To execute its diversification strategy,
Callon entered two onshore areas, the Permian Basin of West Texas
and the Haynesville natural gas shale in Louisiana. Over the past
two years the company has placed increased emphasis on its
oil-prone Permian assets and deemphasized its natural gas exposure
in the Haynesville (Callon's Haynesville acreage is held by
production and the company previously indicated that it has no
plans to drill the remaining five locations until natural gas
commodity prices improve).
Growing Oil Exposure in the Permian Basin
The company operates all of its Permian acreage and has
positions in both the Delaware Basin portion on the western side of
the Permian and in the Midland Basin east of the Central Basin
Platform. Callon first entered the Permian Basin in 2009, with the
acquisition of approximately 8,202 net acres in the Delaware Basin,
which included proved reserves of 1.5 MMBOE, four recompletion
targets, 11 proved undeveloped drilling locations and 61 unproved
drilling locations and then production of 475 BOEPD. The primary
focus of this initial entry into the Permian was, and continues to
be, the Wolfberry oil formation. Below is a stratigraphic depiction
of the Wolfberry formation.
(Click to enlarge)
Since its initial entry into the Permian, Callon lifted itself
up by its own bootstraps with a drilling program that helped drive
onshore oil production to an exit rate of 1,335 BOEPD as of
year-end 2011 from only 470 BOEPD when the company first entered
the region in 2009.
Callon strengthened its growth platform in the Permian with its
most recent acquisition of 9,539 net acres announced on February
15, 2012, bringing CPE's total exposure to this multi-pay,
multi-play oil-prone region to just over 24,000 net acres. The
primary targets in the new acreage, located mainly in the Midland
Basin, include the emerging oil-prone Wolfcamp B and Cline
formations. Callon plans to develop these potential pay zones with
horizontal drilling and multi-stage fracture completion methods,
following in the footsteps of leading operators like Laredo
Petroleum, El Paso Approach and Pioneer Natural Resources.
Callon plans to strengthen its Permian drilling program by going
to full-time two rigs, up from one. The new rig, provided by
Helmerich & Payne under a two-year agreement commencing most
likely in the second quarter of 2012, is a new-generation rig,
capable of efficiently drilling horizontal wells. The rig will most
likely be put to work first in the company's East Bloxom Field in
Upton County, where CPE has identified 24 horizontal drilling
locations prospective for the Wolfcamp B.
In the north part of the Midland Basin, CPE acquired
approximately 14,500 net acres in Borden County, which the company
believes is prospective for the Cline Shale.
(Click to enlarge)
(Click to enlarge)
For the Cline, Callon is modeling well economics based on
results from other operators and estimating EUR of 420 MBOE per
well, 60% crude oil, 30-day IP of 578 BOEPD (75% oil). These
estimates assume 160-acre spacing, a 4,000-foot lateral leg and a
15-stage fracture completion. When we input the variables, we
estimate a Cline well is capable of generating an IRR of 26% at
commodity prices of $90.00 per Bbl and $2.00 per Mcf. Assuming gas
reinjection and no revenue generated from produced natural gas, the
breakeven point for a Cline well based on our well economics is
$62.01 per Bbl.
For more information about the Cline Shale which includes a rate
of return commodity price sensitivity analysis on horizontal Cline
wells, please see Laredo Petroleum's investor presentation.
Click here for the presentation
Production Outlook
Callon produced 1.8 MMBOE in 2011, an increase of 10% over 2010
and 54% of the company's production stream consisted of oil and
natural gas liquids. Driving the production increase was the
company's Permian drilling program. CPE drilled 36 gross (33 net)
vertical Wolfberry wells in 2011, which increased net production to
965 BOEPD in 2011, up from 411 BOEPD in 2010. The company exited
the year producing 1,335 BOEPD from the Permian. Total onshore
production in 2011 was 454 MBOE, up 96% higher from the previous
year, and in 2011 approximately 58% of total onshore production
volumes consisted of oil, as compared to 51% in 2010. Clearly, the
company's focus on the Permian has helped Callon become more
oily.
Callon is transitioning its onshore drilling program to focus on
horizontal wells, namely the Wolfcamp B in its legacy East Bloxom
Field in Upton County and then the Cline formation in Borden
County. CPE plans to drill up to seven gross (6.7 net) horizontal
wells with the new generation rig, which is scheduled to be
delivered in the second quarter of 2012. In addition, Callon plans
to drill 21 gross (14.7 net) new vertical wells targeting the
Wolfberry formation on its legacy Permian acreage.
At Habanero, the operator [Shell U.S. (RDS.B)] expects to
commence drilling a sidetrack to the #2 well in the fourth quarter
of 2012, targeting up-dip proved undeveloped reserves. The company
reported that it had been notified that the Habanero Field will be
temporarily shut-in for maintenance for a total of approximately 60
days during the second and third quarters of 2012.
At Medusa, the operator [Murphy Oil (
MUR
)] has indicated that the platform will be shut-in for
approximately 25 days during the second quarter of 2012 for
construction work on the West Delta 143 oil pipeline, through which
Medusa produces.
Combined, scheduled downtime at its offshore fields combined
with the transition to horizontal drilling in the Permian Basin are
expected to result in a relatively flat production forecast for
2012. Callon anticipates it will produce approximately between 1.7
and 1.9 MMBOE in 2012, essentially flat when compared to 2011.
Although total company production may be flat in 2012, onshore
production from the Permian Basin is expected to double over 2011,
driving further increases in oil production and the percentage of
proved reserves located onshore.
Visible Growth Potential
In total, we estimate that Callon has an inventory of
approximately 220 unrisked drilling locations in the Permian Basin,
which represents more than six years of visible growth potential at
2011 activity rates (Callon drilled 33 net wells in 2011).
In its legacy Wolfberry acreage, where the company drilled 65
wells by year-end 2011, Callon has 129 remaining unrisked drilling
locations on 40-acre spacing. By year-end 2012, CPE expects to have
all 9,500 net acres held by production. The industry is
experimenting with 20-acre spacing and if results are economic,
then there is upside for additional drilling inventory from high
density drilling.
On the company's recently acquired leasehold in Borden County,
Callon is targeting the Cline Shale. With approximately 14,500 net
acres in the play and assuming 160-acre spacing, Callon could have
as many of 91 net unrisked drilling locations prospective for the
Cline.
In 2012, Callon's focus is on horizontal drilling in the Midland
Basin, the Cline oil shale to the north and the Wolfcamp B
formation in the south part of the company's position.
A Stronger Balance Sheet, Improved Profitability and
Liquidity
Since 2009, Callon strengthened its balance sheet by reducing
debt to $107 million at year-end 2011, down from $249 million at
year-end 2009. The 57% reduction in debt outstanding was achieved
through a combination of restructurings and pay downs. Today,
Callon's primary debt piece is $107 million in 13% notes that
mature on September 15, 2016. The company has a $45 million
revolving credit facility, and at year-end 2011 the company had no
borrowings outstanding on the line.
Reducing debt and adding new onshore reserves improved Callon's
debt metrics. At April 20, 2012, Callon's debt-to-market
capitalization ratio was 52%, as compared to an average and median
of 130% and 50%, respectively for the 24-company micro-cap E&P
group in EnerCom's database. Debt reduction combined with
increasing proved reserves cut Callon's debt-to-proved reserves to
$6.72 per BOE at year-end 2011, down from $28.96 per BOE at
year-end 2009.
Along with having a track record of lowering debt in the last
three years, profitability has simultaneously trended upward.
Callon's trailing twelve month operating cash margin per BOE, an
operations-based metric which measures the amount of money
generated from a company's core operations per production, is
defined as oil and gas sales minus realized derivatives, lease
operating expenses, production taxes, transportations expenses,
general and administrative expenses and net interest, all divided
by production. As of April 20, 2012, Callon's operating cash margin
increased to $47.95 per BOE, up from $26.88 per BOE as of year-end
2009.
Callon's total liquidity at December 31, 2011 was $89 million,
which consisted of $44 million in cash and $45 million in borrowing
capacity on the company's revolving credit facility. The company
did not disclose how much it paid for its newly-acquired assets in
the Permian Basin; however, CPE did announce that the lease bonus
payments were made out of existing cash balances, which implies a
cost per acre of less than $3,000 per acre, assuming the company
used all of its available cash. We do not, however, estimate that
the company paid that much as recent transactions have been in the
range of $1,300 per acre and if that is any guide, Callon more
likely spent approximately $18.9 million in its most recent Permian
acquisition.
The company's 2012 capital expenditure budget of $139 million is
32% higher than CPE's 2011 budget and 80% of it is earmarked to
drilling in the Permian Basin. Callon guided to a drilling program
consisting of 21 (gross) vertical and seven (gross) horizontal
Permian oil wells, acquisition of additional acreage (the budget is
inclusive of the recent Permian leasehold acquisition) and seismic
data acquisition and interpretation work. Approximately $28 million
is allocated to the planned Habanero #2 sidetrack well (operated by
Shell) and capitalized costs. Management indicated that the 2012
capital budget would be funded entirely from cash flow generated
from operations, existing cash and borrowing capacity on the
company's revolving credit facility.
Valuation
We looked at the company's valuation based on two methodologies
including a Sum-of-the-Parts Net Asset Valuation and EnerCom's Five
Factor Model [5FM]. We note that as of market close on April 20,
2012, shares of CPE were trading at $5.21 per share. Using a
weighted average valuation for both of our methodologies, we
estimate the per-share value of Callon to range between $6.18 and
$14.44. Our composite valuation, consisting of the weighted average
of three valuation estimates, is $10.56 per share.
Sum-of-the-Parts Net Asset Valuation
(Click to enlarge)
Production
For the year-ended December 31, 2011, production averaged 30,280
thousand cubic feet equivalence per day (Mcfe/d) for CPE. For our
valuation, we compiled a list of comparable peers for CPE and
applied a low/high enterprise value to trailing twelve month
production per day (EV/P). We used the 25th percentile peer group
EV/P of $9,920 Mcfe/d to represent the low end of our production
valuation and the 75th percentile peer group EV/P of $20,661 to
represent the high end of our production valuation. Applying total
shares outstanding of 39.4 million as of December 31, 2011, we
assess the production value per share to range between $7.62 and
$15.88.
Undeveloped Acreage
Inclusive of the announced Permian acquisition on February 15,
2012, Callon's total undeveloped acreage in the Permian Basin is
17,691 net acres. Although the transaction value was not disclosed,
we assess the fair market value of the Permian acreage at $1,239
per acre based on recent Permian transactions. On a per share
basis, we assess the value of the Permian undeveloped acreage at
$0.56.
Callon recognizes a carrying value of $2.3 million as of
December 31, 2011 for its Federal onshore properties and we assess
a per share value of $0.06. A carrying value is not recognized for
any of the undeveloped acreage associated with the Federal offshore
blocks as no development plans to develop this acreage has been
recognized by Callon. As such, we do not assess any value to the
associated acreage.
Sum-of-the-Parts
After adjusting for net debt and estimated acquisition costs for
the Permian acreage transaction on February 15, 2012, we assess the
value of Callon's shares to range between $6.18 and $14.44.
EnerCom's Five Factor Model
Using EnerCom's proprietary Five Factor Model [5FM], on April
20, 2012, CPE's 2012 P/CFPS ratio should be 5.7X, rather than the
2.7X that it presently trades, a difference of 108%. This would
imply a share price of $10.82 per share.
This 5FM analysis compares CPE's 2012 estimated price to cash
flow per share to EnerCom's 24-company micro cap peer group.
EnerCom's 5FM was designed to be used as a starting point for
evaluating E&P and OilService relative valuation - against a
large group of companies or a selected set of operating or market
cap peers. The Five Factors are metrics that we believe management
teams have the most control over - costs/expenses and growth. The
table below compares CPE's ECI Value Drivers to EnerCom's
24-company small cap peer group (as of April 20, 2012).
(Click to enlarge)
By focusing on the key variables that management can control,
the 5FM helps identify the strongest teams most capable of creating
value at any point of the energy cycle, making one's view of
commodity prices a separate decision. When a company is evaluated
using the 5FM versus a selected set of peers, we find that the
resulting Predictive Value can explain more than 87% of the
variability in a company's forward price to cash flow per share. We
believe the 5FM can be an early signpost in identifying potential
disconnects between company value and market perception.
Composite Valuation
Assuming a weighted average to the two valuation methodologies,
we estimate the shares of CPE to be valued at $10.56 per basic and
diluted share. While both methodologies point to an undervalued
situation, additional upside exists from the 14,470 net Permian
acres recently acquired in February 2012. Our sum-of-the-parts net
asset value provides no value per share after deducing acquisition
costs to this acreage. As Callon commences development in the new
acreage, we expect the added value of development to provide upside
potential to the $10.56 per share.
(Click to enlarge)
Disclosure:
I am long [[CPE]].
Disclaimer: Oil & Gas 360® did not receive compensation
for the publishing of this company note. Professionals associated
with Oil & Gas 360® hold a long investment position in Callon
Petroleum, but do not intend to buy or sell company shares over
the next five business days. Although Callon Petroleum pays Oil
& Gas 360® a monthly fee to be a profiled company on the
website, Oil & Gas 360® reserves the right to publish notes
and observations on any company that is sees fit to
distribute.
See also
Gold And Silver - Daily Outlook June 21
on seekingalpha.com