Oil Driller IPO Athlon Energy Races In Permian Basin

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The Permian Basin, which lies in western Texas and stretches across into southeast New Mexico, is having an oil exploration and production rebirth.

The basin has one of the world's thickest deposits of rocks from the Permian geologic period. While oil and gas outfits have been operating here for decades, an infusion of new technologies has launched another "oil rush."

Athlon Energy ( ATHL ) is ready to benefit from the area's recent revival. The Forth Worth, Texas-based independent oil and gas explorer has only been operating since 2011 and went public in August of this year. It currently holds nearly 100,000 net acres with an average working interest of 93% in the area.

So far, it's been developing vertical wells and has done a good job at that. It produced more than 11,000 barrels of oil equivalent a day in the second quarter, a 68% jump vs. the year-ago period.

Athlon's operations mainly focus on the Wolfberry play, an area characterized by high oil and liquids-rich natural gas. But now that horizontal drilling technology offers incremental opportunities on the same acreage, Athlon is ideally positioned to gain from the innovation.

"The Permian Basin has definitely seen a renaissance over the past couple of years. It's one of the oldest basins in the U.S. to find oil in," said Will Green, an analyst at Stephens. "What we've seen in the last handful of years is companies moving from a vertical approach toward more horizontal drilling."

For Athlon "it's been great" in the Permian Basin and "100% of the assets" are there, he said. "And it's been a focus on taking what's traditionally been a vertical play and moving more horizontally."

Sideways Strategy

Athlon dipped its toes into horizontal drilling in August. It plans to drill four horizontal wells by the end of the year. That's in addition to seven vertical rigs that it will be running this year. By year's end, it expects to have drilled a total of 161 gross operated vertical wells.

"We plan to drill our first two horizontal wells in Midland County and then move to Glasscock County to drill two additional wells in 2013," Athlon CEO Bob Reeves said in the company's second-quarter earnings release. "This is an exciting time for Athlon as we commence our horizontal drilling program that we expect will further accelerate returns on our deep well inventory in the prolific Midland Basin."

Horizontal drilling is when an oil and gas explorer drills down vertically about 8,000 to 10,000 feet and then starts going laterally anywhere between 7,000 and 10,000 feet. This allows it to contact more rock and extract more oil using hydraulic fracturing, or fracking.

Adam Michael, analyst at Miller Tabak, said that by adding horizontal drilling, a company can recover 10 times as much oil as it does with vertical wells. "There is a lot of horizontal optionality for Athlon because of the emerging technologies that allow those operators to unlock this value," he noted.

Cost Of Drilling

So far, Athlon's vertical wells have proven to be very profitable and have given the firm a consistent rate of return in addition to providing it with solid cash flow. But while a vertical well can cost approximately $2 million, the cost of a horizontal well can range closer to $6 million to $8 million, Green said.

Management stated that the $554 million in liquidity raised at its IPO will be used for future drilling activity. Michael estimates that the IPO proceeds and the company's generated cash flow from the vertical drilling program will fund most of the 2013 required capex of $350 million and much, if not all, of the $420 million estimated capex requirement in 2014.

More Oil, Same Space

But while horizontal drilling is more expensive, it also provides a higher return and in the end is more efficient. From each vertical well, a company can produce about 140,000 barrels of oil equivalent ( BOE ) over the life of the well, notes Green. In comparison, a horizontal well's lifetime production can be as high as 600,000 to 700,000 BOE. He expects about a third of Athlon's 2014 production growth to come from horizontal drilling.

"Companies like Athlon, that have built good acreage positions, have lots of running room. All of a sudden, they have 10 years of drilling inventory of really good oil wells," Michael said. "The nice thing about the Permian is you don't just have one formation you're drilling, you have multiple stacked formations."

That multiplies acreage by a multiple of how many formations you have, he says, and in the Permian it could be as many as six formations.

About 65% of Athlon stock is owned by the private equity firmApollo Global Management ( APO ). Management is considered strong with a solid financial background.

Prior to Athlon's formation, CEO Reeves, a certified public accountant, served as CFO atEncore Energy Partners (ENP). Before joining Athlon in 2013, CFO William Butler was a managing director at the investment banking firm Stephens, and before that he was treasurer at XTO Energy, which later became a subsidiary ofExxon Mobil ( XOM ).

Management Approach

This sort of financial experience at the top differentiates Athlon from many oil and gas producers, which often have engineers or other technical people at the helm.

Athlon management applies a conservative approach to the company's financials, while showing a nearly 100% success rate in drilling vertically. In addition, Apollo has several members on Athlon's board and very active participation.

Athlon also has solid hedges in place for the price of oil, at more than $92 per barrel of oil for 2013 and 2014. For the second half of 2013, oil hedging represents 92% of 2013 and 84% of 2014 estimated production, Michael notes in a research report. This is a lot higher than the typical hedging target in the industry of more than 50%. It provides higher visibility into Athlon's earnings going forward.

"They've got the right real estate and you're seeing a dynamic time in the Permian where companies are moving from vertical drilling to horizontal drilling," Michael said. "The more results we get out of Athlon and other area operators, the more conviction investors get. You're definitely seeing that process happening now and so far it looks really really encouraging."

Athlon is the 28th largest company by market capitalization among the 102 in IBD's Oil & Gas-U.S. Exploration & Production industry group. Dominated byEOG Resources ( EOG ),Anadarko Petroleum (APC) andPioneer Natural Resources (PXD), the group is currently ranked No. 5 of 197 that IBD tracks.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: APO , ATHL , BOE , EOG , XOM

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