A Bonanza In The Sweet Spot Of A Colorado Oil Field

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.

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

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

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