Storm Cat Energy – Part I – Small Package, Big Growth

Storm Cat Energy (SCU) March 28, 2007. $0.97.

A Penny For Your Thoughts. First, you've got to love the name. Denver based E&P with 27 employees. All production comes from coalbed methane, CBM, in the Powder River Basin of Wyoming. Early stage plays in Canadian CBM and U.S. shale (Fayetteville).

Year end 2006:

• production: exited 2006 at 8 mmcfepd net from 318 wells in the PRB.
• proved reserves: 28.7 Bcfe

Year end 2007 goals:

• production: exit over 25 Mmcfepd net (up 3 fold)
  
• proved reserves: 80+ Bcfe.

Warning: These are not high risk plays but management has set pretty lofty goals. I like the growth profile and the low cost nature of the plays however management has, in my opinion, violated my golden rule for small cap E&P companies: "Under Promise and Over Deliver".

By plotting out fairly aggressive production goals on a quarterly basis management has set a pretty high mark for themselves. While I believe their stated goals are achievable (a 6 fold increase in production in 2 years as you'll see below) I think they've left little room for error. Personally, I'd rather leave room for upside surprise than have to explain missed numbers or worse, be forced to reduce guidance. Perhaps they're bagging the numbers already and if that's the case I'm just being overly cautious. We shall see soon enough.

They also include production from new plays that have not yet seen their first Mcf of gas. To be fair this is pretty low risk stuff and it's not as big a sin as including a risky exploration production wedge would have been. For the most part their plays involve a relatively straightforward manufacturing operation (both CBM and shale), with a process perfected by others that the management team's commendable experience level should allow it to emulate and improve upon.

Even if I risk their Canadian and Fayetteville shale plays quite heavily they should easily be able to achieve remarkable production and EBITDA growth over the next several years.

Disclosure: I own a position here.

Primary Risk: The Balance Sheet.

• Negative working cap: not generally a big deal for an E&P
• Quite a bit of new convertible debt:
  • $50 million in two tranches issued Jan and March 2007
  • 9.25% interest
  • converts at $1.17 per share when:
    • 18 months after issuance when
      • stock exceeds $2.05 for 20 out of 30 days
    • potential dilution of ~43 million shares (61%)
  • Projected EBITDA coverage moves to >5x by 2008.

Production Growth Profile (provided by the company as of March 2007)

click to enlarge.

This is the company's read on production growth: current production of ~ 8 Mmcfepd (1Q07) grows to ~54 Mcfepd by the of 2008. A nearly 6 fold increase in less than 2 years. Half of the growth comes form the PRB, with the Canadian properties and the Fayetteville shale contributing the remainder.

Areas of Operation

Powder River Basin( Wyoming) - Coalbed Methane - CBM

• All of their currently booked reserves and production
• Acquired 10.3 bcf in 2006 from Barrett.
• Acres: 31,900 net
• Operate roughly 90%.
• 2006: Spud 86 wells.
• PRB Well Economics:
  • Well costs: $150,000.
  • Average net risked reserves: 0.137 Bcf.
  • F&D: $1.09 / Mcf.
  • Low lease operating expense, LOE.

• Typical well:
  • After dewatering (3 months) peak production of 0.185 Mmcfgpd by month nine, then 33% annual decline.
  • declines to 0.6 in 6 months and tails out at a 15% decline thereafter.

• 2007 : Drill and compete 170+ wells (double production

• 2007 capex: 150k X 170 = ~ $26mm - working interest

• Prospective acreage for another 340+ drillsites.

Summary: manufacturing operation, little to no exploratory risk

My forecast for PRB production growth (note: this is a bit rigid but should be pretty fairly accurate and tracks management's guidance pretty closely)

click to enlarge

Fayettville Shale (Arkansas)

• 14,000 net acres (bought in at $165/acre). Close proximity to Southwestern's (SWN) producing Fayetteville gas fields.
• Step #1: Participate with Southwestern operated wells
  • 14 wells in various stages of drilling and completion now
  • SCU has low working interest here (1-8%)
  • This is a good way for a small E&P to cut it's teeth in a new play while learning from the dominant, seasoned player.
• Step #2: 2007 Storm Cat to drill as operator ~ 12 gross / 6 net wells beginning mid 2007.
  • pipeline planning and access underway.
• Fayetteville Shale Well Economics:
  • $1.8 mm to drill;
  • avg net risked reserves: 1.008 Bcf;
  • F&D: $1.79
  • LOE: low
• Typical well:
  • 1.3 Mmcfgpd IP
  • declines to 0.6 in 6 months and tails out at a 15% decline thereafter.

• 130+ drilling locations remain on acreage

click to enlarge

Onshore Cook Inlet (Alaska)

• 24,500 net acres
• 22 identified
• 1 well planned 2007

Elk Valley (British Columbia)

• 100% working interest
• 77,775 net acre CBM play
• thick: 290 ft avg coal thickness
• gassy coals: 250 -600 standard cubic foot per ton
• thinking 250+ wells
• near infrastructure
• 5 wells drilled 2006, fracced and now dewatering
• expecting preliminary productin 2H07
• On paper these look extremely attractive but since they haven't decided to drill more yet (pending production from the first wells) I'll wait to give them credit here in my model.

Alberta

• Manville CBM play
• 3 wells drilled to date.
• 5 wells planned 2007
• Ditto the "looks good on paper" comment of the Elk Valley section above.

Even without adding SCU's other plays just yet, the production profile is impressive (Mcfgpd)

Part II. Financial addendum to follow shortly