Warren Resources (WRES)

 

The Nutshell: Warren's primary assets are a) two waterflood units in the Wilmington Field of Southern California - from here they produce essentially all of their oil and about 60% of their total production and b)  two coalbed methane plays in the Powder River and Washakie (Green River) Basins in Wyoming which until recently have provided a growing wedge of natural gas production.  While they have large undeveloped potential in both plays, neither of their programs work well at the low prices seen in the first quarter. The reserves in California are low risk, long lived, and predictable to produce with the application of sufficient capital and newer technologies. As of last quarter they were cash strapped with a tapped out revolver and negative cash flow.  This is not exploration but exploitation and those long-lived assets mean that they are not on a production treadmill so they can afford to "hunker down" and await higher prices, keeping spending at a minimum to maintain production levels. Like many of their oily brethren their stock price has suffered enormously, much more than oil itself did. My sense is they will "make it" and that as oil rises so too will their equity valuation, either via a rising stock price or via by acquisition by a larger entity who finds it cheaper to "drill on Wall Street" than with the drillbit.  I own the common at $1.80 and some November calls a little higher than here.

Reserves: A story of price.

• 2007 Reserves: 59.4 Million Barrels of Oil Equivalent (MMBOE) (when oil prices ended the year at $86.21 per barrel).
  

• 2008 Reserves: 21.5 MMBOE. This is not a typo, this number is derived using a 2008 year end oil price of $32.92 held flat into the future. It's a silly but required SEC rule and despite the fact that the reserves didn't simply evaporate, it appears that way on the books. Note also that with oil now changing hands north of $60 per barrel we don't see the reserves jump back onto the books. No matter, they are still there except for the tiny slice they produced last year.

• 2008 Strip Price Adjusted Reserves: 38.4 MMBOE. When they issued their reserve report, the company also issued an unofficial statement of reserves based on the five year forward crude strip in place in February. You can see that using the same calculations that produced the 21.5 MMBOE in the previous bullet (the official reserve number for 2008) the incorporation of a higher strip price sent reserves up by a whopping 78%. While I'm not thrilled with all of the new SEC reserve rules that have been proposed for use in 2009 and beyond it will be a good thing when the SEC allows companies to use average commodity prices instead of "single point in time pricing". Todays strip would yield another significant bump in reserves were it allowed to be used.

• Unbooked, Unrisked Reserve Potential: 238 MMBOE. I usually take these with a grain of salt but since much of the assets here are either underexploited or untest (acreage not yet drilled in the case of the CBM) it is worth noting.  Essentially this says that if they got the recoveries they think they could and that all of the plays worked the reserve potential is about 10x what they have currently booked. With high commodity prices more of this is likely to work.
  
  • Wilminton Units: 125 MMBOE
    
  • Washakie Basin: 113 MMBOE

Total Enterprise Value: TEV per Barrel or per BOE provides a floor on thinking about company reserves. The TEV of the company values the proved reserves at $11.33 per BOE  (using end of 2008 figures) which is pretty fair given current prices for an in ground valuation.  Normally, I'd expect reserves like WRES 'to be discounted to its peers given their low API gravity - this is heavy oil with some as low as 14 degree gravity, California reserves which are always going to garner lower prices on the market. Their Rockies gas assets would be valued at a discount as well simply due to the glut of gas at present in the Rockies.  However, if you look at them on the  basis of those reserves that have been written down from the 2007 levels, but are not in fact gone, you come up with a much lower TEV to reserve valuation of $4.11 per BOE, a veritable bargain as reserves go, and something which may put them in play in the third quarter when I think deal activity in the E&P sector will begin to come back from the dead.

 

Quick Look At Last Quarter's Cash Costs: The model simply doesn't work at these low prices ...

... But Prices Have Not Always Been and Will Not Always Be This Low ...

... And Production Has Been Increasing Since High Prices Were Reached ...

Cash Margins: Their costs have been fairly consistent for a small cap and so you can see margins have rising and fallen with commodity prices.

 

Model With Sensitivities. I've included a simple model with 3 different oil price decks but holding gas flat at $5 with an eye towards conservatism in the costs, and the incorporation of some unfortunate hedges for about half of expected 2009 oil volumes. They were not cash flow positive in the first quarter but you can see in each case below they return to positive cash flow. Obviously the higher oil goes the better but note that they are unhedged for oil in 2010 and this will start to factor into thinking in the next few months as it will take the governor off their earnings capacity.

 

Hedges

• 2009 you can see in the table above ... nice on natural gas, falling underwater on oil
• 2010:
  • About 50% of current levels of gas production hedged at $6.45
  • Unhedged on oil.

One last table ... a look at the impact of their oil hedges falling off in 2010. On the best $75 oil price case, note that cash flow roughly doubles 2009 levels even with a 10% production decline.

Balance Sheet: In a word, leveraged. 

• 44% Net debt to total cap. High, but manageable
• Quarterly interest is running $1.5 mm 
• They have about $5 million of room left on the revolver.
  
• Next redetermination is scheduled for October 2009
• They have the right to obtain second mortgage lien financing of another $30 mm over the next 6 months.
• 09 EBITDA of $12 mm vs $6 mm of interest is low.

Capex Plan 2009: Given their cash strapped nature they are planning to spend only enough to get through this trough in prices: $11 million. $7 mm for California, $4 mm for Wyoming.

Brief Thoughts About Their Areas of Operation and History:

 

California Oil - Los Angeles Basin, Southern California.

Wilmington Townlot Unit  (WTU)

• Old California oil field, been on waterflood since the 1970s.
• WRES took over the unit in March 2005 and has an 80.9% net revenue interest
• They put reserves here at 13.7 MMBOE using the aforementioned February 2009 strip price. It would be higher now.
  
• Stacked pays - 6 sands
  
• Exploiting using sinusoidal wells (thinking of a horizontal well porpoising or undulating in and out of the pays to maximize exposure to different sands)
• Production has risen from 375 bopd gross in March 2005 (when they took it over) to > 3,000 bopd by YE 2008.
  • they've taken the play into the modern age, now using 3D and now employ horizontal
    
• They have a permit to redevelop the Unit with 540 new wells using multi-well drilling and production cellars.
  
• Current status: 5/2009 minimal capex, not drilling new wells.

 

  North Wilmington Unit (NWU)

• Another old oil field, (SUN) began water floods here in the 1970s, field has produced about one quarter of estimated original oil in place and like many older oil fields fell into, if not neglect, then a state of under capitalization.
  
• 84.65% NRI
• They began a horizontal water flood in 2Q08.  These are also sinusoidal wells
  
  • Pattern to date of the wells has been:
    
    • Production inclines 70% first 6 months,
      
    • inclines another 15% over the next year 
      
    • and then declines of a long period at 10% per annum
      
• Production in April 2009 stood at 500 bopd gross or 425 bopd net, about 10% of company production and up from 300 bopd at the time they took over in 2005.
  
• 12.5 MMBoe, also on strip prices.
  
• Current status: 5/2009: minimal capex, not drilling new wells

 

Washakie Basin - Atlantic Rim Coalbed Methane Project - South Central Wyoming

• 94,095 net acres
• JV with (APC), 141,000 gross, 50/50 JV
• 1.0 Bcfe EUR in their largest unit (they have 6 with various working interests) 
• potential for 800 gross wells
  
• gross field production in Feb 2009 was 22.5 mmcfepd
• typical CBM, low IP, peak at just under 1 MMcfgpd and then slowly decline ad infinitum (20 to 30 years), so you drill lots, in a manufacturing style when prices are good.
  

 

Non-Core Assets:

• About 2,700 net acres in conventional oil and gas properties located primarily in New Mexico, Texas and North Dakota.
• Any and all of these may get monetized.