Description

The big picture is 15+ TCF of gas in place (worth over $22B @ $1.5B/TCF) that will cost $8 to 9 billion to retrieve. So a net value could be $13B on a current EV of $2.4B.

Compton Petroleum
In the quadrant southeast of Calgary, there has been extraordinary drilling success for natural gas over the past dozen years. Compton’s Southern Alberta land position is surrounded by all this drilling activity and is part of the same geological ‘fairway’.

Please view the slide show on their website at: http://www.comptonpetroleum.com/06Slides/06index.html

Note their land position shown in blue squares on slide #13, and compare it with slide #14. This highlights the change in drilling density from 1993 to 2005 shown on these slides by the black dots. Compton is poised to enjoy a similar drillbit success to Encana, who drilled the heavy density in the upper right, as well as Burlington & Apache who pock-marked the rest of the landscape. Now Compton’s goal is to prove up reserves by drilling the same density over its 1.1 million net acres.

12/31/04 reserves were 463 bcfe of Provens and 230 bcfe of Probables for a 2P of 693 bcfe. Each of five different target areas could independently double the 2004 reserves on their own. In time they will all be converted to ‘Provens’ as Compton’s aggressive drilling program builds high quality, long life reserves:

Properties - See slide #23: Summary of Key areas

Southern Alberta TCF recoverable
Horseshoe Canyon-CBM 4.0
Plains Belly River 3.9
Hooker Basal Quartz 3.5
Callum Belly River 2.5
Central Alberta
Niton Gething/Rock Cr 1.3

TOTAL TCF Recoverable 15.2

Though the main event is Southern Alberta’s tight gas plays, other properties include similar gas resources in Central Alberta as well as traditional oil & gas in Northern Alberta that will likely be sold once fully developed. Currently 13 rigs are working their land area where they have 5 to 10 years of drilling inventory.

The high repeatability among drilling prospects allows for low exploration risk with predictable costs & production levels. They have already found the gas, so the E in this E&P company is exploitation (not exploration). The third quarter 2005 drilling success rate was 97%, with 312 wells drilled YTD through Nov. 10th out of a 390 well program for 2005. Their 2005 CapEx will be C$450 million with C$300 million in cash flow expected. Using the lower end of expected recoverables and a much lower than actual 80% drilling success rate, the minimum 2005 reserve add is 272 bcfe before taking out 70 bcfe in production for a minimum estimated 2005 reserve statement 2P of 894 bcfe (Our high end of recoverables at a 90% success rate would be an add of 590 bcf for a total of 1,213 bcfe achievable 2P by the end of 2005). As the table above (and on their slide #23) shows, this will eventually be a 15 TCF play... just huge!

Expected 2005 reserves (assumes 70 BCF production):
894 BCF at 80% drilling success rate
1213 BCF at 90% drilling success rate

In addition, and not in our Reserve adds, is the inclusion in 2005 of the Edmonton CBM and Worsely plays into reserves (Note: Worsely is in Northern Alberta and not mentioned in data above) which were excluded from the 2004 report due to timing issues with arrival of core analysis to the reserve auditors.

Future drilling is going to be brisk with 480 wells planned for 2006 on a $575 million capital budget with $475 million of cash flow expected, 570 wells for 2007, and 670 for 2008. This aggressive program seems achievable given the fact that they drilled 147 wells in Q3 alone and have appropriate access to equipment and crews. Tie-ins in some areas will be delayed but what matters is proving up the reserves... producing them is a monetization decision.

Though costs are rising and labor is increasingly harder to find, Compton's Southern Alberta locations are near Calgary and a big help in competing for labor vs. other Canadian drillers such as the oil sands players who operate much farther north. Because they are so close to Calgary, in-field drilling personnel can sleep at their homes each night... That's not possible up in Athabasca by the oil sands where it gets VERY cold in winter.

Enterprise Value:
$2.39 billion (132.6 fd shares @ $14.70 plus US$388m debt, US$60m Minority Interest, less 7m+ cash)

EV/’05 Reserves: US$2.68/mcf or $16.10/boe
As their ramp continues, these reserve stats will plummet since the reserves in the denominator are rising quickly.

The heavy drilling (capital spending) program exceeds current cash flow so the shortfall will be funded with debt and minor asset sales. They have recently refinanced 9.9% debt and replaced it with US$300m of 7.625% paper due 2013. Compton is currently an asset play, but starts to get very interesting a few years out as a production story as well.

One third of 2005 production is hedged with collars (at high rates: C$8.09-10.60 for Nov05-Mar06, C$7.25-10.25 for Apr06-Oct06) to help protect the drilling program, yet they still maintain sensitivity to the run-up in gas prices with $2.4m in additional cash flow exposure to a $1 change in WTI and $4m exposure to a $0.10 change in AECO (Alberta spot Gas, currently C$10.40 and way above our projections which use realized prices of C$7.66 for 2005.). Their gas is mostly medium sour which goes for approximately 7% discount to spot. During Q3 they did slightly better realizing C$8.46/mcf vs. an average AECO of C$8.91 which is a 5% discount.

Current production is 30,000 boe/d with 140 more wells already drilled and awaiting tie-in (16 pipeline & construction crews are working feverishly on this). In three years, production will ramp to well over 100,000+ boe/d. The “tight gas” nature of the resources means it is under high pressure and thus rapid initial production is followed by a low long-term production decline rates with an overall expected well life of greater than ten years making these ideal assets for a royalty trust structure. Compton’s discretionary cash flow margin of C$23 per boe based on 2005 exit production at sales of C$46/boe, overwhelmingly covers F&D costs which averaged C$7.75 per boe from 2002-2004 and is expected to diminish greatly as the drilling program expands. Under these assumptions, Compton is achieving a recycle ratio of nearly 3x.

With over 1,754 net sections of land, if downspacing to more wells per section is approved, recoverables could be higher than estimated.

They are replicating Encana’s strategy of aggressive drilling to prove up reserves as fast as possible in unconventional resource plays. I think they get bought out before the full drilling program comes to fruition. Some majors have looked at them, but presumably are waiting until Compton gets over its near term capx hump before acquireing.

Historically, the Canadian sell-side has been tepid on management (though bullish on the assets) because they have not been a production story. A NYSE listing under symbol CMZ was initiated on December 6th and US sell side coverage will be a help in getting the story out.

Catalyst

1) 2005 reserve data
2) Recent NYSE listing on December 6th
3) US Sell-side coverage (Morgan Stanley initiated already, others to follow) in addition to Canadian Sell-side coverage.
4) Production growth ramp