Description
Venoco is a small cap E&P with California oil and gas assets which has been cut in half of late. VQ's legacy assets are both oil and gas. Specifically, they have long-lived, low-decline off-shore oil production (Sockeye, South Ellwood and West Montalvo.) With old, disadvantageously-priced contracts rolling off, VQ will get $13 a barrel more for their oil in 2012. ( California crude now trades at a premium to WTI. )
Venoco also operates 2 of the 3 largest natural gas fields in CA. Venoco will drill 40 wells and do 220 recompletions this year in their Sacramento Basin gas fields, where much of the production - in the black even at current gas prices -- is profitably hedged for 2011 and 12 with $6 floors. VQ has announced its plans to increase production in its legacy oil and gas fields next year by 10%.
So why is VQ so hated that even analysts down-grading the stock admit it's now trading at about half its NAV?
There are several reasons: First, VQ's debt level. Also, its high capex and missed production target caused by disappointing early results of its new oil play, the Monterey Shale.
First Debt: VQ's $628 million of net debt seems a lot compared to its $642mcap and $220m of consensus ebitda for 2011, but the first tranche of the debt isn't due for six years. Further their new 200m revolver is undrawn. Most important, management expects to sell its non-core (Texas)Hastings oil field for $250 to 400 million next year. Should the company be successful, these funds will be used, in large part, to cut debt. Thus, while VQ's debt screens as uncomfortably large, it is long term and will soon be cut by major asset sales. Chairman/Ceo and 55% owner Tim Marquez is promising 2011's year end 2.6 times debt to Ebitda level will move to a 1 to 1 ratio by the end of 2012.
Next capex. VQ will spend $200 million on capex this year with the figure rising to $400million next. While Wall Street is happy to see high capex when it gives a quick pop in production, so far that has not been the case. Although VQ managed to keep legacy asset production near flat (ex property sales) with just $100m of investment, the $100m management invested in the Monterey shale has, as yet, created scant production. We all know Wall Street hates paying for fruitless "science projects," but there is reason to believe management when they say the commercial ramp of the Monterey will come next year.
First, a word about the Monterey Shale. It's a play that yields light oil at moderate depths and is naturally fractured. The EIA's (U.S. Energy Information Administration) July 2011 review of emerging shale plays puts the recoverable resource there at 15.42 billion barrels (as opposed to, say, the Eagle Ford and Bakken shales which are each said to have between 3 and 4 billion barrels a play.) So three times the size of the Eagle Ford - not too shabby.
Of course, the Monterey isn't just one field. It's a number of areas - all with the same source rock but each with slightly different characteristics - meaning it can take a while to figure out the best approach to each. And VQ, whose 214,00 net Monterey acres make it the 2nd largest Monterey acreage holder after Oxy, spent the past year trying out a number of different approaches (horizontal, vertical, fracked, acidized) on its Salinas Valley, Santa Maria Basin, Sevier and San Joaquin Basin Monterey fields. To be frank, VQ's communications on all the different fields and approaches confused Wall Street. At the same time Oxy was telling a much cleaner, simpler story. They focusing on one field and seriously ramping production in the San Joaquin Basin (where they did a Joint 3-D shoot with VQ.) Oxy was drilling vertical wells yielding roughly 300 barrels a day of oil while VQ (which owns 112,100 acres in the same area) was trying horizontals. That now turns out to have been a mistake. The verticals outperformed the horizontals at much lower cost. Trial and error over, VQ is currently planning to drill approximately 75 vertical wells in the Monterey next year. Many will be in the San Joaquin Basin near Oxy. But perhaps the best opportunity in the next 6 months may come from wells VQ will be drilling in the (Monterey) Sevier field. If this somewhat different field works it could produce 70MMbarrels which could lift the stock to the $30 range. (And Sevier is only 10% of the company's acreage.)
The recent past was admittedly a frustrating time for Venoco shareholders, but the knowledge obtained by Monterey trial and error is now being put to good use and could lead to drilling results that would send the stock higher in the back half of the year.
Catalyst
At current levels, you are creating the equity for roughly half the mid teens value per share PV10 value of the proved reserves. You are also creating their proved reserves at about $14.5 per BOE. The company estimates their unproven reserves (primarily in the Monterry shale) of 567 additional MMBOE for a total of 653.6MMBOE of proven and unproven reserves or $1.9 per BOE. While the company may be way off in its calculations, they value the unrisked PV10 at $142 per shares and the risked PV 10 at $64.4 per shares. The key catalyst for the stock to rocket would be the Monterrey play must proving out. That said, just a return to something close to the PV 10 value of their proved reserves (where it was trading until the recent market selloff), would return the stock to the mid teens and be an approximately 50% return from here.