Contango Oil & Gas: New Ways To Make Money
Last year the Contango Oil & Gas (MCF) made two significant purchases that changed the company's strategy. This year, management will be "thinking outside the box" to generate some free cash flow as well as better than expected earnings.
"Really the only asset class in the oil and gas industry, which isn't decreased in value in the last month, is latent storage capacity which we have in spades."
Management is looking at some decent returns by producing the oil now and then storing it until prices are better. There are couple of ways to "hedge" by locking in the profit now from the contango that exists in the futures curve. Management would basically forgo current cash flow (and build inventory by utilizing some ample storage capacity) in the hopes of making a lot more cash in the future. Management estimates that this strategy could make anywhere from 20% to 75% profit from the current price.
Management did not sit still after the acquisitions. Instead management hedged production in the fall. So most of the anticipated production has been hedged. Any cash flow against that hedged amount will most likely be used to reduce debt. The capital budget has been stripped to only the most necessary work needed.
One of the biggest differences between the prior management and the new management is the priority to repay debt asap. This management is actually somewhat debt averse. Therefore, a piece of whatever cash flow is available will go towards reducing the debt load. The previous management never reduced the debt until it became absolutely necessary. That treatment of debt nearly led to a reorganization.
Surprisingly the "Iron Flea" prospect still works (is profitable) at current pricing based upon a successful result. Management feels that the risk is minimal and the price of the well compared to a possible success is a bargain. This well will be drilled in the second quarter. These offshore wells in the shallow waters of the Gulf Of Mexico can be very significant to company cash flow and reserve estimates.
Under Kenneth Peak, the deceased past CEO of the company, Contango had an extremely good growth record to brag about based upon the exploration results in the shallow offshore waters of the Gulf of Mexico. Along with Kenneth Peak, Brad Juneau was a co-founder of Contango Oil & Gas. This latest deal looks like a revival of an old very profitable formula. Juneau Exploration brought the prospects to Contango. Contango would drill, develop, and produce successful finds. That formula worked up until the death of Kenneth Peak.
Compared to the more explored deeper waters of the Gulf of Mexico, the leasing and operating costs of the shallow shelf are generally much lower. A lot of the area produces natural gas. Previously under Kenneth Peak, Contango drilled a lot of offshore gas producing wells that were the mainstay of company production for many years.
Gas is not worth nearly as much as the oil production further out in the Gulf of Mexico. But sometimes the gas wells have a relatively large amount of production that lowers the production costs significantly or (more rarely) a true oil prospect becomes available. In this case, the target is oil. Hopefully, this well for the first time in a while will be a success and revive the offshore business that has long been the backbone of cash generation for this company.
Also noticeably different this time around is a stated company objective to drill the well on-time and within the budget. The last well drilled in the Gulf of Mexico by the company went way over budget and was a dry hole. I covered in a previous article how the whole drilling budget was used up on one well. The frustration of the board of directors led to the exit of Brad Juneau as president and the later merger with Crimson Exploration.
However, that merger with Crimson was not successful. Much of the acquired assets have been sold for whatever cash price they are worth. Even the Bullseye prospect (which was that management's last great hope before the current management) has now been significantly impaired. The discouraging results of some Bullseye wells will most likely result in a strategy shift in the future towards the NE Bullseye leases. The impairment of the value of the Bullseye leases is probably the final signature failure of the previous management.
The result is very little production from the previous management remains.
Instead, the "new" Contango features the remaining offshore production from discoveries while Kenneth Peak was still CEO. This remaining production was combined with the new purchases of White Star and Will Energy. These would appear to be core areas for future growth at the current time.
This management will function as a "consolidator". Contango will be a vehicle to acquire properties at bargain prices from distressed sellers. Growth through exploration and development does not appear to be a high priority. Management only plans to drill one well in the current fiscal year and that well is offshore. The growth plan includes growth by consolidation of distressed properties similar to the acquisitions already made. The latest challenges of the OPEC price war and the coronavirus make that strategy an ideal way to grow as long as the company does not become over-leveraged.
The rest of the capital budget will complete some drilled but uncompleted wells while adding some infrastructure as needed.
Summary
The stock price is now back to where it was when the market feared that the company could not refinance its debt about a year or so ago. Yet this company now has far more attractive prospects than it did at that time. This management has accomplished quite a bit in one year.
he first took control of the company. Most of the remaining Crimson and Crimson management purchased properties have been sold or are for sale.
Like many companies, this one has sought to increase the liquids production in its primarily natural gas business. Right now, management appears to be on its way to a long-term more profitable production mix. The average selling price fell quite a bit less than the price of natural gas fell. This happened in spite of the remarkable drop in natural gas liquids pricing.
The current fiscal year will definitely be off to a slow start. But the idea that the offshore well is viable in the current environment demonstrates the profitability orientation of this management. It also demonstrates a very determined goal to make this company into the low cost producer it once was.
This reincarnation of Contango evidently will revive the very successful offshore program in the shallow shelf waters of the Gulf of Mexico. But this time that program will be balanced with some low cost onshore production. There also appears to be a move to take advantage of the contango shown in the futures curve.
There is more than one way to make money in this business. But the key is to keep successfully making money no matter the current industry conditions. This management appears to understand that. If that is the case, then investors can look forward to a return of the stock price to some levels not seen for the past few years.