Wednesday, February 24, 2010

Petrohawk: Smaller Chokes, Bigger Results?

Earlier this week, Petrohawk had its quarterly earnings call. The company had an operations call earlier this month, so there wasn’t a ton of new information, but there was some good stuff.

Petrohawk is one of the biggest players in the Haynesville Shale with a $900 million 2010 capital budget and 17 operated rigs, not including its non-operated interests in active acreage in San Augustine and Nacogdoches Counties, TX (mostly operated by EOG and Noble), making it the third most active Haynesville driller by my count. The company expects to drill around 115 to 120 operated Haynesville wells in 2010. Well costs for 2009 averaged $10.5 million but were down to around $9 million by fourth quarter 2009. The company expects to get well costs down to the $8 to $9 million range in 2010.

On its call, the company noted that it has “concluded its on-the-ground leasing effort in the Haynesville Shale,” so don’t look for any new acreage additions (or landmen knocking on the door). The company did some “mop-up” leasing in 2009 to fill in gaps.

Petrohawk offered some detail on its new “restricted production practices,” in which the company reduces the size of the choke on a well to purposely reduce the flow of gas. The belief is that the reduced flow rate will flatten out the decline rate and lead to higher recoveries (EURs) in the long term. Petrohawk believes that a well on a smaller choke will produce the same amount of gas on a wider choke over a 12 month period. The first test well has produced seven to eight months of production data, and the company plans to use the technique on about half of its 2010 wells. Expect initial production rates for these wells to be in the 7-10 MMcf/day range.

This restricted choke technique being used by several other companies and likely will gain widespread acceptance across the play. I’m no geologist, but it seems that the very high pressures encountered in the Haynesville Shale are a new and uncommon working environment and the producers are learning a great deal from trial and error. Probably the two biggest knocks on the Haynesville Shale are its steep decline rates and high well costs. If engineers can figure out how to flatten the decline curve a little bit and simultaneously improve recoveries, the economics will be even more attractive.

Over the past couple of years, Petrohawk, like many other producers, has sold new shares and floated new debt issuances to fund capital costs. Now that the company has a decent amount of debt on its books and the capital markets are still in poor shape, the next phase of sourcing capital is the upscale pawn shop, a.k.a. asset divestiture.

On the risk/reward continuum of the natural gas industry, producers are fairly high up the curve. They can see huge returns, but it requires lots of capital to continually drill wells. The high lease bonuses and drilling costs in the Haynesville Shale only exacerbate this situation.

Selling assets isn’t always a negative, but I always look twice when a company starts selling its stuff to fund growth. In Petrohawk’s case, the company is selling (1) its Haynesville midstream business, (2) its interests in the Terryville Field in Lincoln Parish, LA and (3) its interests in the WEHLU Field in Oklahoma. The company expects these sales to close in the first half of 2010 and generate about $1 billion, which will be used to fund its 2010 and 2011 capital budgets. The company also mentioned on the call that it might sell an interest in its captive Hawk Field Services business with the (implied) intent to spin it off some day and not have to fund its ongoing capex.

I don’t mean to sound too down on selling assets. If you can sell assets (especially those that might now be a distraction for you) for full value, more power to you. The downside is that the company’s “revenue portfolio” is considerably less diversified, which might increase its risk. In this case, Petrohawk is selling assets to partially fund its upcoming drilling budgets for the Haynesville and Eagle Ford Shales. These likely are good bets, but there is a lot less of a safety net if anything goes wrong.

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