Exxon’s Trash is a Dog’s Breakfast for Energy XXI
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While the Exxon Mobil (NYSE: XOM) assets that Energy XXI (NASDAQ: EXXI) recently purchased were far from trash, they were legacy Gulf of Mexico shelf assets that Exxon no longer considered worthwhile for capital expenditures. Exxon did the logical thing and shopped the market for buyers. EXXI saw an opportunity to transition beyond its acquire and exploit strategy, and ponied up $1.01B to make that transaction. The properties, with their 49.5 MMBOE (million barrels of oil equivalent) and 20 MBOE/d (thousand barrels of oil equivalent per day) of production, dovetailed with their current operations geographically and provided a large ready drill inventory. What wasn’t a strategic asset for Exxon, is now an opportunity for EXXI to grow organically from its own drilling program, and the rewards are just beginning to come to the forefront.
Some may be familiar with EXXI as the minority partner of McMoRan Exploration Company (NYSE: MMR) in the “Ultradeep” Gulf of Mexico shelf wildcat Nat-Gas project. Jim Bob Moffett, McMoRan’s Co-Chair, President, and CEO has re-written the deposition models of the floor of the Gulf while drilling some of the deepest holes ever spud there. The reward is access to the same prolific Wilcox sands identified out in Deepwater back on the shelf, where production infrastructure already exists to get hydrocarbons back to shore economically. Unfortunately, the prize that’s now been identified in a number of wells is locked under 30,000 feet rock at extreme temperatures and pressures beyond the capabilities of current equipment. That’s meant plenty of bumps along the way and frustrating waiting periods for drilling tools and production equipment.
Still, the potential of the project is huge, and even the majors have taken notice. Chevron (NYSE: CVX) recently spud Lineham Creek in Coastal Louisiana in partnership with McMoRan and Energy XXI, validating the Ultradeep projects in the eyes of many. Now the market awaits first news of a flow test at the proof of concept Davy Jones 1 well. That flow test is now overdue, most recently delayed after perforation equipment failed to fire about a month or so back. Guidance at EXXI’s latest earnings call now schedules that flow test as a Q4 event (EXXI is on a June fiscal year end). The latest bad news at Davy Jones has meant a 40% fall from recent February levels for MMR. In contrast, EXXI shares held up better to the disappointing news, largely due to their own internal drilling program that’s running at a smoother pace.
The hors d’oeuvres from EXXI’s Exxon buffet are just now beginning to arrive. Wednesday night, EXXI reported Q3 production growth that investors hope is just a hint of things to come. Third quarter production averaged 45.3 MBOE/d (70% oil), but exited at 52.4 MBOE/d as EXXI brought new production from recent work on line. While that number seems a bit low given Q2’s average production of 42.7 MBOE/d and an exit rate in the 50s, production shut-ins due to completion work and rig moves explains the anomaly. This dog’s busy digging holes in its new backyard, with 9 rigs running and a drilling inventory that’s extremely large for a company of its size. Fourth quarter guidance is for incremental production adds of 10 MBOE/d. Asked if those six new wells should push them through the 60 MBOE/d rate, John Schiller, Chairman and CEO replied that a “high 50s” rate was more likely.
With two quarters of production gains and a string of quarterly earnings growth, analysts were getting more aggressive with their targets, and Schiller may be trying to moderate their targets a bit. Earnings reported for Q3 were $1.04, short of analysts’ $1.13 consensus. Backing out a $0.07 one-time charge on retirement of preferred shares, EPS was $1.11. Closer, but still a small miss. There was also a note of caution from Schiller on reading too much into flow rates from Davy Jones 1 once tested. Schiller pointed to the reservoir’s permeability as more important than production rates. These data will allow them to better predict production rates for Davy Jones 2, and DJ2 with its larger casing will be much more significant from a production standpoint. Completion of Davey Jones 2 is slated for calendar year-end 2012. EXXI’s new production from the Exxon acquisition should be in full swing by then. Davy Jones 1 is certainly critical as proof of concept, but the larger prize from a production standpoint, is certainly the rest of the Ultradeep portfolio beginning with Davy Jones 2.
On a promising note, EXXI’s strong cash flow led the board of directors to declare a small $0.07 dividend for shareholders. Shares of EXXI were down Thursday and have fallen sharply as of mid-day Friday. Given the expected production adds in Q4 and the massive potential of the Ultradeep projects, this consolidation of shares may prove a buying opportunity for investors interested in a stake in the Ultradeep with less risk than an ownership stake in MMR.
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