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Can Oklahoma's STACK Play Save Gastar Exploration From Bankruptcy?

Summary

Gastar Exploration is in a survival mode because of its debt overhang, high cash burn rate and declining liquidity.

To me, Gastar carries a substantial risk of default with a negative outlook and can't continue with the current financial structure for long.

It has to sell a portion of its assets and/or make another dilutive financing within the next six months.

When it comes to the high-risk common and preferred equity, I stay on the sidelines because my energy portfolio has low-risk firms with pristine balance sheets for triple-digit returns.

Instead, the STACK bulls can consider buying Gastar's senior secured notes currently trading at a discount to par value, given their priority claim on the underlying assets.

The most prolific wells with the highest IRRs in the Williston Basin are located in the Fort Berthold Reservation. Halcon Resources (NYSE:HK) had significant exposure to this area.

The sweetest of the sweet spots in the Eagle Ford play partly covers Karnes and Gonzales counties where a narrow over-pressure strip of the oil window exists, followed by specific areas within LaSalle and DeWitt counties. And Penn Virginia Corporation (OTCPK:PVAHQ) owned significant acreage in Eagle Ford's sweet spot.

Nevertheless, these prolific assets didn't save Halcon Resources and Penn Virginia Corporation from bankruptcy. Both firms filed for bankruptcy a few months ago.

And unlike most SA contributors and analysts who were very bullish on both companies until 2015, I was very bearish on them and repeatedly discouraged investors from buying these overleveraged producers.

On that front, I also disagreed with George Soros and his bullish approach on Penn Virginia in mid-2014, when Soros Fund Management bought a 9.18% stake, clearly noting that he arrived "too late to the party". To me, a storm was coming, but George Soros was unable to see it. And because talk is cheap, the proof is found in my articles here, here and here.

Can the emerging STACK play save Gastar Exploration, Inc. (NYSEMKT:GST) from bankruptcy? To me, the company currently is on a razor's edge, and I dare say that its survival is highly questionable, as shown in the next paragraphs.

The Good

1) Rising oil and gas prices: As forecasted in my detailed article here, there are some key fundamental reasons why natural gas prices in North America have improved significantly over the last months.

And as mentioned in detail in the linked article above, this is a result of increasing demand in the U.S. (electric power generation, coal-to-gas plant conversions, LNG exports, exports to Mexico) and flat to declining production. With rig counts at historical lows and higher debt levels preventing many producers from increasing capital investment, natural gas prices should continue improving into 2017.

Also, longer term appears increasingly bullish with LNG export capacity of more than 9 Bcf/d currently operating or under construction on the U.S. Gulf Coast while U.S. exports to Mexico are expected to continue increasing as multiple new export pipelines and interconnections are completed by the end of 2017.

And when it comes to the oil prices, oil markets are on the path to rebalancing and the upward trend will continue by 2018. Actually, my estimate is that WTI will exceed $60/bbl in the first half of 2017, which bodes well for the company's overly weak balance sheet.

2) Promising STACK play: The STACK play is an emerging oily play with a multi-zone stacked pay potential (i.e. Meramec, Oswego, Osage, Woodford, Hunton formations) and balanced commodity mix (~55% oil and liquids) that has attracted the attention of key industry players lately.

Although this play is still in the early stages of development and caution is required, Wells Fargo's (NYSE:WFC) Equity Research believes that this is the third most economic play behind only core Niobrara and Permian while Bentek Energy LLC, an energy market analytics company, considers it to be one of the top five plays in the U.S., as shown below:

Also, JPMorgan (NYSE:JPM) Upstream Equity Research believes that the STACK play has the potential to be the next franchise asset in the U.S. E&P while Goldman Sachs (NYSE:GS) Upstream Equity Research expects the SCOOP/STACK to provide the highest oil production CAGR for the rest of the decade among all major oil basins. Of the two plays, SCOOP is older, but still has high activity.

And Enable Midstream's (NYSE:ENBL) growth initiatives seem to support this view. Specifically, a few weeks ago, Enable Midstream doubled its position in the area with the completion of its Bradley II plant, a 200 MMcf/d natural gas processing plant at its Bradley Processing Complex in Grady County, Oklahoma.

For reference, Enable Midstream is the top processor in the STACK (Sooner Trend, Anadarko Basin, Canadian and Kingfisher Counties) and SCOOP (South Central Oklahoma Oil Province) plays with more than double the processing capacity of its closest peer and 22 rigs drilling wells contractually dedicated to its gas gathering and processing systems, as shown below...

...and below:

That said, Gastar's assets are well located in central Oklahoma, as illustrated below:

3) Vibrant M&A activity in the STACK play: In December 2015, Devon Energy (NYSE:DVN) paid $1.9 billion and acquired Felix Energy. Felix owned 80,000 net acres in the STACK play with production of ~9,000 boepd and 2P Reserves of 400 MMboe. Therefore, Devon paid $211,111/boepd and $4.75/boe of 2P reserves.

In May 2016, Newfield Exploration Co. (NYSE:NFX) bought about 42,000 acres in the STACK from Chesapeake Energy Corp. (NYSE:CHK) for $470 million. The production from the assets was ~3,800 boepd (55% oil and NGLs), and therefore, Newfield paid about $123,684/boepd. Also, excluding PDP and reimbursement allocations for the STACK wells, which are currently drilling or have been drilled and are planned for completion, the undeveloped acreage value equates to approximately $10,000/acre.

In May 2016, Vanguard Natural Resources (NYSE:VNR) sold its SCOOP/STACK holdings (20,000 net acres) to Titanium Exploration Partners LLC for $273 million. These assets produced approximately 8,333 boepd (~52% natural gas) and had 39.8 MMboe of 1P Reserves (56% natural gas), so Vanguard paid about $32,761/boepd and $6.86/boe of 1P Reserves.

In June 2016, Marathon Oil (NYSE:MRO) paid $888 million and acquired PayRock Energy, which like Felix, controls drilling rights in the STACK. Specifically, PayRock holds approximately 61,000 net surface acres, which produce about 9,000 boepd in the Anadarko Basin STACK and holds 330 MMboe of 2P reserves. As a result, Marathon paid about $98,667/boepd and $2.69/boe of 2P reserves. Also, adjusted for proved developed producing (PDP) reserves, the implied acreage value is $11,800/acre.

To sum it up:

Deals

$/boepd

$/boe (1P)

$/boe (2P)

Devon/Felix

211,111

-

4.75

Newfield/Chesapeake

123,684

-

-

Vanguard/Titanium

32,761

6.86

-

Marathon/PayRock

98,667

-

2.69

Click to enlarge

4) Active hedging program: Gastar has an active hedging strategy in place that increases the realized oil and gas prices while minimizing the variability in its cash flows.

Specifically, it has hedged 75% of 2016 PDP oil and NGLs production with $70.75 average floor and 80% of 2016 PDP gas production with $3.48 average floor (as of 08/01/2016) thus far...


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