Here are some ways to do it:
- Generally, a number of estimation methods are allowed: decline curve analysis (DCA), analogy, reservoir modelling, volumetric, pressure, or some combination of those methods, etc. You can cherry pick among those methods to choose the one that yields outlier numbers. The least time-consuming method is to use DCA, with Arps equations, with a high b-factor and with a low Dmin value.
- For DCA, you can use the analogy method for the underlying assumptions to “supplement” your wells’ production data with historical data that goes further back. Like #1, the optionality in methods allow you to cherry pick.
- You could use the analogy method on wells that have undergone significant capex/opex spending on enhanced oil recovery techniques. However, because you likely do not have access to those wells’ capex+opex figures, you could over/underestimate the economics of your own wells.
- In Canada, you are allowed to use commodity price forecasts that are well above the futures curve. (*Things were very different in the early 2000s.)
- You could book reserves for non-producing wells, e.g. wells that are shut-in and wells that were not completed due to poor economics. Theoretically, these wells could be NPV positive with higher commodity prices.
I find that ranking stocks is a useful analytical tool. Ranking stocks against each other helps me be more realistic about how good or how bad a stock is.
I have some extreme and unconventional viewpoints. Many “value investors” would have a list that would be the opposite of mine. Many of the stocks I have shorted have been mentioned on ValueInvestorsClub.com as longs or potential longs. Many of these people are quite intelligent and eloquent. In my opinion, the longs do not understand how they are being bamboozled and misled by stock promoters. I’ve written about this many times on this blog (e.g. “How would a sociopath fleece investors in oil and gas?” and “Beating Wall Street in oil and gas“).
While the independent E&P sector has seen a meltdown in share prices, I don’t see undervaluation. The problem is that many of the companies continue to be run by stock promoters and charlatans (more so in the small caps than the large caps). Until the management teams get better, I don’t think that the independent E&P space will be a good place to look for longs. My prediction is that there will be more pain to come when NGL prices collapse.
I think that ACMP’s cash flows will decline due to:
- Less gas being carried on their gathering pipelines. Throughput will decline as shale gas wells naturally decline. Throughput on ACMP’s existing assets cannot grow unless more shale gas wells are drilled.
- Cash flows from minimum volume commitments ending.
*Disclosure: I am short ACMP common. This is not one of my better short ideas and I may cover this position in the future.
Here’s what I think about Chesapeake…
Originally, I thought that Chesapeake may have been using its midstream deals to inflate its profits. I was mistaken. Chesapeake’s midstream vehicle (now named Access Midstream Partners) was structured in a very one-sided deal that heavily favored Chesapeake.
I don’t think that many people give credit to Aubrey McClendon for this deal.
This is a small position for me that I bought puts yesterday (Nov 5). At the time, I did not realize that earnings was today. The implied volatility on CHK options is in the low 30s for the 2016 LEAPs and seems to be rather low. The historical volatility in the past 3 years was 40.97 according to Morningstar. I think that the stock is a little overvalued (see my CHK post) and that the put options are a little undervalued. This trade doesn’t have the greatest margin of safety.
Chesapeake is an oil & gas stock that has been owned by many notable value investors (Mason Hawkins, Lou Simpson) and has often been written up as a long on VIC more than once. In my cynical opinion, Chesapeake is an example of a stock where supposedly sophisticated investors have been continually fooled by management. Since its IPO in 1983, Chesapeake has done a very poor job at value creation and generating GAAP earnings. However, book value per share has gone up dramatically since Chesapeake has been continually selling shares at higher and higher prices.
Perhaps shareholders will realize that they aren’t going to make money and should stop buying stock through secondary offerings (and convertible debt). However, I don’t think that Chesapeake is a compelling short as the company is not the worst company in the E&P space.