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    Cimarex targets Permian, Mid-Continent

    Objective is best after-tax return on invested capital

    Photo courtesy of Mark Doolittle, Doolittle Photography, Longmont, Colorado
    Left to right:
    John Lambuth, vice president of exploration
    Steve Bell, executive vice president of business development
    Tom Jorden, chairman, president and CEO
    Paul Korus, senior vice president and CFO
    Photo courtesy of Mark Doolittle, Doolittle Photography, Longmont, Colorado

    EDITOR'S NOTE: Denver-based Cimarex Energy (NYSE: XEC) is an independent oil and gas exploration and production company with operations mainly in Texas, New Mexico, and Oklahoma. The company was added to the S&P 500 on June 20. OGFJ recently spoke with Tom Jorden, the company's chairman, president, and CEO.

    OIL & GAS FINANCIAL JOURNAL: Tom, can you tell our readers a little about your professional background and what prepared you for your current role at Cimarex?

    TOM JORDEN: I'm a geophysicist by education and have bachelor's and master's degrees from the Colorado School of Mines. After getting my undergraduate degree, I was hired by Superior Oil in Houston and worked in a number of different areas. When Superior was acquired by Mobil, I became a member of a group that was tasked with implementing a lot of what was then current research, most of it out of Stanford (University). That rekindled my interest in going back to graduate school. After earning my master's, I went to work for Union Pacific Resources for about six years doing a number of different things. After that, I joined our predecessor company, Key Production Company, in 1993. Key was a spin-off of Apache, and the founder of Key was the late Mick Merelli, a former president of Apache, who was a mentor to me and virtually every member of the executive team. At that point, Key had about a $30 million enterprise value. In 2002, Key merged with the oil and gas assets of Helmerich & Payne, a drilling contractor, and we formed Cimarex. So this was essentially the birth of Cimarex. We've made a few deals along the way, but we've grown predominantly through the drillbit.

    OGFJ: How did the company come to be named Cimarex Energy?

    JORDEN: It was originally planned to be Cimarron Exploration Company. Both Helmerich & Payne and Key Production had long histories of operations in western Oklahoma, a part of which was known as Cimarron Territory. However, we discovered that the name was already registered, so we chose Cimarex, which is a combination of "Cimarron" and "exploration." We've been explaining that name for the past 12 years.

    OGFJ: Cimarex is mainly a mid-continent and West Texas operator. Why did you choose to focus on those two areas?

    JORDEN: Our management team has never wanted to be concentrated in one particular basin nor with one commodity. When we formed the predecessor organization 20 years ago, we didn't have a lot of base properties. In fact, we didn't operate a single well. We were always a company that was built on ideas and internal generation, so we value the flexibility that multi-basin exposure provides. You never know when your next idea will arise or where it will lead you, so we thought we would have more opportunities if we operated in more than one area. Over our history, you will find that we were one of the most active drillers in the Sacramento Valley at one point; we were big in the Mississippi Salt Basin; we've been an onshore Gulf Coast player; and we've been in the Hardeman Basin in North Texas. So we've had a number of different projects over the course of time.

    Cimarex joined the resource era in 2006-2007. That's when focusing on a particular area became strategically more important. Western Oklahoma was our largest existing asset, and then we picked up our Permian Basin assets in 2005 when we bought Magnum Hunter I. We found those were really top tier basins, and they have been our focus ever since. However, we still have a new ventures group, and we would love to have additional focus areas.

    OGFJ: Which of these basins shows the most promise currently?

    JORDEN: It's an interesting question if we contrast the Permian with the Anadarko Basin. If we had this conversation six months ago, the answer would have been clear and unequivocal. It would have been the Permian. The Permian is a multi-objective basin, and we have a tremendous footprint there with a great generating team. But over the last few months, we've had a real renaissance in the Anadarko Basin, in particular our Cana-Woodford shale play has been brought back to life. It was never dead, but was just at a point where it was not competing well with the Permian on a return basis. We've recently had some technical innovations, especially with regard to completions, that have enabled it to compete head-to-head with our Permian assets. This puts us in a wonderful position with two top-tier basins, great asset positions, and tremendous flexibility in places to invest for outstanding returns.

    OGFJ: Cimarex thinks unconventionally when allocating capital. You have said that an after-tax rate of return on invested capital is a better marker than finding-and-development costs. Can you explain this line of thinking?

    JORDEN: Our core premise is that we're long-term players, and we want to create real, measureable value. In the short term, there can be trades around different metrics, but in the long run, value is measured by return on invested capital. Any business in any sector would tell you that. It's been said that the stock market is a voting machine in the short term, but in the long term, it's a weighing machine. That's our investment philosophy. From time to time, markets can become distracted by finding-and-development costs as a metric, reserve replacement, and even growth as a metric. But in the long run, I think that after-tax rate of return on invested capital is the best way to reinvest and grow. So we always try to find the highest rates of return within our portfolio. To that end, we are geography agnostic and commodity agnostic. We're focused on how to get the best rate of return over the long haul. That is how we manage the company.

    OGFJ: Can you give us your thoughts on the drilling and development of the unconventional resource plays within your asset base? Also, what percentage of your assets is unconventional?

    JORDEN: I'll start with the second question. Unconventional is 100% of our drilling portfolio. With very few exceptions, every well we drill is a horizontal resource-type target. And by that I mean plays with very tight reservoirs that require multi-stage fracturing. Now we still drill some wells in western Oklahoma that you could argue whether or not they're resource plays. But they're all tight reservoirs with horizontal drilling.

    Completing a Cimarex-operated well in Culberson County, Texas. Photo courtesy of Cimarex
    Completing a Cimarex-operated well in Culberson County, Texas. Photo courtesy of Cimarex

    That's really changed the landscape. You asked about capital allocation and how that changes our investment strategy. Today, we have a multi-year long and deep inventory of projects, so it takes more strategic thinking to develop those than drilling one-off targets. We have to look years ahead. In order to properly develop these resource plays, we have to do the science necessary to understand what the optimum spacing for development should be. You have to have the infrastructure ready, including water sourcing, water disposing, frac sands, electrification, oil and gas takeaway – it's all those things that are required to manufacture in the field. Then you need to have the financing lined up. Of course the human element is the most important thing. You have to have the people necessary to get the job done. So, science, infrastructure, financing, and people are the four critical elements you need to be able to execute your business plan at attractive rates of return. It's a different ballgame from what we were playing when we were doing conventional drilling. It's very capital intensive. Cimarex and most of our peers are in a phase where we're outspending cash flow, and that provides some challenges from a financing standpoint. Our business is completely different than it was just three to five years ago.

    OGFJ: Five years ago, Cimarex was primarily a natural gas player. What were the industry markers that told you it was time to increase the company's exposure to oil and liquids-rich properties?

    JORDEN: It's pretty simply really. It's all about that after-tax rate of return. It did not come from a strategic preference of oil over gas. We have no strategic preference. The Magnum Hunter acquisition in 2005 gave us an immediate major footprint – at the time about 370,000 net acres and 700,000 gross acres in the Permian Basin. We became a major Permian player almost overnight. The Permian has three major provinces – the Delaware Basin to the west, the Central Basin platform, and the Midland Basin to the east. Our assets were mainly in the Delaware, and there the play was deep gas. At that time, most in the industry were drilling deep gas wells. But in 2007, we looked at that program and decided it really wasn't generating the kind of returns we liked.

    Meanwhile, we had kicked off a couple of reentry programs out of old oil wells and were very, very stunned at the uplift we got when we drilled horizontal wells in some of these tight reservoirs. In 2007, we redirected our Permian effort to drill horizontal oil wells. By 2008, we had invested more than $300 million drilling horizontal Bone Spring oil wells in the Permian Basin. So we got a head start in this race to horizontal oil.

    OGFJ: Was there a learning curve in making the switch from gas to oil?

    JORDEN: Our geoscience group began developing new ideas for drilling in horizontal oil plays. Our exploration and production people, our midstream team and our marketing group all worked together to execute the plan that made these plays so prolific. It was a total team effort.

    OGFJ: And you were able to accomplish your goals within the asset base you already had?

    JORDEN: Yes. But over the years we've added a tremendous amount of new acreage. It's been seven years since we began targeting oil plays with horizontal drilling.

    Cimarex drilling operations in the Delaware Basin. Photo courtesy of Cimarex
    Cimarex drilling operations in the Delaware Basin. Photo courtesy of Cimarex

    OGFJ: Cimarex has one of the lowest PUD percentages and lowest debt ratios in the industry. What is the strategic thinking behind this?

    JORDEN: Our philosophy is evolving. It's never been a principle of ours to have a low percentage of proved undeveloped reserves. It was a practice during an era when Cimarex was drilling one-off vertical wells, and it was also a practice that was appropriate for a highly cyclic business, particularly with any kind of debt. We're in a business that's seen some pretty severe commodity cycles. Our experience has shown us that you don't want to enter into a down cycle debt-laden. We've seen some of our competitors struggle in down cycles, and some real opportunities come to us during those times. I wouldn't say we are debt-averse, but you're probably going to find us with a little lower debt structure than what some of our peers are comfortable with. You have different management teams and different management styles. We're also willing to take on some debt, but we stress test our investments at low commodity prices. We also stress test our overall corporate balance sheet and income statement because we want to be sure that if we do see a commodity correction, we're prepared for it. At Cimarex, we're building an ark, not a party boat. We want our company to be built to last.

    We want to make sure we can withstand short- and long-term commodity cycle corrections. We stress test our investments down to $60 NYMEX oil and $3 NYMEX gas. Fortunately, we have a lot of opportunities that can withstand those prices. We're very pleased with the resiliency of our investment portfolio.

    Moving on to PUDs, the SEC changed the PUD rule in 2009 and instead of clarifying, I think it became a little murkier. The practice across our industry in interpreting those SEC rules is pretty varied. We take a more conservative interpretation than some of our peers. I will say this – our assets look just like those of our peers, and we look at that on a continual basis. We're currently doing a lot of pilot spacing projects that will give us some flexibility on that subject. If you have pilot projects that are spread geographically around your assets, you have a stronger argument to book a few more PUDs.

    Something else that the SEC changed when they revised the rules is they instituted the "Five-Year Rule" where if you're not developing your PUD reserves in a five-year time horizon, they're going to pressure you to take those off the books. We've seen some of our peers get caught in that, and we're not going to let that happen to us. We don't ever want to see our capital allocation having to respond to our reserve booking. And by that I mean we don't want to be pressured to get out and drill things that aren't our highest rates of return because we were trying to manage not having to take them off our books because of the Five-Year Rule. As we drill some of these pilots, you'll probably see us put a few more PUDs on the books. However, I don't know if you'll see us get to the average of our peer group. We'll probably always have a lower percentage.

    OGFJ: What is your thinking as far as the cyclical nature of the industry is concerned and how shale might have changed that?

    JORDEN: Here at Cimarex we're serious students of this topic, but we don't do original research on it. Our thinking is largely driven by what we read and study. What we've seen is a lessening of volatility in commodity prices over the last few years. If you look at the financial crisis of 2009 to the present and you compare that against historical trends, you'd find less volatility in both oil and gas. So, yes, the situation has changed because of the resource plays. I think there's a different psychology of supply in the gas markets. I think the belief is that the supply will be there for the long term, so you don't see emotional swings in the market. There's no better example of this than the winter of 2013-2014 where we did see gas move up in price, but it was nothing like what happened 10 years ago.

    Triple Crown natural gas plant in Culberson, County, Texas. Photo courtesy of Cimarex
    Triple Crown natural gas plant in Culberson, County, Texas. Photo courtesy of Cimarex

    When it comes to oil, it's more difficult to call. We share the concerns that many people have expressed about the flood of US domestic oil production – with domestically produced crude displacing imports and the disconnect between refining capacity and domestic supply. But all these predictions don't fully take into account a very dynamic market. Markets correct, and markets find a way to "fix it." So we look at NYMEX futures prices and we run our downside cases, but we also run a case where we say what if commodity prices stay where they are? We're in roughly supply and demand balance today at these commodity prices, and the futures market is in backwardation. But futures prices are an inexact predictor, particularly with some of the banking reforms we've seen. Many of the major banks are now out of futures trading, so there's much less liquidity in the futures market. As a result, the market is a little different than it was just a few years ago. This is a windy answer to say that we really don't know. But we never want to shortchange the markets and their ability to adapt to changing circumstances. We also need to take into account geopolitical instability, and some of that is impacting both oil and gas markets. So, yes, I think that shales have changed the psychology of both supply and demand, and that free markets will correct for it and keep them healthy.

    OGFJ: Cimarex has some of the highest cash margins in the industry. What are some of the company's operating strengths for extracting value from its properties?

    JORDEN: We're very proud of our organization and our focus. We get up every morning, and we try to be good at our core business. We don't look at clever financial schemes or deals. Our mindset is that we had better execute, and we had better be good scientists, good operations people, good marketing people, maintain good financial backing, and focus on the fundamentals. To that end, Cimarex is more a block-and-tackling organization. Not to be trite, but we spend a lot of our energy trying to be good at the business. We have a culture where people are encouraged to open their minds and challenge one another. The objective is to move our projects forward. I think our cash margins are a direct reflection of that. We don't get complacent. We're in an industry where we have so much quality competition that if you get complacent you'll get run over by some great competitors. So we focus on execution, our cost structure, and the fundamentals.

    OGFJ: It sounds to me as if your science background is coming into play here with your emphasis on the basics over cleverness.

    JORDEN: Well that's right. But we wouldn't be where we are without many outstanding people in our organization. I come from a science background, not a finance background, but Paul Korus, our CFO, is a partner of mine and teaches me a lot on financial subjects. My value add to the organization is getting engaged in the science, and Paul backstops me on the financial.

    OGFJ: You've talked a lot about strategic direction. What can you tell us about your ideas on implementing capital investment, and how do you pivot, how do you change when the situation changes?

    JORDEN: That's the challenge. One of the things I tell our organization is that our assets will change over time. Five or 10 years ago, our assets didn't look anything like they do now. It wouldn't surprise me if they look very different in the future. So I tell everyone not to fall in love with assets but to chase the highest rates of return. There could be no better outcome than new assets supplanting our existing assets because they're that much richer on a return basis.

    We always have an eye on new opportunities. We have two major basins today, so we certainly have room for one or two others. If we have a chance to acquire assets in a new basin at returns that compete with our existing returns, that would be attractive to us.

    "We're willing to take on some debt, but we stress test our investments at low commodity prices. We also stress test our overall corporate balance sheet and income statement because we want to be sure that if we do see a commodity correction, we’re prepared for it. At Cimarex, we’re building an ark, not a party boat. We want our company to be built to last." — Tom Jorden, chairman, president and CEO, Cimarex Tom Jorden, chairman, president and CEO, Cimarex
    Photo courtesy of Cimarex

    OGFJ: If you chose to expand into other basins, what are your thoughts as to where that might be?

    JORDEN: Our assets today are concentrated in New Mexico, Texas, and Oklahoma. Those states are really good states to operate in. We have a long-established oil and gas industry in all three states. We have knowledgeable regulators, landowners and mineral owners; and we have infrastructure in place. We have people who understand the business, so a good, safe, responsible operator can really execute a long-term strategy in all three of those areas. We cherish that.

    As we look at some of the other areas where we're not currently operating, I have to say that these three states are in the forefront of our minds. Some of our competitors face some headwinds, regulatory and political, that I think in the long run will be solved because the market logic is just overwhelming in favor of the industry. But some of those basins are pretty far from home for us, and it would take a pretty significant footprint for us to want to establish a new venture there.

    OGFJ: Are you concerned about state and local governments trying to place additional regulations on hydraulic fracturing in states like Colorado, for instance? Or perhaps a total ban on fracturing?

    JORDEN: If the discussion in any of these areas is around facts, then the facts will prevail. And the facts are overwhelmingly in the industry's favor. That doesn't mean that the industry should operate willy-nilly. Most companies are deeply committed to safe, responsible conduct with as light an environmental footprint as possible. That's a real commitment on the part of the industry. So if the debate is on facts, these resources will be developed. And the markets will have a voice in this. It's pretty hard to swim upstream against free markets. The United States has a tremendous opportunity here, and we should recognize the opportunity and not blow it.

    OGFJ: With the surge in production here in the US, that would seem to make our country less susceptible to price spikes such as we've had frequently in the past due to geopolitical unrest in places like Iraq, a major oil producer with some of the largest reserves in the world. Is that a fair statement?

    JORDEN: From an energy standpoint, the United States is the envy of the world. With our rich natural resources, contract law, private mineral rights, technology, innovation, hundreds of small companies, capitalism, and entrepreneurism, we are changing the energy landscape for the US and, consequently, the world. What has happened in the US in the last five or six years is unprecedented in energy history. Last year, the US became the world's largest energy producer in combined oil and natural gas. We're seeing increases in production while the rest of the world is struggling to stay flat or arrest declines. Not only do we have low energy prices, but we have energy security. That gives us a tremendous opportunity, and it's one we should appreciate.

    There's a reason it's happened in America and not the rest of the world, and that's by and large because of our market structure, private ownership of mineral rights, and contract law, but it's also a vital capitalistic system where people are motivated to innovate and aggressively explore. All this has given the US an unparalleled opportunity at this point in time.

    OGFJ: Thanks very much for your time today, Tom.

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