OIL & GAS FINANCIAL JOURNAL: PDC Energy, formerly Petroleum Development Corporation, has key strongholds in the Wattenberg Field and Piceance Basin of the Rocky Mountains. Recently, you've expanded your footprint in the Marcellus Shale, the Wolfberry, and in the Niobrara. What motivated this expansion and development?
RICHARD W. MCCULLOUGH: Our expansion into the Marcellus, Wolfberry, and the Niobrara was the result of an extensive strategic planning process we completed in 2009. We recognize that we need to add assets capable of delivering higher growth and higher capital efficiency. In addition, we seek to add assets that provide strong drill well returns even in a $4 to $7 per mcf gas world.
As we looked at our core assets, we concluded that we need to (1) drive down our costs in assets like Piceance; (2) accelerate development of our Wattenberg oil and liquid rich field; (3) exploit our Marcellus shale gas position; and (3) increase our oil and liquid rich mix by adding assets in the Permian Wolfberry and by de-risking and delineating our exciting new horizontal oil play in the Niobrara.
By building our portfolio with growth and higher return assets, along with our emphasis in 2009 on strengthening our balance sheet and hedging our gas exposures, we have positioned the company for a very promising future and as a result, the stock is up over 80% in the last year.
OGFJ: Approximately 80% of your company's production stream stems from natural gas. With the Wolfberry and Niobrara acquisitions and your current operating position in the Wattenberg, it appears that you're shifting toward a more balanced oil and natural gas portfolio. What is the genesis of this transition?
MCCULLOUGH: As we compete in a low gas environment, we have set a target to take our oil mix from 20% today to 35% in five years. Our existing Wattenberg vertical drilling program and re-frac opportunities, combined with our new positions and opportunities in the Permian and Niobrara make that a real possibility. We plan to spend approximately $140 million in 2010 developmental capex — up from $68 million in 2009, with the majority of it being spent in Wattenberg. In addition, we are spending another $100 million in acquisitions, mostly in assets with oil and high liquids content.
We are very fortunate in that we currently have about 200,000 acres in our four large project areas with only about 10,000 acres subject to drilling requirements to hold the leases. We believe this is a very strategic advantage and one of the reasons why we continue to look at additional JVs or drill to earn opportunities to earn our way into additional lease positions.
OGFJ: In 2010, you made the decision to redeploy a rig in the Piceance Basin. Why deploy resources into the Piceance in today's low-priced natural gas environment?
MCCULLOUGH: While our drilling inventory is expanding and we have more options to drill higher return wells (i.e., Marcellus, Wolfberry, and Niobrara horizontals), Piceance is still a major project area for PDC with substantial reserves, low finding and development costs, and predictable production growth. We have a sizeable investment in the play and our economics are attractive enough for us to drill today. We continue to pursue enhancement projects in our Piceance field designed to improve operating margins. These projects include our planned water disposal facility, super fracs, and other initiatives.
Given the current price environment, we will likely maintain a one-rig program in our Piceance field to maintain production and convert PUDs to cash-flowing PDPs. As gas prices rebound and our economics improve, we will likely ramp up our Piceance drilling. If some of our enhancement projects drive better economics, we hopefully could add another rig sooner.
OGFJ: Since assuming the helm at PDC Energy two years ago, you've moved the company's headquarters from Bridgeport, West Virginia; built a new management team; and expanded the company's portfolio of projects. Do you currently have the staff in place to execute on these changes, and what metrics will you use to measure success?
MCCULLOUGH: We have a very capable team in place. Our board has been extremely supportive of our strategic plan, and as we have built our management team, we have added people who have many years of E&P experience gained in much larger organizations with track records of adding shareholder value.
|Drilling operations in PDC's Wattenberg Field|
Photo courtesy of PDC Energy
In March of this year, we rolled out five new corporate metrics that we use to evaluate our success. We are very focused on driving shareholder value and have focused on key metrics that we think drive an E&P company's long-term value. We selected both operational and financial measures. Executive compensation is closely tied to how the company meets the targets for these metrics. We are now implementing a new bonus program for non-executives that will link their compensation to supporting business unit metrics.
The five metrics we use are: (1) cash flow per share; (2) Capital efficiency; (3) TTM Operating and G&A expense per mcfe; (4) reserve replacement; and (5) annual production volumes.
OGFJ: PDC Energy is among the top in its peer group in capital efficiency and production replacement. The company also has low finding and development costs. Despite this, the company continues to trade at a significant discount to its peer group. What are investors missing? And in a related manner, in July of this year, you announced a detailed three-year growth plan. How are investors better prepared with this information?
MCCULLOUGH: At our Analyst Day on July 15, we outlined several reasons why we believe we trade at a discount as well as the steps we are taking to improve our valuation.
The natural gas price declines of 2008 combined with substantial negative basis in the Rockies hurt all stocks of Rockies producers. But, it may have hurt PDC the most because of our extensive drilling inventory in the Piceance play. Like other small operators, we had to substantially cut our drilling capital, and as a result, our production began to decline in late 2009 and 2010.
In response, we became very focused on driving down our costs, improving our balance sheet, hedging our gas to protect our cash flows, and built out a top notch A&D team and began doing acquisitions to build our drilling inventory and production. Today we are drilling in all of our projects, and our production is again on a substantial growth pace. However, I think there was a legitimate market sentiment regarding whether PDC could return to its growth years. Between 2005 and 2009, PDC grew production at a 34% annual rate. We know we can grow again, but we have to overcome this market perception and we understand it.
So, on Analyst Day, we rolled out our three-year plan showing how we could achieve an annual production growth target of 15% to 20% and potential reserve adds of 600 bcfe to over one tcfe with very little external capital. In addition, we have redoubled our efforts to meet with investors and prospective investors. Our stock is up more than 80% in the past year, and we are one of the best performing stocks in our peer group. We believe our future growth plans are exciting and achievable.
OGFJ: In PDC's early days, the company used drilling partnerships to raise capital. In the past two years, however, you've started repurchasing those partnerships. What is the rationale behind this decision and how will PDC benefit when all of the drilling partnerships are repurchased?
MCCULLOUGH: Our business strategy is to grow our company through an acquire and exploit approach with an initial emphasis on driving down costs in our core projects through scale and operational efficiencies. The buying back of partnerships helps with both objectives.
At one time we operated as many as 75 partnerships. Today we operate 31, with most of them in our Piceance and Wattenberg fields. Current production net to the LPs is approximately 25 mmcf/d with proved reserves of about 125 bcfe. As operator, we obviously know these assets very well, and they are actually interspersed among our core PDC assets. To re-acquire the partners' interest in these wells, cleans up our story for investors, simplifies our financial reporting and eliminates a significant amount of administrative burden, consolidates our operations, makes the general maintenance of the wells more effective, and improves our per unit costs metrics of G&A, LOE, etc.
OGFJ: Natural gas prices continue to hover in the $4 to $6 per million cubic foot range. Must companies be prepared to operate in this price environment long-term? How well is PDC Energy equipped to operate in this pricing environment?
MCCULLOUGH: We are committed and prepared to compete in a $4 to $7 price environment. One of the ways we do that is by continuing to drive down costs and improve efficiencies in our projects. Our drilling times in our Piceance and vertical Wattenberg program have improved, and we are seeing improving EURs in Wattenberg from improved fracture technology. Also, in Piceance we have a water disposal well being implemented in the third quarter which will further drive our costs down in that play. And, finally, our increasing oil mix and economies of scale associated with our planned growth will be huge positive factors in the future.
OGFJ: Earlier this year, EOG Resources and Noble Energy announced successful drilling results in the Niobrara. More importantly, Noble announced that it had drilled horizontally in areas where they had previously drilled vertical wells. What is the impact of this to PDC's 70,000-acre position? What is your company's upside potential in the Niobrara?
MCCULLOUGH: The EOG well drilled in late 2009 and the early results announced by Noble have everyone in the play, including us, very excited. If you have seen the maps that Noble used to show its initial four-well results, three of these wells are in the northeast quadrant of the core Wattenberg field where we operate. Their fourth well, the Gemini, was their best and was drilled among previously developed vertical wells.
|First horizontal Marcellus well in the Appalachian Basin|
Photo courtesy of PDC Energy
We are in the early stages of evaluating our core Wattenberg position and will be drilling our first horizontal wells on 5,600 acres that we recently acquired. Based on other operators' results, our initial estimates are that there may be as much as 13 tcf of gas equivalent in place on our acreage. Using a 5% recovery factor, which seems to be the early norm for the play, could put total reserves in the 650 bcfe range. PDC's total IP reserve base at the end of 2009 was a little over 700 bcfe and these horizontal Niobrara wells have a 70% higher capital efficiency factor than our existing vertical Wattenberg wells that generate 40% to 45% IRRs in today's markets.
Suffice it to say, the horizontal Niobrara opportunity could be a game changer for PDC. It is very important to note that our three-year growth targets of 15% to 20% do not yet include any volumes from this horizontal play. We will update these projections once we have initial results from our first wells.
OGFJ: The Marcellus Shale is perhaps the largest natural gas play in North America. Along with your joint venture partner, Lime Rock, you control more than 58,000 acres in Pennsylvania and West Virginia. What is the status of your horizontal drilling program?
MCCULLOUGH: We've drilled eight vertical wells, seven of which were drilled in West Virginia. The program was highly focused on obtaining geologic information through coring and confirming rock thicknesses, porosity, the pressure regime and gas in place estimates. We were very encouraged by these results, and it confirmed that our best results should come from a horizontal drilling program, which we began earlier this year.
To date we have drilled and completed three horizontal wells in West Virginia, which are currently on flow back and clean up. We have recently executed a midstream capacity arrangement and are negotiating a two-year drilling rig contract.
OGFJ: It seems that PDC will be very busy in the next few years. Thanks very much for taking the time from all this to talk to us.
From left to right: Lance Lauck, senior vice president, business development; Richard McCullough, chairman and CEO; Gysle Shellum, CFO; Daniel Amidon, general counsel; Barton Brookman, senior vice president, exploration and production
Photo courtesy of PDC Energy