The recent pullback in small cap oil and gas has provided an entry point. This has been a gift, as an improving world economy has increased demand for refined products. The direct beneficiaries are the refiners and especially those levered to the Bakken. PBF Energy (PBF) and Northern Tier (NTI) are both very good ways to play wide Brent/WTI differentials, and even wider Brent/Bakken Light. As it becomes more difficult to get Bakken crude out of North Dakota, operators will see margins tighten. Although I am bullish the Bakken going forward, other areas may be better like the Utica and Marcellus. Rex Energy (REXX) could see 2014 production growth over 50% as Butler County EURs are increasing while costs continue to head lower. It is also important to note that ethane rejection is improving as is IRRs. My favorite play for 2014 may be even better, as Wattenberg Field and the northeast extension has several catalysts going forward. Wattenberg infrastructure has historically lagged production and this was the theme for 2013. This looks to change in 2014. The O'Connor plant has eased some of the high line pressures and several operators have stated 2014 would see infrastructure constraints lessened. This is especially important on the natural gas side as there is still quite a bit of flaring taking place. We are also seeing tighter spacing, as operators have done a good job of de-risking. Very low well costs provide excellent IRRs. This stacked play, in general, has three Niobrara intervals and one Codell. Other targets are being identified deeper in the geology, so there is still upside.
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Wattenberg operator Bonanza Creek (BCEI), has seen its shares pull back recently. There has been little justification, as it reported a good Q3 and should finish the year strong. It had a bottom line number of 63 cents per share versus the Street's estimate of 50 cents. Year-over-year, its revenues more than doubled to $126 million. 90% of revenues were from liquids production. Its resource mix was 66% oil, 6% NGLs and 28% natural gas. Production increased 88% year-over-year and 32% sequentially. Average realized prices improved year-over-year. Bonanza saw crude realizations of $100.37/bbl versus $87.75/bbl. Natural gas in Q3 was $4.58/Mcf versus $3.36/Mcf a year earlier. NGL pricing declined to $55.14/bbl from $56.41/bbl. LOEs improved to $7.98/Boe year-over-year from $9.76/Boe. G&A also improved. Q3 of 2013 was reported at $6.87/Boe versus $9.12/Boe in Q3 of 2012. DD&A increased to $22.63/Boe versus Q3 of last year's $20.48/Boe.
Two-thirds of Bonanza's production comes from Wattenberg Field. Production increased 135% year-over-year and 41% sequentially. Horizontal production was up 271%. It spud 26.1 net wells, and tied 28.3 net wells to sales. It has three rigs running and all are working the new super-section test. These wells will be completed in Q1 of 2014. Bonanza's focus has been on the Niobrara B. It is testing 40-acre spacing and extended reach laterals at this interval. Its Wattenberg extension acreage has a B bench much like Noble's (NBL) Wells Ranch. It is testing both the C bench and Codell. The geology shows the C bench thins in Bonanza's acreage but should still be economic. The Codell is just as good in the western half, but thins to the east and may not be economic. There will be an eastern Codell test sometime next year. The A bench is not being tested by Bonanza. There are a couple of reasons for this. It thins and has less resistivity than in Wells Ranch. This interval is the most shallow, so well pressures will be lower. I would guess Bonanza will test this pay zone in the future, but it has not set a time frame for this to occur. 40-acre downspacing of the B bench has produced similar results to 80-acre spacing. The four well pilot test had an average 30-day IP of 343 Boe/d and produced 80% oil. The average 60-day IP rate was 292 Boe/d and produced 77% oil. This test experienced high line pressures, which restricted flow, resulting in lower expected production. Think of high line pressures as a tighter choke, as it restricts flow. Bonanza's first two 40-acre test resulted in an average 30-day IP rate of 418 Boe/d. There was some negativity with respect to the Catalyst well results. Expectations were high and the IP rates came in low. This did weigh on the stock, but keep in mind these are within the company model. High line pressure, which is choking back production, produces lower production rates. When figured in, the results were quite good. This was much worse on the two eastern wells, where this is the worst. B bench extended laterals have produced very well, with a much slower rate of depletion. Bonanza's second extended reach lateral produced a 30-day IP rate of 767 Boe/d, and a 60-day rate of 752 Boe/d. The Codell has been very interesting, as it was once thought all of Bonanza's acreage was outside its productive zone. It currently has 3 Codell completions, with a 30-day average of 540 Boe/d. These wells produce less crude which is 69% of the resource mix. The C bench has proven better than expected. The average 30-day IP rate for the five completed wells is 422 Boe/d.
An important catalyst for Bonanza is the Carlile shale. The most eastern part of its acreage has a thinning Codell interval. Because of this, some of this acreage is not prospective the Codell. The Carlile is positioned below the Codell. Bonanza may find the Carlile to be economic in its eastern leasehold. If this is the case, it could significantly increase EURs. Keep in mind, if the Carlile is good on its eastern acreage, other operators further east like Synergy (SYRG), Carrizo (CRZO) and Whiting (WLL) could all benefit. Bonanza believes the Greenhorn and J Sand intervals could be economic as well. For Q3, vertical production decreased significantly sequentially. Average daily production in Q2 was 1200 Boe/d versus 700 Boe/d in Q3. Flooding had little to do with this as only 26 verticals were shut in. This is a small number compared to its total of 255 producing vertical wells. The majority was linked to its horizontal program. New horizontals kill vertical offsets. What this basically means, is the vertical well stops producing due to communication with the nearby horizontal well. High line pressures make it more difficult to get the wells back on line. So this also affected Q3 production. Bonanza will be able to get the verticals started again, but this will be a continuing issue. Bonanza's Pronghorn wells have been affected more than any other area. It estimates a negative impact of 100 Boe/d on a 30-day IP rate. This has had a much larger impact on 2013 wells versus 2012.
Bonanza noted that work continued on a number of significant infrastructure projects designed to reduce system gathering pressures. It also added upgrades to its gas gathering system. Midstream partners increased gas processing capacity and added area compression facilities. Look for lower water costs as Bonanza added pipe to transport frac water to its well sites in Q3. 30 and 60 day IP rates improved in Q3 but Bonanza states this is not because of the O'Connor plant. Although it started up in October, line pressures didn't reduce until Q4. So production improvements have more to do with well design than infrastructure.
One third of Bonanza's production comes from its Cotton Valley program. This play is gassier with a resource mix of 51% oil, 17% NGLs and 32% natural gas. Production increased 34% year-over-year. It drilled 8.3 net wells and tied 10.3 net wells to sales. It continues the recompletion program. It has tested 5-acre spacing, with no interference. Recently, these wells have been producing better. A higher percentage of natural gas has increased well pressures and improved production. There has been some additional excitement in the Brown Dense. Southwestern (SWN) reported an excellent vertical. The Sharp 22-22-1 #1, in Union Parish, LA was drilled to a total vertical depth of 9,776 feet and completed in three stages. It achieved a peak 24-hour production rate of 600 b/d of oil with an API gravity of 52 degrees, and 1.3 MMcf/d of 1,240-Btu gas. After 88 days in production, the Sharp well averaged 530 b/d of oil and 1.1 MMcf/d of gas on a 16/64-inch choke. The biggest issue with the Brown Dense is well costs. Although it is a vertical play, well costs average $10 million. This is an exploration phase number, and well costs could go lower to $6 million. We are starting to see commercial numbers and this bodes well for Bonanza. We are uncertain as to its horizontal viability, or how big the play is, but this result helps to validate. Keep in mind, we are in the early innings. Southwestern only had 10 operated Brown Dense wells at the end of Q3.
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Bonanza has the second largest acreage position in the North Park Basin. Obviously this is not as prolific as the northeast extension, but we are starting to see decent results. This is still in exploration mode, with little by the way of data. EOG Resources (EOG) has accumulated a sizeable position. The North Park Basin's best well was by Ellora Energy 3. Its Hebron #3-12H flowed approximately 1,054 barrels of oil in a 24-hour test period, with 400 pounds per square inch flowing casing pressure on a 48/64th-inch choke. I wouldn't get too excited as this is the only notable result I know of. The Hebron vertical was roughly 6300 feet with a 4100 foot 19 stage lateral that used 3.9 million pounds of sand. This was a Niobrara D bench well. Bonanza's estimates for North Park are EURs of 211 MBoe, but this was drawn from an EOG well back in 2008. I would guess the Hebron well models much better, but we need depletion data and it could take 6 months of production to get an idea of how to develop EURs. Bonanza plans to test its acreage in 2014.
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In summary, we were afforded a buying opportunity as Bonanza Creek's stock has pulled back. Some of its more recent well results in Wattenberg have been lower than expectations. The market seems to have missed how these have been affected by high line pressures. Infrastructure additions on the natural gas side should improve this especially in Pronghorn wells. In reality, this data has been in line with company expectations. Looking ahead, Bonanza believes it will be at the top end of 2014 guidance. To accomplish this, it will have to see production growth in Q4. Bonanza does have 14 completions to turn to sales, and should see IP rate improvements. There is additional upside to 40-acre downspacing of the Niobrara B, and extended laterals. Next year, we will have an idea of how the Niobrara and Codell intervals produce in concert with its super-section test. More importantly, we will see how the Carlile produces in the east. This test could substantiate much higher acreage values for acreage outside the Codell economic leaseholds. It has acreage in two spec plays, both having recent excellent well results. These two specific intervals could be very important if we find the areas are economic. Looking ahead, I see a very good Q4; high line pressures will abate, improving IP rates, and giving us a better view of how the Northeast Extension produces. Not only is there upside in Q4, but longer term, Bonanza's stock price has 30% upside with respect to its 12-month price target.
Disclosure: I am long BCEI, REXX, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Additional disclosure: This is not a buy recommendation. The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, are not guaranteed for accuracy or completeness, do not reflect actual investment results, do not take into consideration commissions, margin interest and other costs, and are not guarantees of future results. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market or financial product does not guarantee future results or returns. For more articles like this check out our website at shaleexperts.com. Fracwater Solutions L.L.C. engages in industrial water solutions for oil and gas companies in North Dakota. This includes constructing water depots, pipelines and disposal wells. It also provides contracting services for all types of construction at well sites. Other services include soil remediation. Please contact me via email if you are interested in working with us. For more of my articles and other pertinent information on the oil and gas sector, go to shaleexperts.com.
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