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No. of Recommendations: 15
Since we have a lot of interest in oil lately, I thought I’d ask for comments on Energy XXI (EXXI). EXXI has been flat this year, despite a lot of potential adds to production. They’re just getting their teeth into their most recent acquisition and it’s a big one with a lot potential. Unfortunately, bumps in bringing an important Ultradeep well to production with McMoRan (MMR) likely has some potential EXXI investors nervous, which may be a cause for share flatness. MMR shares are down 40% from their most recent highs. Any and all comments would be appreciated. I apologize in advance for the extreme length. Brevity is not a strength of mine.

Energy XXI

Energy XXI is a growing, liquids-dominated E&P based in Houston, TX and incorporated in Bermuda that trades on the NASDAQ under the symbol EXXI. The company is young but aggressive, founded in 2005 as a $300MM investment vehicle to acquire oil and gas properties. Prior to 2007, it traded only on the London exchange. It began trading on the NASDAQ in 2007 after completing its three initial acquisitions. Chairman, CEO and founder John Schiller, a 30 year E&P veteran, has held a number of positions in the oil industry, most recently as VP of exploration and development at Devon Energy. He is a graduate of A&M, with a degree in Petroleum Engineering. So, management is technically proficient and very hands on. Twenty-one operates almost exclusively in the shallow water shelf of the Gulf of Mexico (GOM), and their assets are virtually all off-shore Louisiana around the mouth of the Mississippi River. They have a small on-shore presence as well. This concentration in the Eastern edge of the currently allowable GOM drilling region has both benefits and detractions. While it reduces operational costs, it also increases geographical risk. It is possible for a serious hurricane to have a devastating effect on the company, since all of their production is located in a relatively small area of the Gulf. EXXI shares can sometimes dip on that risk.

Their core business strategy is development based, focused on extending the life of mature fields through the use of new exploration and development technologies. As a result, the majority of reserves are in the proved developed category (70%), and production is a primary driver of valuation. Having recently acquired sizeable offshore assets from Exxon, they have a large inventory of new drilling opportunities and several rigs busy. The fact that they are so busy is one of the aspects that makes them interesting; there should be a large increase in production in the next few months to years. This is a very busy company with lots of bits in the ground. Since the fields they operate are all shelf fields, targeted pay zones are all relatively shallow (with the notable exception of some partnered deep targets; more below). As such, CapEx for their core ops is relatively low for off-shore work. Since water depths are shallow, permitting has not been a problem. Production is heavily liquid oriented as are the majority of their drilling inventory targets. They hedge much of their production to minimize the effects of pricing fluctuations. This has been the case since inception and one can expect continued hedging from EXXI. Given their localization, they also price to LLS (Louisiana Light Sweet). LLS actually prices at a premium to Brent, let alone WTI. So, EXXI is in a sweet spot from a revenue perspective. The company is a fairly aggressive user of debt, and for a company of its size is very acquisitive. The company is profitable and has been since mid-2010, trading at a PE of 14.6 on a TTM basis. They pay no dividend, but have paid a small one in the past.

Some may be familiar with EXXI’s participation in a high profile partnership with McMoRan in the Ultradeep wildcat gas projects in the shallow water GOM. Here’s a Forbes article for background:

(You can find a whole lot of other Ultradeep articles by Joan Lappin in you google. As a qualifier, she’s definitely a perma-bull, but she has excellent access to management at both McMoRan and Energy XXI. As a result she’s well informed, if a little bit biased.)

The Ultradeep partnership includes McMoRan, Energy XXI and Tex Moncrief. Given EXXI’s relatively low exposure to the expensive yet promising project (working interests are varied and run in a range around 20%) and their substantial core production, EXXI has been the low-risk way to play the Ultradeep story. As a result, EXXI shares have held their value through the Ultradeep bumps better than MMR shares. MMR shares are 40% off their recent February levels due to slowdowns in the program. The market is breathlessly awaiting first production news on the first of these Ultradeep wells, Davy Jones #1. Completion of Davy Jones has been plagued by problems and flow tests are overdue. That’s critical, since there has been speculation that these wells would never produce given their very high temperature and pressure conditions. In fact, Davy Jones has eaten tools voraciously. But, McMoRan stubbornly persisted and third-party vendors have come through on their end, pushing the envelope on the technology to withstand the difficult conditions. A lot is at stake, since Davy Jones #1 is just the tip of the iceberg. Davy Jones #2 and Blackbeard East are at bottom depth awaiting completion. Blackbeard West, Lafitte and Lineham Hill are currently drilling, and additional prospects await drilling. Davy Jones #1 in many ways is just proof of concept. While the delay has seriously impacted MMR shares, its effect on EXXI shares has been less significant. They’ve essentially been flat. That’s of interest, since EXXI, even without success at Davy Jones is looking at some very major production increases from its own organic drilling program. This may actually be a good buying opportunity as the street is distracted by the “big” prize and appears to be ignoring the multitude of “little” prizes EXXI has in store that in aggregate may be an even bigger value for shareholders. It may prove to be an even better opportunity if the Ultradeep program ultimately performs as management anticipates.

Acquisition History

Energy XXI exists off table scraps, purchasing producing assets that are cast off for a variety of reasons. They refer to their business model as “acquire and exploit”. Through application of new seismic technology to these mature fields, they elongate production lifetimes and boost reserves. They typically buy declining fields in need of CapEx, then rework and recomplete wells in addition to any additional exploration that might be suggested by seismic. Essentially, they milk the properties by giving them more TLC than their prior owners were willing to commit. Typically, these mature fields haven’t been picked over with new technology and/or are not considered important enough assets for that kind of expenditure. They’re also concentrated geographically in the Gulf of Mexico (GOM). This adds to catastrophic hurricane risk, but reduces cost of personnel, providing operating synergies. (It has also meant lower acquisition costs, since some assets purchased have been shut-in by hurricane damage.) They run pretty lean from a personnel perspective. This is the business model that built them and it’s the same model that most likely will continue to grow them in the future, with one caveat: for the moment, unless something extraordinary happens that provides an exceptional value, EXXI has enough on its plate with their latest acquisition. They now have sufficient internal drilling prospects to grow organically with the recent Exxon Mobil asset purchase. So, for the moment Schiller is not in acquisition mode, and is focused on growing through the drill bit. This last one’s been a game-changer.

Energy XXI came to market on the NASDAQ in August of 2007 with a collection of assets assembled over a two year period on three acquisitions. At that time, the company operated 338 wells in 60 producing fields. Its first acquisition was the April 2006 purchase of Marlin Energy Offshore and its working interest in 34 oil and gas fields with reserves totaled at 25.2 MMBOE (million barrels of oil equivalent) of proved reserves (60% oil) for $421.1MM (most of the net interest was in a single large field; South Timbalier 21. It is still a major production asset). At the time of the transaction, Marlin was impacted by hurricane activity and was partially shut-in. The deal itself was structured as a reverse merger, and London shares of the original company (EGY) ceased trading after the merger.

This acquisition was quickly followed by the purchase of GOM assets from Castex Energy, adding 10.2 MMBOE of proved reserves for a cash cost of $311.2MM. I’ve found little additional detail on this acquisition. As near as I can tell, the acquisition involved onshore assets in Southern Louisiana. While I can’t be sure, I believe there’s little significant current production from this acquisition. This one seems like a miss…

The early acquisition that literally put EXXI on the map occurred in June of 2007, when Energy XXI acquired partial interest in the GOM assets of POGO. (Their listing on the NASDAQ coincided with this purchase.) These assets, which included 50% working interest in 22 fields, net 20.2 MMBOE of proved reserves (70% oil) and 7.9 MBOEd (thousands of barrels of oil equivalent per day) to production (62% oil). EXXI served as working partner with a second purchaser, Tokyo based MitEnergy Upstream LLC acquiring the remaining interest. These assets are large, old fields in the Main Pass area at the mouth of the Mississippi. They’ve historically been prolific producers at good margins, and are oil rich. They remain some of the key assets of the company today. The acquisition totaled $419.5MM for the 50% interest and was funded with a combination of bank and private placement debt.

The fourth acquisition, while not the largest, was probably the best in terms of value. Still in the midst of the crisis and with oil prices plummeting off their peak in December of 2009, Energy XXI acquired the remaining 50% interest in the POGO fields they had originally purchased for $420MM in 2007. The price tag was $259MM in cash, funded by combined equity and preferred secondary equity placements. MitEnergy wanted to retire its interest. Energy XXI as operating partner of the wells in question was able to pounce on the fields, making the acquisition at a 40% discount from the price two years prior. At the time of the acquisition, third-party proved reserves and production were both up, estimated at 22.9 MMBOE and 8 MBOEd (77% oil), with 2 MBOEd shut in due to hurricane damage. These ex-POGO properties now comprise the backbone production assets for Energy XXI.

While the POGO acquisition provided the foundation for the company, the most recent acquisition provides EXXI its first real opportunity for sustainable organic growth. Because of that carrot, Schiller chose to take on a major acquisition funded through debt. Energy XXI purchased a portion of Exxon Mobil’s shallow water GOM assets for $1.01B funded in cash and debt. Proved reserves totaled 49.5 MMBOE, 68% of which are proved developed. Proved and probable reserves totaled 66 MMBOE, 61% of which is oil. The assets are on 9 fields, all positioned in and aroundE XXI’s current properties in the South Timbalier/Main Pass area in Louisiana around the mouth off the Mississippi. For the dollar cost, production was somewhat limited at 20 MBOEd, so on a flowing barrel basis this was not as impressive a deal as the buyout of MitEnergy on the former POGO fields. However, on a reserve basis it’s a much better deal, primarily because there was a lot of potential for immediate production gains and even reserve increases with a limited capex. The deal included a lot of acquired seismic and even personnel and production assets associated with the fields.

Pro forma for the acquisition, Energy XXI would become the third-largest oil producer on the Gulf of Mexico shelf, with interests in seven of the top 11 oil fields on the shelf. Estimated proved plus probable reserves would increase 72 percent to 158.1 million BOE from 92.1 million BOE at the company's June 20, 2010 fiscal year end. Production would increase to approximately 46,000 BOE per day, up more than 77 percent from the 25,900 BOE per day average in the most recent fiscal quarter ended Sept. 30, 2010, with oil representing 63 percent.

At this point, EXXI has changed, flipping from acquire and exploit, to just plain-old exploit. And there’s a lot on their plate.

The table below contains a summary of EXXI’s acquisitions, including their cost on reserve and production bases:

acquisition Cost Reserves Production Cost/BOE Cost/BOEd %Oil
Marlin $421.1 25.2 ? $16.71 ? 60%
Castex $311.2 10.2 ? $30.51 ?
POGO #1 $419 20.2 7,900 $20.77 $53,101.27 70%
MitEnergy $259 22.9 8,000 $11.31 $32,375.00 70%
Exxon Shelf $1,010 49.5 20,000 $20.40 $50,500.00 60%

Acquisition costs are in millions of $USD. Reserves are stated in millions of barrels of oil equivalent. Costs are calculated on BOE proved reserve (barrels of oil equivalent) and BOEd (barrels of oil equivalent per pay) production bases.

The low cost of the second half of the POGO assets from MitEnergy pops out immediately. But, the sheer size of the Exxon Mobil GOM shelf assets has been a game-changer.

It’s all about the Ultradeep?

At the moment, the market seems to be distracted from the Exxon asset development gains by the lack of progress of a single well: Davy Jones #1. As noted above, Davy Jones is one of several “Ultradeep” wells (greater than 25,000 feet below the mudline) that Energy XXI is drilling in partnership with McMoRan (MMR). McMoRan is the managing partner in a four way JV. The prize is access to the Wilcox trend from shallow water. Some of the largest recent discoveries in the GOM have been in the deepwater, miles off shore. The majors chose to wildcat in the deepwater for a simple reason. Hypothetically, they could drill older deposits more rapidly because there was less rock to drill through before hitting older strata that might bear hydrocarbons. That gamble paid off well, with high profile wildcat strikes like Jack and Cascade. The problem with those finds is that they’re very hard to produce, with no infrastructure ready in place to get hydrocarbons back to shore. Enter Jim Bob Moffett, the “Mo” in McMoRan.’

Moffett is a widely respected geologist who felt that the current geological map of the floor of the GOM was wrong. Put in simple terms, he felt that if Lower tertiary Wilcox sands could be reached on-shore and also in the middle of the Gulf, then it was likely they could be reached from other locations between those two points. MMR acquired a set of properties with existing wellbores that fall on a roughly north-south line from the Louisiana coast into the Gulf. The idea was to re-enter the wellbores and take them deeper, using the data obtained from core samples to verify or refute the existing geological model of the GOM floor. To make a long story short, the then-current models were wrong. Over time, Moffett has re-written those models, landing pay in Ultradeep wells along the way. The first well to reach the Lower tertiary Wilcox sands was Davy Jones. After a second delineation well, the structure as currently mapped is a huge field that may contain up to 4.5 Tcf of natural gas. The battle now is to produce that field.

That’s a huge task littered with problems. The Wilcox sands here on the shelf lie under 30,000 feet of rock. Temperatures and pressures are tremendously high, well beyond the specs of current production equipment. In fact, these wells were beyond the specs of much of the equipment used in the process of drilling. Even logging the wellbores to verify hydrocarbons was a challenge that took multiple tries. Davy Jones ate a lot of tools along the way; literally burning them up before data could be obtained. Complicating matters was a very small wellbore. To speed up drilling and lower costs, McMoRan entered existing wellbores, deepening them. While that had obvious cost advantages, it also presented some complications. The hole they re-entered was sub-optimally sized for that depth. By the time they reached bottom depth, the casing was extremely tight, resulting in stuck tools on more than one occasion. It also will restrict production rates, if and when DJ produces. Newer wellbores currently in progress are much larger, hopefully eliminating a repeat of the problem. Regardless, what was learned at DJ has accelerated later drilling and significantly lowered costs.

The current problem involves completion (specifically perforation) of the Wilcox sands at Davy Jones #1. Production at Davy Jones #1 was promised as a Q1 event. So far, all the Street’s received is completion progress reports. The latest was not encouraging. When the perforation guns were triggered to perf the lowest Wilcox sands they failed to fire. McMoRan moved up-well and tried again. They got some flow, but were required by regulators to shut the well in before they could clear the drilling mud from the casing. So, while they’ve confirmed gas by flare, they have not performed a flow test as promised. MMR was hammered as news of further delays came out. Production success at Davy Jones #1 is pivotal to proving the potential of the trend. It’s clear that there’s gas there. But, can they produce it economically? It took a year to design and fabricate the equipment needed to produce at these pressures. Success here would mean that a whole slew of other wells were feasible. There’s a lot riding on the production test; far more than just the nat gas in this one field. Between Energy XXI and McMoRan, potential Ultra-deep targets total sixteen prospects, six of which are currently in various stages of drilling or completion. The drilling success has not gone unnoticed either. Majors, previously uninterested in Ultradeep prospects are now taking notice. Exxon’s recent sale of assets to Energy XXI noticeably involved royalty overrides for Exxon on any Ultradeep production from the fields, and Chevron invited McMoRan to participate in an Ultradeep prospect at Lineham Creek, LA. Moffett agreed as long as all his partners were included in the deal, so EXXI and Moncrief are along for the ride on the Chevron partnership as well. Moffet and Schiller are close friends, a bonus for EXXI shareholders.

Or is it really about the production gains?

While the Ultradeep is certainly a reason that many have purchased EXXI shares, that’s far from the end of the story. In fact, it’s arguably not even the most significant near-term catalyst. With the recent Exxon Mobil acquisition, EXXI now has a sufficient reserve base to grow organically through the drill bit for the first time in its young history. And that potential is actually quite large from a production standpoint. Between the new XOM properties and their original assets, EXXI now operates six of the largest 11 fields on the GOM shelf, and is the third largest shelf producer with over 42 MBOEd at the closer of the December quarter. They’re also busy, running 9 rigs currently, about a quarter of the rigs operating on the shelf. The XOM fields are loaded with low hanging fruit, with lots of easy opportunities to boost production from rework and recompletions. There’s also a substantial inventory of low risk drilling opportunities, moving up-dip on existing fields, drilling adjoining productive sands fault block-separated, and targeting amplitudes identified by the existing seismic acquired from Exxon. Some of these fields are fifty years old and still producing, with new reserves being added in the process of production. But, they were also suffering from a lack of needed capex, as Exxon had bigger fish to fry. Since acquisition roughly a year ago, total production from the XOM properties is up 30%, with oil production up 40%. A quick sketch of some of the early work gives one an idea of the economics of these workovers:

• At South Pass 89, EXXI recompleted 6 wells, initially bringing 6.8 MBOEd on production with a total expenditure of $19.4MM. Production has declined to 2.7 MBOEd from gas on the property (the gas fields apparently decline faster than oil here on the shelf), but production remains three times the acquired rate. Despite the fact that much of this is gas, CapEx on this field will be paid off in 4 months. All the gravy then belongs to Energy XXI.
• Grand Isle 16, a much bigger field producing around 3 MBOEd at acquisition had 10 wells recompleted, with 2 additional wells drilled. Production now exceeds 12 MBOEd, four times the acquired rate. Total capex was $63.6MM with a total payoff time of 7.4 months production.
• Costello, not yet on-production is expected to add an additional 3.7 MBOEd to those numbers.
• Pi, shortly behind Costello, is anticipated to add 2.2 MBOEd in June.
• West Delta 73, just beginning its work is slated to bring three P UD wells on-line with 3 MBOEd, with capex paid off by cash flow in 6.6 months.

In total, there is a current inventory of 136 prospects to work through. That gives you an idea of why EXXI made this acquisition. Small potatoes to Exxon is a meal for EXXI. Nor are they finished with their original properties:

• Main Pass 73, an original multi-well POGO asset on two blocks is still producing with two new wells recently brought on-production. Since acquisition, reserves at Main Pass have increased 90%. Onyx and Ashton, two new wells prompted by refined seismic studies, added to production (3400 BOEd for Onyx alone) bringing total field production to over 12 MBOEd for the complex.
• Main Pass 61, another POGO asset is scheduled for drilling this month. Carinos, targeting pay at 8,000 feet is anticipated to bring 2.6 MBOEd on production in June of 2012.

In all, production gains over the next 12 months could exceed 30 MBOEd, almost 70% of December 2011’s production levels. Despite those anticipated gains, the PPS has been relatively flat, losing some of its temporary February gains. The softness despite this guidance may be attributable to the difficulty with getting Davy Jones #1 on production. However, a case can be made that Davy Jones is obscuring the “smaller” story of organic production growth through EXXI’s less-exciting properties.

With the potential to almost double production on low cost drilling inventory, one would expect considerable cash flow improvement. Forward FCF projections provided by management are $300MM, $550MM, $800MM, and $915MM for 2012, 2013, 2014 and 2015, respectively (these projections include estimates of CapEx, interest payments on debt, and dividends on the preferred stock). Increases in CapEx could push these numbers higher if things go according to plan.

Current valuation

As noted above, EXXI has been an aggressive user of debt. Last quarter’s end, they had outstanding revolver debt of $28.5MM (interest rate of LIBOR + 3%), $750MM of 2017s (9.25%), and $250MM of 2019s (7.75%). The revolver is being aggressively paid down. Unfortunately, the notes are not callable until 2014. So, their strategy as communicated will be to stockpile cash, reducing their effective net leverage. In 2014, they’ll likely begin a partial call process retiring some of this debt. If another acquisition comes along that was too tempting to pass on, I’d expect some restructuring of the current notes in conjunction with the financing for any new acquisition (this is how the XOM shelf purchase was handled). Cash as of Dec 31, 2011 was $79.4MM, up from $28.4MM in Q1 of 2012 (EXXI is on a fiscal cycle ending in June). Projected cash flow is positive. 2012 EBITDA through six months was $412MM. Interest expense on the notes is $88.8MM, making interest coverage over 4.5 times.

EXXI's current Enterprise Value: $1,028 MM (LTD plus revolver) + $2,840 MM (Mkt cap) + $106 MM preferred stock - $79 MM cash = $3,895 MM

On a proved reserve basis, EXXI is pricing at $33 a barrel with 116.6 MMBOE proved reserves:

$3,895 MM/ 116.6MM = $33.40/ BOE

On a flowing barrel basis, they price at $91,000 per flowing barrel, with most recent (12/2011) production of 42,700 BOEd:

$3,895 MM/ 42,700 = $91,200/BOEd

Making some quick comps to other GOM producers suggests a somewhat lofty valuation (for these comps, preferred equity is excluded from the calculations for the sake of simplification):

Ticker Debt MktCap EV Res. Oil Production EV/BOE EV/BOEd
ATPG $1.98 $0.33 $2.30 119 66% 24,600 $19.34 $93,577.24
EPL $0.20 $0.60 $0.80 37.1 74% 10,000 $21.64 $80,300.00
SGY $0.62 $1.27 $1.89 100 46% 44,000 $18.90 $42,954.55
EXXI $1.03 $2.59 $3.62 116.6 72% 42,700 $31.04 $84,754.10
NFX $3.01 $4.34 $7.35 709.8 41% 145,000 $10.35 $50,662.07

Market capitalization, debt and EV in billions of $USD. Reserves in MMBOE (millions of barrels oil equivalent). Production in BOEd (barrels of oil equivalent per day). Stone’s numbers were converted from TCF per day. (Hope I calculated it right…).

All are GOM producers, although Newfield also has significant international operations making them a less optimal comp. Newfield and Stone are assets as gas-rich and would be expected to be cheaper. EPL, would seem a good comp with a comparable liquid-rich percentage, but it’s a small fish in relation to EXXI. ATP Oil & Gas has serious balance sheet issues that are depressing its valuation. On the whole, EXXI’s valuation seems high, likely because of the potential for additional upside due to both the Ultradeep play and the production growth potential. As I see it, the Ultradeep will probably be felt more in terms of reserve builds than production originally, while the Exxon assets will obviously be felt in terms of production build. If you consider the Ultradeep from a reserve perspective, you get some healthy potential.

Current estimates of “unrisked” potential for the trend if proven is 100 TCF gross. That’s the PR anyway, which by its nature is a bit suspect. What is less suspect though, is the reserve estimate on Davy Jones, Blackbeard East and Blackbeard West. These wells are either drilled or near bottom, so they have a lot of data here and their reserve estimates are less speculative. Those three wells alone are estimated to net EXXI 1.15 TCF. None of these reserves are proven, so they’re not reflected in the table above. Adding 1.15 TCF (209 MMBOE) to reserves, more than doubles current levels. Most if not all is gas. But, that’s a big add, and runs the apparent price down a lot:

117 MMBOE + 209 MMBOE = 326 MMBOE
$3,895MM /326 MMBOE = $11.95/ BOE

Moving these reserves to proved would be a big step, bringing their valuation in line with the comps, if not a little cheap considering the high liquids percentage of their assets. That’s also only three of the Ultradeep prospects. There are 17 wells listed in the combined inventories of MMR and EXXI. There’s a lot of potential there if Davy Jones #1 can flow and prove the trend. It likely won’t mean much current production added given the small casing they’re stuck with, but Davy Jones #2, with much larger casing is 12 months down the road as they wait on equipment for its completion. Ultimately the mechanical issues encountered at DJ #1 will make completion of DJ #2 smoother. Clearly, there’s a lot of potential value riding on the test. Nor is Davy Jones #1 the end of potential catalysts: (1) Blackbeard East is in development planning stages after encountering hydrocarbons in Miocene, Frio and Sparta sections, (2) Blackbeard West is drilling, currently just above its projected Miocene target, (3) Lafitte is near bottom having encountered pay in multiple zones, and (4) Lineham Creek was recently spud. Working interests vary by well, ranging from 14.35 to 17.5% Net Royalty Interest. While the majority of any reserves are expected to be gas, there is some potential for liquids in the shallower sands of Blackbeard East and Lafitte.

From a production standpoint, Schiller strongly suggested that they’ll exit Q4 in June at 60,000 BOEd. That’s not hard to believe given the wells they’ve added. Production was 42.7 MBOEd in December. Since then they’ve added Onyx at 3400, Winters at 711 and Magnum at 950. That’s approximately 47,760 on line at the moment, not counting a lot of gas in that Winters number. They also have Carinos spudding this month (“planned initial production 2600 BOEd), Costello in completion (3700 BOEd), Pi spudding this month (2200 BOEd), Miller completing (2400 BOEd), Camshaft completing (1800 BOEd), and finally Sparkplug spudding (1400 BOEd) all potentially producing before fiscal year end in June 2012. That list totals out to 61,860 when added to the Dec 2011 production as a base. So, given the inventory, it seems that 60 MMBOEd is within reach by June. Nor is that the complete list of wells of coming on production in the next quarter; there are a couple of additional completions not listed and Golden Bear, a large gas field could push into Q4 if things go well.

At 60 MMBOEd, EXXI’s valuation is more in line with the rest of the industry:
$3,895 MM / 60,000 BOEd = $64,900/ BOEd

It’s still a bit rich when you look at some of the comps, but many of those comps like Stone and Newfield are running at much lower liquids, so their lower valuations are justified.

Finally, there’s an even simpler perspective. Given their drilling inventory, cost and pricing estimates, EXXI provides the following guidance for future pre-tax FCF (EBITDA less CapEx less interest on debt):

Year FCF FCF/share
2012 $300.00 $3.92
2013 $550.00 $7.19
2014 $800.00 $10.45
2015 $915.00 $11.96

FCF is in millions of $USD. FCF/share is based on a share count of 76.53 million shares outstanding. Provided they execute and oil prices remain strong, the potential for PPS appreciation is obvious with that kind of growth. Looking back to the recent past, EXXI has traded with an EV/FCF multiple in the range of 12.9 to 14.7. Projecting that 13 multiple forward and assuming no retirement of debt provides some indication of just how much potential exists they execute:

2012 $300.00 12.90 $37.11 12.90 $37.11
2013 $550.00 10.00 $58.42 13.00 $79.98
2014 $800.00 10.00 $91.09 13.00 $122.45
2015 $915.00 10.00 $106.12 13.00 $141.98

PPS of $37.11 is the Friday close. FCF is in millions of $USD. Calculations assume a constant share count and no retirement of debt.

Even given a contraction in multiple to 10x, there’s substantial upside if their production gains are realized ($58 in 2013, $106 in 2015). That requires oil to stay up in price obviously, one reason EXXI actively hedges. There’s 25 MBOEd of production hedges in place in 2012, 22 MBOEd for 2013, and 13 MBOEd in place already for 2014. I’d expect that pattern to continue as it’s been a key component of their strategy from the outset.


Energy XXI is an independent Gulf of Mexico oil and gas producer, geographically concentrated off the Louisiana coast around the mouth of the Mississippi. Founded in 2005 as an Oil and Gas investment company focused on acquisitions, the company began trading on the Nasdaq in 2007, after completing its first three acquisitions. Their most recent acquisition of shelf assets from Exxon Mobil has been a game changer, providing the potential to nearly double production in less than 12 months and triple cash flow by 2015. EXXI’s inventory now includes over 100 projects ranging from simple recompletions and workovers to new drilling projects, with many already underway. Production should jump from 47 MBOEd to 60 MBOEd by FY end in June of 2012. In addition to their internal drilling program, EXXI is also an original partner on McMoRan’s Ultradeep drilling program targeting Lower tertiary strata at deep drilling depths from shallow water. Drilling in that program has identified Wilcox sands bearing hydrocarbons, and the trend if proven has potential for 100 TCF of gas gross. Davy Jones #1 is in the late stages of completion awaiting perforation and flow testing. However, its final completion has been plagued by equipment problems related to the exceptionally high temperatures and pressures at these depths. Shares of MMR have fallen on the news, and EXXI has been essentially flat this year, despite impending production gains from their own drilling program. This may be a buying opportunity for a company expected to double its production even without the success of the Ultradeep program. Success of Davy Jones #1 may have an even more pronounced effect on the shares.

Shares trade at $37.11 as of Friday, recovering after a brief retreat from their 52 week high of $39.65.

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I apologize in advance for the extreme length. Brevity is not a strength of mine.

If you say so, but IMO, "extreme length" isn't a weakness of yours either.

Nice job!

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peter this is amazing. Not long at all just right

Where did you get all this information on each individual field? great research.

Is the Davy Jones #1 just gas? Seems like a lot of trouble and expense to go through just to get to gas

thanks for the excellent work. They look promising
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Actually, the individual well information is pulled from recent presentations. Schiller gets in depth on these XOM acquisition prospects to make his point about how profitable they will be. There was some mild skepticism from analyts at first, but he's a good communicator and made his rationale clear to them. These presentations are part of that effort. Other information is from 10Ks and Qs. They're a small company, so they provide a lot more detail on individual drilling ops than larger companies ever could or would.

Yes, DJ#1 is most likely just gas. It's big, though. The DJ structure encompasses 4 lease blocks, and the single field is 200,000 square acres in area. Expectation is that it will be economic at today's prices and unlike an unconventional well, this big bugger will hopefully still be producing decades from now like some of the legacy fields EXXI operates (some were originally found in the 1950s, I believe). The nice thing about EXXI is that it's future is not completely dependent on the Ultradeep. You get the potential upside without the big risk you get in MMR. MMR's future seems much more dependent on the Ultradeep.

Virtually all of the wells have encountered hydrocarbons in multiple strata. In the process of going that deep they are often drilling through two or three seperate reservoirs. In some of the other wells, especially the Blackbeard wells, there seems to be some potential for oil. But, that's really just internet rumor-mongering and conjecture on the part of other people. I don't recall hearing management commit to the possibility of liquids. I've actually heard the opposite as Schiller has avoided the speculative question. But, BBE and Lafitte have shallower pay zones in addition to the deep reserves that could contain oil as I've understood from those rumors. (I have no basis for my own opinion; I'm not an expert and can only parrot what management provides, so I'll expect gas.) You also need to figure in the value of proving the trend, since MMR and EXXI have a total of 17 prospects in the play, with only six in progress.

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To add to the other follow up, this is a lot of gas, and is better understood as a frontier play like the presalt deposits in Brazil and West Africa. EXXI (and in my opinion, MMR moreso) are developing intellectual capital in developing the high pressure/high pressure UD deposits.
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A little update:

EXXI reported after the close today. Their call is tomorrow morning. Estimates, which had been raised from $1.08 to $1.13 were missed. EXXI reported $1.04 per share on a fully diluted basis. However, $0.07 per share were one time charges associated with the retirement on some of their preferred shares. Exclusion of that charge, results in a $1.11 per share figure, still shy of the consensus.

Production averaged 45,300 BOEd, up from the Q2 exit rate of 42,000 BOEd. The exit rate for Q3 was 52,350 BOEd. The press release stated they expect another 10,000 BOEd in new production coming on-line in Q4. Of course, there could be depletion of current production to partially offset those gains. There does appear to be the potential to hit a 60,000 BOEd exit rate for FY 2012, though.

As far as DJ is concerned, they're fishing out the perf guns to get back down to the lowest F sand in the Wilcox. They anticipate a flow test in Q4. (We'll see, working in this hole has been a challenge.)

Mixed bag....

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