Point of View: Ultra Petroleum's growth relies on long-life US gas, Chinese oil

Ultra Petroleum Corp., Houston, relies upon two vastly different asset bases for its future growth: core long-life natural gas reserves in the Green River basin of southwestern Wyoming and oil production in the shallow waters of Bohai Bay off China.

Michael D. Watford, Ultra's chairman, president, and CEO, said the company entered China through an affordable opportunity to buy a stake in an international oil project having upside to pair with Ultra's sizeable US gas properties.

Ultra obtained the Bohai Bay assets through the acquisition of Pendaries Petroleum Ltd., Houston (OGJ Online, Dec. 1, 2000). Meanwhile, the company has made gas production strides during the last 4 years in Wyoming, where it owns more than 188,000 gross acres.

"We started the year with a 40 bcfe production target, a significant increase over the almost 29 bcfe from last year," Watford said. "In the first quarter, we bumped it up to 42 bcfe, and in the second quarter we bumped it to 44 bcfe. We are clearly on target. The company's production target for 2005 is 65 bcfe.

Bohai Bay

The China asset provided Ultra diversity in commodity and geography, Watford said. The company's wholly owned subsidiary, Sino-American Energy Corp., commenced oil sales in September.

"Production from our first two fields started in mid-July and is currently 30,000 b/d of oil, of which Ultra is entitled to about 10%. Field productivity continues to exceed expectations," Watford said of Bohai Bay.

Kerr-McGee Corp., Oklahoma City, is the operator, and CNOOC Ltd. is a partner. Ultra has interests in two large blocks that together cover 677,000 acres in shallow waters.

"When we acquired the properties, there were two discovered fields in 2001," Watford said. "We have nine discovered fields now. Two are on production, and we probably will have another 1-2 fields come on production each year during the next 4 years."

He called the exploration potential on the Chinese blocks "tremendous." His previous international experience was as CEO of Nuevo Energy Co., Houston, which had interests in West Africa.

"We have been funding Bohai Bay since 2001, so it is nice to finally have a little production that will help carry its own weight," Watford said. "We are looking at 500,000-600,000 bbl net to Ultra this year. That is 3 bcfe on a 44 bcfe target, or 6%. Next year, we are looking at 10-12 bcfe contribution from Bohai Bay, so that is about 18%."

Wyoming remains the company's primary driver of value creation and cash flow. The Wyoming assets are divided between the prolific 25-sq-mile Jonah field and 100-sq-mile Pinedale anticline area.

Wyoming

"We don't fully understand how large it is because we haven't drilled everywhere yet," Watford acknowledged of the company's Wyoming reserve base. "A lot of our wells easily will produce 40 years, but it is going to require large amounts of capital and thousands of wells. It's going to be like a San Juan basin in terms of huge long-life gas resources with a low decline rate."

Ultra is the largest acreage holder on the Pinedale anticline, which had no development until mid-2000 when the company's environmental impact statement was finalized. During 4 years, Ultra had a 100% drill- ing success rate there.

The company's proved reserves have grown from less than 50 bcf to 1.1 tcf by yearend 2003. Ultra has identified drilling locations expected to increase reserves to 4-6 tcf.

Watford said a reduction in well spacing in Jonah field will double the number of wells to be drilled. Ultra had identified 636 wells on 40-acre spacing, down from the earlier 80-acre spacing. Now, the company has begun 20-acre spacing in the northern part of the anticline.

"It is logical that you will see the rest of the anticline downspace as well but probably not until early next year. We are doing a lot of work to determine as best we can what the proper well spacing is," Watson said. "We think we are headed to 10 acres/well although we haven't done all the work yet."

Company history, outlook

Analysts frequently credit Watford for turning around Ultra since he joined the company in 1999. He said the company at that time had a large acreage position but poor exploratory record and weak financial condition.

In his first 90 days with Ultra, Watford cut the payroll from 36 people in three offices to 13 people in one office. He sold some properties to raise cash and worked to regain the confidence of investors and creditors. In the process, he kept the Pinedale anticline.

"It was clearly one of those turnaround opportunities where if you do it right, you come out smelling like a rose. We were able to do it right and were able—because of the asset base—to blossom," he said.

Watford sees no reason to buy other companies.

"I don't think any other company has the upside that we have. So I think if we were to look at buying other companies, we would just be diluting our shareholder return," he said.

Ultra has grown while maintaining one of the lowest cost structures in the industry, he said, adding that shareholders expect continuing growth at low cost.

"We are a big believer in under-promising and over-delivering," he said. "We try to set targets that show tremendous amounts of growth, more growth than our peer group. But we set the targets in a way that we think we have a reasonable chance of exceeding those.

He added: "The investment community gives you higher evaluation if you can do that and sustain that for a number of years. That is what we are continuing to do."

Given current oil and gas prices, US independents are generating high returns and cash flows, he noted, adding: "They have this big reinvestment risk. This is a question that comes from a lot of portfolio managers: What are you going to do with this cash? Do you have projects with reasonable economics to reinvest it? Are you going to return it to shareholders, either through stock buybacks or dividends?

"That is where Ultra separates itself from its peer group. We have easily a decade of high-rate-of-return reinvestment opportunities in our property base."