Sam Fletcher
Senior Writer
Cross Timbers Oil Co. in Forth Worth completed its latest acquisition in early January, spending $115 million for producing properties in the prolific Bossier natural gas play of East Texas and Louisiana. Over the last 4 years, the independent has spent $1 billion to acquire 1 tcf of gas reserves, even as Wall Street was pressuring the industry to deleverage. That contrarian strategy helped the company build a record inventory of reserves and prospects while churning out a record cash flow that now makes it a sweetheart of investment analysts.
Chairman and CEO Bob R. Simpson is a 25-year veteran who helped build Southland Royalty Co. and created four publicly traded royalty trusts before co-founding Cross Timbers in 1986. In an interview, Simpson talked about the company�s development and future plans.
OGJ Online: What sets you apart from your peers?
Simpson: We�ve been growing faster than probably anyone in the last 4 years. In 1996, the company put its focus on acquiring gas properties. We about tripled our reserves during that period, from 795 bcf of gas equivalent to 2.1 tcf. Virtually all of our growth was in natural gas. Our production also increased from 102 MMcfd in 1996 to 340 MMcfd in 2000. In 2001, we expect to do 407 MMcfd.
What sets us apart, if I had to pick a variable, is our ability, on acquisitions, to enhance reserves and production by more than 50% over what we paid for them, on average. That�s the difference.
OGJ Online: How do you go about enhancing these properties once you buy them? What are you looking for?
Simpson: Well, we have about 70 reservoir engineers, so we take a technical approach. We buy quality properties. And we�ve tried to buy from owners where, in the greater scheme of things, it made sense that they were not paying much attention to the properties because they had more important projects to put their senior staff on.
It�s the parable of the food chain, and we�ve played it successfully by bringing a higher level of expertise to a property that the seller was not working as hard, for logical reasons. Maybe it�s major oil company that had bigger fish to fry, or maybe a utility-owned asset and they had a whole different agenda. Or it could be a smaller independent that just didn�t have the capital.
OGJ Online: What are your core areas of operation?
Simpson: Four years ago, the company was basically in three areas�Hugoton, Permian basin, and other, with other being Oklahoma. That adds up to 36% of the current company. The three areas we added are Arkoma, which is now 21%, and that�s in Arkansas, primarily, that we bought in 1999; East Texas, 21%, we bought that in 1998; and San Juan basin, 19%, bought in 1997. That�s 61% of the company that didn�t exist 4 years ago. So the company has kind of reinvented itself and come out in five core areas, which would be Permian basin, Hugoton, San Juan, East Texas, and Arkoma.
We�re now looking to East Texas, where the Bossier play is, for our immediate growth. East Texas production equals about 140 MMcfd. East Texas is the largest, followed by Arkoma. The East Texas pinnacle reef play was the predecessor to this Bossier play. The pinnacle reef play was pretty dicey, kind of like drilling down a chimney 3 miles away. That was a tough play. We were never in on that one.
The Bossier play has evolved into the Bossier sand, the Cotton Valley sand and Cotton Valley lime�a different kind of play. The wells are 10,000-12,000 ft deep, and we haven�t drilled a dry hole yet.
Most of our San Juan basin operation is conventional production, but we do have some coalbed methane.
The Permian basin is primarily oil. We do about 12,000 b/d of oil. We view our oil properties as long-lived, quality cash cows where we seek to maintain production and reserves, but not growth. At these oil prices, we�ve been using about a third of our cash flow to maintain reserves and production, so that leaves two thirds of that cash available for other corporate uses.
About a third of our oil production is in Alaska in Cook Inlet where we�ve got long-lived offshore production. It�s similar to West Texas in complexity; it just happens to be in 40 ft of water. It�s a cash cow, too, and we lump that production in with the Permian Basin.
About 80% of our business is gas.
OGJ Online: With the spike in natural gas prices this winter, that�s creating record cash flow for the company.
Simpson: Recent price run-ups to $10/Mcf were unsustainable and ill-advised, if we could have avoided it. I think we can price ourselves out of the market. We certainly lost considerable demand this winter, which ended up being an allocator of a commodity that was in shortage. People shut down ammonia plants and fertilizer plants, and switched to alternative fuels anywhere they could. If I had my choice, I wish gas hadn�t gone above $6/Mcf.
The real question is in terms of values. Are we in an era like the mid-1970s to mid-1980s where values became real and the marketplace paid for them as they showed up in acquisition after acquisition? Or are we simply in another 2-year boom-and-bust? The jury is out on that. I kind of feel like it�s a little different this time�it�s going to be more like 1975-1985 decade. But Wall Street is not pricing stocks that way.
Some financial analysts predicted (an average gas price of) $3.75/Mcf this year, and the NYMEX right now is close to $6/Mcf. But they also predicted that oil would be going back down below $20/bbl, and the last time I checked it was $31/bbl. They�ve just been absolutely wrong about that. But again, who knows�sometimes they get it right, too.
OGJ Online: That�s true. But when you look at what�s happening in California with brownouts, it looks like the gas market is really skating on the edge as far as demand outstripping deliverability. It looks on paper now like the only direction for gas prices is up.
Simpson: It could be. I look at statistics like, what�s domestic production done in the last decade, and the answer is flat. I look at 1997, our last drilling boom, and domestic production was almost flat for gas. If (analysts) are anywhere close to right on demand for natural gas over the next decade, the outlook (for producers) has just got to be bright. There�s no way we can meet the demand projections I�ve seen on $3/Mcf gas. You could argue that maybe they�re too optimistic on the demand for gas.
But as for supply, thinking that we�re going to meet increased demand by ramping up US production, I haven�t seen any evidence in the last decade where it�s rampable. The underlying decline curve may be 25% or so, probably 40% in the Gulf of Mexico.
Independents were kind of like wheat farmers in the last decade. Basically, we drilled our very best, most prolific development wells and told ourselves we were making money because we looked at variable costs, which is what farmers do. We didn�t price in our capital, or the replacement of that opportunity.
I would bet that the last several hundred wells being drilled every month now are not remotely as economic as the first 500-600 that are being drilled. I would bet again that the market is going to be disappointed on what the production response is, particularly with us being limited on the number of rigs available. The industry ran 4,500 rigs in the early 1980s, but 1,200 today kind of maxes us out.
OGJ Online: What will be Cross Timbers� strategy for the coming year to meet these challenges?
Simpson: What we plan to do is, first of all, live within cash flow. That�s a luxury we have because as we tripled reserves in the last four years, we also tripled the in-house captured drilling opportunities, particularly in the Bossier trend in East Texas. We�ve got at least 500 well sites there that have potentially 1.2 tcf of reserves. We�re going to put a little more than half of our budget there this year. From opportunities we own today, we expect a 20% growth in gas production this year and again next year, with no acquisitions.
I think our balance sheet will become stronger as the year goes along because of retained earnings. Our debt-equity ratio will become stronger. I think the marketplace will come to see that we�re a growth vehicle without having to acquire (more properties). I think we will become more popular in the marketplace. We�re in the best position we�ve ever been in. Every year since I�ve been running this company, I felt we had to acquire to grow. We just don�t have to do that now, because we ended up in such a good position.
OGJ Online: So any growth in the coming year will be through the drill bit.
Simpson: Yes. We�ve got a $250 million budget. But looking at today�s commodity prices and strips, that�s about half of expected cash flow.
We�ll be able to use half of cash flow for our exploitation budget. As for the other half, we�ve committed about $115 million on an acquisition we closed the first week of January that is in this Bossier play. Would we do another acquisition? Yeah, if something like Arkansas came along again. The only difference is this time I�d front it with about half the equity as I did.
Our shareholders were patient with us through the building of the last 4 years. My theme for the last year has been to get the shareholders paid. I don�t want to put them in the penalty box again when they haven�t gotten fully paid for what we�ve done. With the stock at $20/share, and I think there is over 100% upside just on reserve valuation, I�m not going to impair that�I want to see that value play out. So I think the most likely course is a year of drilling and a year of building cash flow, with a stronger financial situation and try to get this valuation up.
OGJ Online: Further down the line, where do you see the company going beyond 2001?
Simpson: In 2002, we have the opportunity to do what we�re doing in 2001 from what we own today. We are a value-oriented company, so I think I�d have to see where we are a year from now before I answer that question. But if we had to do what we�re doing this year one more year, we have the luxury of doing it and grow the company without acquisitions.
I�m more interested in getting what we own valued (higher) than making it larger. I might even dilute it by trying to make it larger, if I were to sell stock at half price or something. If the stock gets more correctly valued, then we have more opportunities to acquire others or to grow, although again, that�s not important to us unless it creates value.
We�re the fourth largest holder of natural gas reserves in the US among independents. That�s pretty large. If we get the stock valued (higher), we�re going to have a $3 billion-plus market cap, and that�s pretty liquid. We�ve kind of got the perfect hand, and I�d like to play it out. The company might create $800 million in value this year, with the cash flow and results from drilling.
It may be a little boring for me�I like to do deals. Living within cash flow, I should still be able to do $250 million worth of deals if they become available. We still have things to do, but they�re more the add-on acquisitions that would increase drilling opportunities in areas we�re already in, already familiar with. We don�t have to buy a fresh franchise in what I would call perhaps an unfriendly environment in terms of price.
OGJ Online: There aren�t many property sales being done right now.
Simpson: That�s from the uncertainty and the inability of buyer and seller to agree. If you want to buy it on $3 gas and the seller wants to sell it on $6 gas, there�s not going to be any deal. Until this flux is over, I don�t think you�ll see too many deals. Maybe (you'll see) company deals�it�s easier to do a stock deal with another company because you don�t have to be absolutely correct on valuations. You just have to be relatively correct. So I think you�ll continue to see mergers.