EPL Oil & Gas

Spend a minute with Gary Hanna, president and CEO at EPL Oil & Gas, and you realize the growth and development opportunities in the shallow-water Gulf of Mexico are transformational. Listen to T.J. Thom, senior vice president and CFO, and you understand why the shallow-water Gulf of Mexico is one of the most economic, high-impact places to operate in the US. Hanna and Thom have made it a priority to re-educate investors on the Gulf of Mexico shelf asking them to take a second look offshore. In the last year, EPL shares have appreciated more than 75% – it seems the street is starting to catch on.

"Investors still believe shelf assets are high-risk and gassy in nature," Hanna explained. "Many believe companies like EPL are on a revolving treadmill with no growth while constantly outspending cash flow – that's just not the case."

Growth Story

EPL's growth strategy is to acquire oil-weighted properties within, or adjacent to, the company's acreage position, and exploit the properties to enhance production and grow reserves. The company recently reported its third quarter production averaged 23,097 boepd, approximately 76% of which was oil-weighted. This represents a 96% increase in oil production from the same quarter last year.

Strategic acquisitions using science and reprocessed data sets have been key. When EPL initially purchased nine million barrels of reserves from Anglo-Suisse in 2011, the goal was to double the reserves through technical expertise. The number nearly tripled, giving rise rise to EPL's goal to target acquisitions with reserves it believes it can triple over the short-term.

"We made a very conscious decision to be leaders in the science of our basin, to understand the regional disposition," said Hanna. "We get these properties and take the time to do very detailed field studies, including all new reprocessed data sets."

The research has paid off, as EPL ran an 85% drilling success rate in the past year, and had comparable results in 2012. All-in finding and development costs ran about $25 to $26 per barrel.

Hanna's company expects similar returns from the September 2012 purchase of 18 million barrels of reserves from Hilcorp. EPL hopes to increase its reserve total to 36 million in just 24 months.

Taking its strategy a step further, the company realized its expertise on the shelf could help unlock organic reserves. Roughly one-third of its $335 million capital program in 2013 will be directed at its new assets. "We take time to develop the property inventory and then hi-grade our opportunities," Hanna explained, referencing a recent report from Netherland, Sewell & Associates on its base and prospect inventory. "If you look at our 2P, we have a very good line of sight on doubling those 18 million barrels."

Protecting free cash flow

Oil price steadiness has allowed EPL to effectively gauge its expenditures. Close attention to its balance sheet and significant hedging protects the company's free cash flow down to $60 per barrel. "Despite being a patient buyer, we're always ready to go," said Thom. "We are currently at 1.3x net debt to EBITDAX, down from 1.6x net debt to EBITDAX just out of the Hilcorp deal (Nov. 2012). The point is to remain in a balanced position to not only acquire, but to exploit." Oil production growth has resulted in significant free cash flow – all of which has been complemented by EPL's commitment to a strong balance sheet. For the first nine months of 2013, EPL reported record oil production which drove its EBITDAX to $384 million.

Challenges and opportunities

Another challenge is EPL's competition, or lack thereof. The company is one of only five pure players in the Gulf, and comparisons with such a small peer sample size can make shareholders hesitant. Even though competitors are limited, EPL has the greatest percentage of oil production, cash margins, cash per barrel, and reserves per production in the basin. The stock currently trades even at 1P, but Hanna says the 2P and 3P is very high quality and an oily, long-life play holds great reward.

EPL hopes to capitalize on its reserves in 2014 as it expands into deeper plays. Hanna singled out "intermediate depth" targets at 12,000 to 20,000 feet, near the salt domes. The company looks at acquisitions as a way to seize opportunity sets, and is open to expansion. "We never take our foot off the accelerator. We try to come out of any acquisition with as much clarity in our balance sheet that we can move forward to another significant deal very quickly."

Additional testing with azimuth shoots, fueled solely by free cash, will enhance EPL's knowledge of its core properties. Hanna says the testing will revolutionize the company's plans in the Gulf, and expects tremendous reserves in as few as three years. The benefits of the investment are multi-faceted, as knowledge is gained on both the shallow and deeper sections. The company's stability has prompted investors to ask if EPL will expand to onshore plays. "Never say never," said Hanna. "We have a lot of running room in our basin and a lot of room to consolidate."