Strong balance sheet is winning strategy for W&T Offshore

EDITOR’S NOTE: Founded in 1983, W&T Offshore is an independent oil and gas company focused primarily in the Gulf of Mexico, including exploration in the deepwater and shelf regions, where it has developed significant technical expertise. W&T has grown through acquisition, exploitation, and exploration, and now holds working interests in more than 155 fields in federal and state waters. OGFJ recently visited founder, chairman, and CEO Tracy Krohn at his office in Houston’s Greenway Plaza.

OIL & GAS FINANCIAL JOURNAL: You recently made a presentation to investors at the IPAA’s OGIS West Conference in San Francisco. What was new for this presentation?

TRACY KROHN: I think what was new since the last presentation was just trying to show how financially strong we are. We have a lot of cash on the balance sheet and we are very underleveraged. The difference between when we went public on Jan. 8, 2005, and where we are now is vast. This is the message we want to convey to analysts and the investment community.

OGFJ: Your company stock, like nearly everyone’s, has fallen in recent weeks and months. Is there an upside to this?

KROHN: For us, the good side is that we have cash. We planned for liquidity a couple of years ago and made that happen. After the Kerr-McGee transaction, after we digested that somewhat, we planned for a rainy day. We knew that oil prices and gas prices wouldn’t go up forever, and we didn’t want to get caught in an overleveraged position. I’ve been in this business all my adult life and I’ve seen several cycles. Anybody who has been through this before knows you have to plan for difficult economic conditions.

OGFJ: Do you think this will be a long-lasting economic downturn? Who in our industry will suffer the most?

KROHN: Well, the service companies are the first ones to take a hit, and they’re taking that hit now. But they’re also the first ones to gain when commodity prices go up. It’s always difficult to project what prices are going to be. The advantage of the Gulf of Mexico is that the cost of goods and services changes relatively quickly with declines or increases in commodity prices. So, unlike the onshore resource play where you have continuing drilling obligations – a contract you’ve signed or commitments you’ve made, we don’t have that. We don’t have any long-term contracts. We can change our plans quickly. However, it will impact some of our competitors in the Gulf.

We’ve all just gone through a rather large hurricane in the Gulf of Mexico [Ike, which made landfall near Galveston, Tex., on Sept. 12-13]. This will affect everyone’s insurance rates, which is why it’s good that we have a good liquidity position. We’ve also got a half a billion dollar credit line, which is uncommitted.

OGFJ: Today is Friday, Oct. 10. How much of your GoM production is still shut in as a result of the hurricane, which came through almost a month ago?

KROHN: Roughly two-thirds of our production is currently shut in. We have a total of nine platforms that were either toppled or are leaning over severely. Two are operated and seven are non-operated. So we still have some damage, and we’re still assessing that damage. Our geographic diversity affords us some protection against hurricane damage. We have assets in the Eastern, Central, and Western portions of the Gulf, stretching about 650 miles from east to west and roughly 300 miles north to south.

OGFJ: How much of your production is gas versus oil?

KROHN: I’d estimate about 55% gas and 45% oil – at least these were the pre-storm rates. It’s pretty balanced, and reserves are about 50/50 as well, plus or minus a few percentage points.

OGFJ: That’s a pretty good position to be in.

KROHN: Yes, it is. I’d like to tell you I was smart enough to plan it that way, but I wasn’t. We just go after the economics. We don’t go after one commodity over another, it’s just the economics.

OGFJ: How much of your assets are operated versus non-operated?

KROHN: The majority are operated – about 67% of our production is operated. Two-thirds of what we produce, we operate.

OGFJ: So would you say you were lucky that only two of your operated platforms were severely damaged by Ike?

KROHN: I’d like to think – not that lucky. We did a lot of work after Hurricanes Katrina and Rita three years ago to prepare for the next one and make our platforms more resistant to hurricane damage. I’d like to think that paid off for us this year. We’re certainly not the only operator in the Gulf that had problems and that lost a lot of platforms. Again, most of our losses were to non-operated platforms. You have to take into account that we are the third-largest acreage holder on the shelf behind Chevron and Apache.

OGFJ: Are you mostly on the shelf?

KROHN: Yes, that’s where most of our production is. But we do have assets out in the deepwater as well.

OGFJ: Can you describe briefly what you’re doing in the deepwater at this time?

KROHN: We are developing Green Canyon Block 646, the “Daniel Boone.” The discovery well was drilled in 2004 to a total measured depth of 12,365 feet. Daniel Boone is located about 120 miles off the coast of Louisiana in 4,230 feet of water. The discovery well encountered approximately 275 feet of high-quality oil and natural gas-bearing sands. W&T intends to produce the well via a subsea production system tied back to the Front Runner spar, which is operated by Murphy Oil. W&T owns a 60% working interest in Daniel Boone and we’re the operator. We expect production to begin in the second half of 2009. We also have our Healey Prospect, in Green Canyon 82. We’ve drilled three wells there and are evaluating the development to that now.

OGFJ: Are you having to build a lot of infrastructure, especially in the deepwater areas you’re developing?

KROHN: Of course there is already a lot of infrastructure in place on the shelf. However, in the deepwater we are investigating what the proper scenario should be. Generally we tend to run subsea tiebacks to wherever we need our production to go.

OGFJ: Let’s go back to the subject of investor presentations. Can you explain why you do them and what you get out of them?

KROHN: Sure. What we get out of them is exposure to different investors and industry analysts. We want to make sure that everyone understands our story. Some of these people we know quite well, and they know us. However, some do not. There’s always somebody new to talk to, and this is why we go to a number of investor events. We talk to institutional investors, we talk to hedge funds, and sometimes individual shareholders come to these conferences because they want to hear what we have to say. The good thing about the Gulf of Mexico is that it makes a lot of money. Obviously investors like that.

OGFJ: How has the credit crunch impacted W&T Offshore? If the current economic downturn lasts years rather than months, how will this affect your company’s ability to grow?

KROHN: Well, that’s the $64 question, isn’t it? I don’t quite know how to answer that because it’s hard to know what to assume. One thing we know – credit markets always come back, at least in one or two years, if not sooner. In the meantime, you have to operate on a cash basis. Fortunately, we are in a very strong cash position. Consistently within W&T, we’ve always operated within cash flow. Other companies don’t do this. We don’t borrow money to drill with. If everybody had to operate on a cash flow basis, we’d be in a pretty good position because we already know how to do that. It’s easy to manage a company when commodity prices are going up. However, it takes good management skills to run a company when prices are going down. When you have to stop drilling, it gets ugly real quick. If the situation continues to deteriorate, I suspect there will be a massive shakeout in our industry. I’ve been through this cycle several times, and it’s always advisable to operate within cash flow. We’ve been doing this for years, and it’s always been the way we operate.

OGFJ: A lot of people think that $140 oil was artificially inflated by market speculation, and that the current drop in prices is just the market correcting itself. However, $70 oil may mean that the pendulum has swung too far in the opposite direction. Long term, we still have increasing demand and concerns about supply. This hasn’t changed. Where do you think prices will go?

KROHN: Who knows? My only concern is that we won’t learn from this again. It always happens. When prices go up, everybody wants to do something about the situation. When prices go back down, we’ll start importing more. This is the cycle we’ve been going through, and we can’t seem to break old habits. Each time this happens, it gets even worse. Yes, there’s been some speculation in the market. Speculators are placing a bet that the prices will go up. If you have a financial reason to hedge, you’re using it as a tool and that’s alright. But once you start speculating, eventually you’re going to get hurt because you can’t be right all the time. It’s no different from betting on a football game.

OGFJ: As a start-up company back in 1983, why did you decide to operate offshore in the Gulf of Mexico, which is fairly capital intensive, when you could have operated onshore with much less capital?

KROHN: The thing I liked about the Gulf of Mexico and the advantage of the Gulf of Mexico is that you put the money in the ground and you make something positive happen, then it comes back to you. Real quick. Onshore you don’t get that dramatic drop in production that you get in the Gulf, but you don’t have that dramatic cash flow either. We’ve been in business for 25 years now, and we’ve had production for 23 of those years. The discovery we’ve made along the way is that you can’t just buy production and you can’t just drill. In the long run, you’ve got to be able to do both and do both pretty well. Anytime you have this kind of alignment, it’s got to be better for shareholders. We believe in running our company based on value and not just what Wall Street thinks we should do. I don’t pretend to understand Wall Street, but I hear they’ve been doing some pretty funny things. I do know that we’ve had wonderful cash flow, and now we’re sitting on a bunch of cash and we feel pretty good about what we’ve done.

OGFJ: Most everyone agrees that we’re importing too much oil and we’re putting our national security at risk by doing so. Let me ask you – do you think the United States can become energy independent or is this a pie-in-the-sky dream?

KROHN: Yes, definitely. We have the technology but we don’t have the will. It’s too easy for us to buy the energy we need from outside rather than producing it here. We have massive reserves of coal, and we have massive reserves of oil shales. We do not utilize these reserves due to political considerations. Nuclear power is a tremendous producer of electricity, but we haven’t built a new nuclear power plant in 30 years. And we’re certainly not being allowed to drill what we need to drill. I get a kick out of politicians who say we [all the energy companies] have 68 million acres under lease in the Gulf of Mexico – why don’t you drill that? That’s making the assumption that you have oil or gas under every acre, which is absurd. Our elected officials are completely out of touch with our business. They don’t understand us. They think oil and gas companies are in business to produce oil and gas. And that’s not true. Oil and gas companies are in business to make money. We need an energy policy in Washington, and we need people in office who understand our strengths and our limitations.

OGFJ: Do you currently have any operations elsewhere in the world, either onshore or offshore?

KROHN: No, almost everything we do is in the Gulf of Mexico. I’ve never precluded going elsewhere, but nothing has worked out so far. We’ve looked all over the world. We’ve looked at Ecuador, Colombia, Guatemala, Argentina. We’ve looked at Nigeria. We’ve looked in China, Indonesia, Russia, the UK North Sea. We’ve looked at foreign countries like California. We don’t have any philosophical reason for not leaving the Gulf, but we just haven’t found the right situation. Aside from the economics, one thing we look for is rule of law. With China and Russia, we couldn’t figure out how we would get paid and we were worried about the rules changing. If people put in an investment, they want to make sure they get paid. We weren’t sure with some of these places.

OGFJ: Have insurance rates gone up significantly for you since Hurricane Katrina and Rita in 2005?

KROHN: Yeah, quite a bit the next year after Katrina. Then they fell a little bit the year after that. And they were even lower for this year. But we’ll probably have some claims this year, and we can expect rates to go up again.

OGFJ: Do you carry insurance against lost production?

KROHN: No, we don’t carry business interruption insurance. As I mentioned earlier, W&T has quite a bit of diversity across the Gulf of Mexico, so we don’t have all our production concentrated in one place. Economically, it’s not the right thing to do.

OGFJ: It must have taken a lot of nerve to start an offshore E&P company on $12,000.

KROHN: Well, I didn’t look at it that way. I was quite a bit younger then, and I figured that if I screwed up, I could always go back to drilling wells for somebody else. The first couple of years were tough with no production, but it got better and we just continued to put the money back in the ground so we could build the company.

OGFJ: What was your background?

KROHN: I’m an engineer. I went to LSU and graduated with a degree in petroleum engineering. Then I went to work for Mobil Oil. Then I left Mobil to go to work for Taylor Energy Co., which was recently bought by a Korean company. And I left them to start up my own company. My goal from the start was to be self employed. I didn’t necessarily know I was going to start an offshore energy company, but that’s how it came about.

OGFJ: Are you from Louisiana originally?

KROHN: No, I was born and raised in Houston. Went to high school here. But I lived over in Louisiana for quite a while.

OGFJ: What are your short-term and long-term goals for the company?

KROHN: We’re coming up on our budget for next year soon, and frankly this is a pretty weird time for me to be doing an interview [laughter]. I have to tell you, it’s extremely difficult to plan in the current environment. There are just so many unknowns. We have a tremendous backlog. However, I don’t think the sky is going to fall. I don’t think we’re going to have a depression.

The good news is that people are still going to work. There are no soup lines. People are still making things, and we’re still exporting them. We’ve had a huge meltdown in the financial services sector, but financial services don’t produce anything. They produce a lot of wealth, and they’re producing a lot of grief right now – but they don’t produce anything tangible. I’m sorry, but credit default swaps aren’t a product. In the energy sector, we actually generate real revenue from real products. We don’t make money unless we sell something.

In our report this year, we go back to the fundamentals. That’s what we’ll do. So I really don’t have a great answer to your question because we haven’t run the numbers yet. But we’ve been through these cycles before as a private company and we’ve prospered. I’m confident we’ll come out of this one in better shape than most. My goal has always been to double the company within five years. That’s still my goal.

OGFJ: One of the consequences of lower commodity prices is that a number of companies, including W&T, have cut back their capex budget for the second half of 2008. Can you explain why you made this decision?

KROHN: Well, the first part of this year we had roughly the same oil economics as we have today. Oil prices were roughly the same, gas prices were a little bit higher, and personnel were readily available to do what we needed to do. As the year progressed and prices continued to go up, equipment got a little bit tighter and personnel got a bit more difficult, so we just decided to cut back because we physically couldn’t get it done. We deferred some of that, and as it turns out, that was the right thing to do. So we started cutting back in July when it became apparent we weren’t going to be able to do everything we had intended to do. The logical assumption is that we’re not going to be able to grow our reserves to where they need to be, but that’s not necessarily accurate.

OGFJ: Speaking of reserves, the SEC is currently reviewing the definition of proved reserves and may take some action redefining reserves categories. What would you like to see them do?

KROHN: With regard to booking reserves, I think there are a lot of reserves that should be booked as something other than “zero.” The legal definitions need to be updated so they are more in tune with reality, and I think the SEC is starting to recognize that. The way proved reserves are defined can definitely change the economics pretty drastically.

OGFJ: Election day is less than a month away as we sit here today. In your view, how important is it for the next President to understand the energy industry and who will help spur the growth of domestic oil and gas resources?

KROHN: It’s very important. We can’t have an administration that will discourage drilling and development. If the mantra truly is that we need to work hard to develop all different forms of energy to try to be energy independent, then that will be an important step towards solving our energy problems. We have some very difficult choices we need to make for this country, and it seems like an easy choice to me. Why would you not choose energy independence? Why would you put your children in harm’s way?

OGFJ: Who would you like to see as the next secretary of energy?

KROHN: Well, I don’t know about a particular individual, but I can give you a job description. I’d like to see an engineer in that role because they know how to solve problems. That’s number one. Not necessarily a petroleum engineer, but someone who is used to using a methodology for problem solving. And I’d like to see somebody who has actually been involved in running a business and making a payroll. And last, I’d like to see someone who has an environmental conscience. People in the oil industry aren’t slash-and-burners who don’t care. We have children, too, and we want them to grow up in a world that is safe for them, where they can breathe clean air. We need somebody in this position who can strike a good balance between the economic side and our environmental needs.

OGFJ: Final question, what do the W and T stand for in W&T Offshore?

KROHN: Whiskey and tequila [pause for effect]. No, there is no definition to the initials. It was a shell company that was given to us in the very beginning by an incorporating agent after we tried a couple of different names that didn’t pass muster. It saved us a couple of hundred dollars to use an existing name, and since we had started out with just $12,000 this sounded like a pretty good deal.

OGFJ: Thanks for taking the time to talk with us, Tracy.