Enerplus changing its strategy to growth-type business model

Don Stowers, Editor, OGFJ

OIL & GAS FINANCIAL JOURNAL: Enerplus has been in business nearly 25 years as an oil and gas income fund. Currently, you are transitioning the business to provide both income and growth to investors. What changes do you need to make to your asset base and business model in order to accomplish this?

GORDON KERR: You're absolutely right. Enerplus was the first oil and gas trust established in Canada almost 25 years ago. In terms of the transition we're focusing on adding growth assets into our portfolio in key resource plays where we can participate in the early stages of development. We feel these types of assets will provide us with greater growth over time. Over the past 18 months, we've added roughly 350,000 net acres of undeveloped land that has significant production and reserves potential in the Marcellus shale gas play primarily in Pennsylvania, the Bakken play in both Saskatchewan and North Dakota and the Deep Basin region of Alberta and British Columbia. However, the more mature cash-generating assets will continue to be very important to us. These provide income to our investors and also provide cash for reinvestment into the asset base. This is essential in order to build the growth component of the business model.

OGFJ: Where are your mature income assets and where are your newer growth assets?

KERR: Most of our cash-generating assets are currently in the Western Canadian Sedimentary Basin, although we do have a significant cash-generating oil asset in Montana. Our growth assets are located on both sides of the US-Canada border. Our strategy over the years has been to build a balanced portfolio of properties that produce both crude oil and natural gas and offer diversity both geographically and geologically. This approach helps us to mitigate risks associated with any one commodity as well as giving us exposure to a variety of play types. Our resource plays include shale gas in the Marcellus, shallow gas, tight gas, crude oil waterfloods, and Bakken/tight oil.

Enerplus established its operations in the US in late 2005 with the acquisition of a 70% working interest in the Sleeping Giant project in the Williston Basin of Montana. This property is one of the largest in the Enerplus portfolio and produces approximately 9,000 boe/day of light sweet crude oil and natural gas from the Bakken formation and is primarily operated by Enerplus. In early 2006, Enerplus opened an office in Denver to manage the development of Sleeping Giant and also to provide a growth platform in the US. Since that time, we've acquired a gross over-riding royalty interest on the Jonah natural gas field in Wyoming, added minor interests in the Sleeping Giant area, purchased approximately 30,000 net acres in North Dakota that has Bakken potential, enterered into the Marcellus shale gas play in northeastern US and we're still pursuing additional opportunities.

In September of last year, we purchased about 116,000 net acres in the Marcellus shale resource play in the northeastern US. We have since increased our holdings in the Marcellus to about 136,000 net acres. This acquisition was the first entry by Enerplus into the US shale gas plays and enabled us to potentially triple our booked reserves in natural gas. We believe the acquisition provides significant future growth potential. With its proximity to the large northeast US natural gas market and expanding pipeline take-away capacity, natural gas from the Marcellus receives a premium price and has one of the lowest breakeven prices of all natural gas producing areas in North America.

OGFJ: Do you have an operating or non-operating position in the Marcellus?

KERR: Our original 116,000-acre position in the Marcellus is a non-operated working interest. However, part of the acreage we've added since that time is acreage where we'll actually operate. We expect to be drilling our first well as an operator later this year. We've been building our capabilities to be an operator in this formation through our joint venture participation in some of the Pennsylvania acreage.

OGFJ: Looking at your acreage in the Bakken, is there still a lot of infrastructure to be built in the areas where you are operating on both sides of the border?

KERR: Well, in general, there is already a lot of infrastructure in and around these areas. However, having said that, some of the locations we plan to develop will need infrastructure. That goes with drilling successful wells. In North Dakota, for instance, there is something on the order of 120 rigs active in the play area right now. There's obviously going to be increased activity associated with building out infrastructure. But that's something we've gotten used to in the oil and gas business.

In our operations in southeastern Saskatchewan in an area called Freda Lake/Neptune, there are already significant operations to the north of us and developing operations to the south and east of us. We'll build out the infrastructure as we go and will be able to tie in to existing lines.

OGFJ: Is it far-fetched to believe that Saskatchewan can become as big an oil province as Alberta?

KERR: [Laughter] Well, the business climate in Saskatchewan is pretty strong. The province has a very business-friendly approach going forward. Saskatchewan has granted a royalty-free period relative to production in some of the areas we'll be drilling in. This is very encouraging for development. We're looking at 100,000 barrels of production per well that will benefit from a royalty rate of roughly 2.5%. After that, the provincial government will receive an increased share of the production, so there is a good economic climate to promote activity within the province.

OGFJ: In 2009, Enerplus drilled a total of 313 net wells and achieved a 99% success rate. Is this typical for the areas you operate in? What methods and extraction techniques are you using to achieve this success rate?

KERR: Well, first of all, up until recently, we've been largely developers of oil and gas assets. Historically, we've been doing a lot of infill type drilling, so these are known reservoirs. Consequently, our success rates have been reflective of that. As we move into these earlier-stage growth plays, there will be a higher level of risk associated with well results. So we're taking that risk into account when we're evaluating our expected outcomes. We're prepared to see lower well success rates in the interest of greater growth and value.

OGFJ: But isn't there less geologic risk in shale formations?

KERR: Yes, and that's part of the attraction. There has been great progress in technology with respect to drilling and completion. Plays that were previously considered uneconomic are now highly prospective. A lot of the conventional risk isn't present because we know the hydrocarbons are there, and now new technology and new drilling techniques have removed some of the other risk as well. This has changed the dynamics of the oil and gas business in the past few years, and we have adjusted our business model accordingly.

OGFJ: What catalysts should investors watch for as Enerplus executes this new business strategy?

KERR: The key will be how we demonstrate our success in these new growth areas. I think we've already demonstrated our capabilities around managing the development of oil and gas assets. And I'd also like to think that we have demonstrated a deep financial stability through the ups and downs of the oil and gas business.

OGFJ: As you move forward, will acquisitions continue to be part of your growth strategy or will growth be organic?

KERR: We've been very successful at strategic acquisitions, so definitely that will be a continuing part of our growth strategy. But we're obviously working to build our organic growth capability by developing assets and through our skill sets and our organization.

OGFJ: Do you have the financial capability to execute on this strategy?

KERR: We believe we have one of the strongest balance sheets in our sector. If you look at our first quarter report, at the end of the quarter we had zero cash drawn against a $1.4 billion unsecured, syndicated bank facility. Our cash flow situation has been very stable. We have always kept a close eye on our debt. We are probably one of the more conservative players in our space and in our business overall. We have a good following in the market as well as good credit support.

OGFJ: Enerplus is listed on both the New York Stock Exchange and the Toronto Stock Exchange. What value do you see in being listed on both exchanges?

KERR: Overall we obviously see it as a plus. Having a NYSE and a TSX listing gives us access to significant capital markets, and that has proved very beneficial to us. It requires extra administrative work because we have reporting obligations on both sides of the border, but by and large it definitely has been a positive being in both the Canadian and US public markets.

OGFJ: You mentioned earlier that Enerplus has a JV partner in the Marcellus. Is this mainly for the financial benefits of sharing the high costs of shale play development or so your company can learn from an experienced operator in that particular play?

KERR: This was an opportunity that presented itself to us to participate in this great play as a non-operating partner. In evaluating whether or not to do the deal, a critical element should be whether or not you would be good partners together. In this case, the answer for both sides was "yes." Chief Oil & Gas, our partner in the Marcellus, has significant experience in shale gas in the US, notably the Barnett Shale in Texas. This was a key element for us. Although Enerplus has been in the oil and gas business for years, we're not so naïve as to believe that we know everything about every type of oil and gas play. So this was a great opportunity for us to participate early in something that we think will build significant value for us and also be alongside an experienced player and learn from that opportunity. As I said, we are positioning to operate our first well in the Marcellus toward the end of 2010.

With respect to our oil operations, we originally had a joint venture in North Dakota. However, given our significant experience operating in the Bakken and our desire to not only increase our ownership in this area, but also operate, we recently bought out our partner there.

OGFJ: Does that include experience in horizontal drilling?

KERR: Yes — we've drilled over 100 horizontal wells, primarily in the Bakken in Montana.

OGFJ: Does Enerplus have the technical capability to succeed as a growth and income-oriented oil and gas company?

KERR: No question. We've been building our technical talent within the organization over the last couple of years. For example, we've created four "chief" positions within our organization. These are senior positions that will provide significant input on our main projects as well as mentoring to our other geosciences staff. We now have a chief of geology, chief of geophysics, chief of reservoir engineering, and chief of production and completion. These positions speak volumes as far as how important we think it is for us to stay ahead of the curve with regard to evolving applications of technology and science.

OGFJ: How will your current investors benefit from your transition from an energy trust to a corporation, and how might your investor base evolve over time?

KERR: First, we will continue to make distributions to our investors. This will not change. Introducing the growth element into our portfolios will combine both the income distribution component and the growth component in order to take advantage of this evolving business in the unconventional space that is happening in the oil and gas business. We believe this will provide a strong total return to our investor base. Investors will still see income distribution, and we expect to see our stock price appreciate as a result of new growth. We think this new business model will better meet the appetite of investors while taking advantage of the new opportunities technology has enabled.

OGFJ: Enerplus has announced a $425 million 2010 capex program. How will you fund this budget and does it incorporate any potential acquisitions?

KERR: The $425 million, which doesn't include potential acquisitions, will be funded primarily out of our cashflow. We have increased our capital budget over last year. At the end of 2009, we distributed about 50% of our cashflow and the other 50% was invested into the assets. Through the first quarter of 2010, this is about the same. When it comes to acquisitions, we would most likely increase our debt, leveraging off of our financial strength. We would also consider equity if we needed to, say in the context of a large acquisition, although we would be very judicious on the equity at this particular point in time. We try to look out a number of years as to what capital would be required, especially with regard to our growth assets. Another part of our strategy is to sell non-core properties that comprise something in the order of 14,000 barrels per day of our production. We've started this process and to date have sold approximately 3,400 boe/day raising proceeds of roughly $180 million. We'll use these proceeds to help fund some of our acquisitions activity as well as some of our development capital spending. We have a variety of options to help us fund our growth prospects over the next few years. As we move forward on building growth assets, this will generate proceeds that can be used for our capital program and growth acquisitions as well.

OGFJ: How do you define "non-core properties?"

KERR: By and large these properties are in Western Canada. They are ones in which we don't see that we'll be able to build a big enough core in these property areas to justify spending our time and our capital on them. A key element of our strategy is to improve our focus and to concentrate our efforts on core properties.

OGFJ: The Marcellus Shale is important to a lot of our readers. Can you tell them where your assets are in that resource play and something about your results there to date?

KERR: Sure. As you know, the Marcellus Shale area is huge. It's about 95,000 square miles and is principally in Pennsylvania, West Virginia, and Maryland. It also extends up into New York. Our acreage positions extend from northeastern Pennsylvania down into Marshall County in West Virginia. I mentioned earlier that we have increased our holdings there to about 136,000 net acres. We're still in the early stages of development but our well results to date are quite promising. Over 70 gross wells have been drilled on our acreage to date across seven counties in Pennsylvania and West Virginia. We're in various stages of completion and tie in and have around 25 wells currently on production. We now have six rigs working in the play.

Average 24-hour test rates of the last 10 wells completed in core areas is 5.7 MMcf/day with the best well in the northeast development area testing at 8.1 MMcf/day and the best well in the southwest area testing at 13.9 MMcf/day. Marcellus production volumes for the 1st quarter averaged 2.7 MMcf/day net to Enerplus and as of June 1 production had increased to approximately 7 MMcf/day net. We continue to expect our exit volumes will be in excess of 18 MMcf/day net. We currently have an approximate 20% working interest in 28 gross producing wells (24 horizontal wells and 4 vertical wells) and 50 gross wells awaiting tie-in, completion or pipeline.

It's working out just better than we have planned and we expect to grow this production over the next 3 to 4 years to be a meaningful part of our portfolio.

OGFJ: Thank you very much for your time.

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