The old habits of wildcatters are hard to break. Once oil prices start to spike, gunning for acquisitions or production will inevitably lead to companies biting off more than they can chew. Again.
Living within cash flow is not the oil and gas industry’s strongest character trait.
Contango Oil & Gas Co. (NYSE MKT: MCF) plans to go the conservative route in 2017. Last year, its moves smacked of playing small ball—the basketball strategy of sacrificing height and strength for a lineup of agility, speed and flexibility.
Contango squeezed into the Permian Basin just that way. In July, the company ended a long hunt for a deal in the basin with the purchase of interests in about 5,000 net undeveloped acres. The company had been skimping on capex to make a move, reports by Seaport Global Securities suggest.
Through its eventual deal, Contango found itself in Pecos County, Texas, in the Southern Delaware Basin, for a price of up to $25 million. The seller has not been disclosed. The deal included 157 gross potential locations in the Wolfcamp A and B and Bone Spring formations.
More recently, since their first acquisition in July, the company and its partner have increased their leasehold, upping Contango’s holdings to 6,250 acres.
In July, Contango completed an offering of 5 million shares for net proceeds of about $46.9 million to fund the acquisition and drilling costs.
With the additional acreage, the company now figures it has 200 gross drilling locations targeting the same formations. And, perhaps as importantly, nearly all of the locations can accommodate 10,000 ft lateral lengths.
Contango’s drilling program has so far earned it a 48.8% working interest in its first three Delaware wells.
But in a basin where acreage fever caused high prices in 2016, Contango got quite a nifty deal, depending ultimately on the quality of its acreage.
On its face, Contango paid $5,000 per acre for a soft Delaware landing —the equivalent of grand theft in the days of elevated acreage prices.
Allan D. Keel, Contango’s president and CEO, said Jan. 9 that the company was fortunate to have acquired high-quality acreage in the Southern Delaware “at a very attractive entry price.”
Recent upstream transactions for area acreage have topped $30,000 per undeveloped acre, after adjusting for production.
Keel said he’s optimistic about the value of the position.
“We believe that our current acreage position in the Delaware has the potential to be very impactful for our shareholders,” he said.
While the company’s initial focus will be on the Wolfcamp A and B and Second Bone Spring, Keel said the company could also see results from other prospective formations.
“The Delaware Basin is one of the few domestic plays that provide return-justified drilling opportunities in the current price environment,” he said.
The company is tilting rapidly toward the Delaware. Its 2017 capex is about $46.3 million—with roughly 80%, $36.6 million, earmarked for drilling or completing nine gross wells in Pecos. Overall, the company’s budget is up about $10 million over 2016.
“The company’s strategy is to drill and complete wells in batches of four before pausing to take time to assess the performance and make adjustments to well design ahead of the next round of drilling,” said Kyle Rhodes, an analyst at RBC Capital Markets.
Much now rests on the company’s Lonestar-Gunfighter well. Completed in November, the #1H is undergoing an Upper Wolfcamp test in the northeast part of the company’s lease. The 10,500 ft horizontal well is expected to begin production in mid- to late-January.
“Contango’s capital budget looks conservative, but we would continue to expect the majority of investor interest to remain on the company's first well results expected in mid/late February,” Rhodes said.
How its wells perform will ultimately shape the company’s capital program and possibly increase it. Contango’s philosophy is to fund expenditures with internally generated cash flow, and that will continue in 2017.
Contango has pulled the trigger in the Delaware. Now it’s a question of seeing how well it draws.
Darren Barbee can be reached at firstname.lastname@example.org.