Ever since Denver independent Basin Exploration changed its strategy a few years ago, from an onshore hunt for reserves to successfully drilling offshore, many other formerly landlocked producers have found offshore activity hard to resist. After all, operating in the Gulf of Mexico enables a company to boost oil and gas production and reserves more rapidly than possible in conventional onshore work. For many companies, entering the Gulf is a natural step in the evolution of their growth plan. They start by taking small, nonoperated interests in onshore wells, graduate to bigger interests and to operating the assets, then progress to acquisitions and exploration. Finally, they have enough sustained cash flow to support wading offshore-where the risks are higher, but the rewards are too. The advantage is faster growth, higher-flowing wells that spread out costs per barrel of oil equivalent and yield fast cash flow, and a shorter reserve life, if a company is dominated by a reserve life of 10-plus years, which Wall Street typically does not reward. Everyone concedes that stepping offshore means stepping onto a faster reserve-replacement treadmill, but proponents argue it is still a viable growth concept. A few skeptics issue a caution, however. Small-cap companies should not go into the Gulf's Shelf, maintains analyst Subash Chandra with Morgan Keegan & Co. "Insurance costs are high. The war chest must be large enough to ride out the dry holes and fund development if discoveries are made. The time from conception to production can be as long as two years. I don't recommend it for companies unless commodity prices are set to run." And let's not even mention the possibility of hurricanes. Three Dallas independents of various sizes have weighed the pros and cons and are pursuing the offshore course: Magnum Hunter Resources, Remington Oil and Gas, and The Wiser Oil Co. And, they are pursuing it together in many cases, by teaming up at offshore lease sales and in drilling programs. For example, Remington and Magnum have a venture whereby Remington shows the latter everything it proposes offshore, and Magnum participates in many, but not necessarily all, of its prospects, usually on a 30% to 40% basis. Remington operates. Wiser does nothing offshore without Remington as a partner. Remington and Magnum recently tested a discovery on West Cameron Block 426 that flowed 9 million cubic feet of gas equivalent (MMcfe) a day. The well is in 102 feet of water in a lease the partners acquired at Lease Sale 178 last year. Remington usually has two or three offshore rigs running at any time. Magnum Hunter Resources Magnum first ventured offshore in May 1999 after buying a 36% stake in TEL Offshore Trust for $10.4 million. (The latter, once a unit of Tenneco, is still traded on Nasdaq.) "The company had nothing offshore before that. We saw it as very fertile ground," says Magnum chairman, president and chief executive Gary C. Evans. "The majors were abandoning the shallow water to go deeper and international. It was no different than how we decided to buy and exploit properties onshore, by looking for smaller targets, behind-pipe pay and plenty of infrastructure in place." Today, although Magnum's onshore property base still forms the core, the offshore component represents almost a fourth of total daily production and reserves. (Before its first-quarter 2002 merger with landlubber Prize Energy, offshore production had grown to nearly half of the total.) "We have always been risk-averse, so we started slowly and to spread the risk, we joint-ventured with other companies at first," Evans says. After TEL, the company took 25% of a 12-well program with Tana Oil & Gas. Later in 1999, Tana sold its properties to Unocal, so the latter became Magnum's partner. Magnum also generates and operates its own prospects. It drills with Remington and others such as Spinnaker Exploration, Hunt Oil (which bought out previous partner Chieftain International), Kerr-McGee, Stone Energy, El Paso, Burlington Resources, W&T Offshore and LLOG Exploration. It even has a small interest in a 21,800-foot Miocene test recently drilled by Ocean Energy. Former Enserch head of exploration Chuck Erwin is Magnum's offshore leader now. Many of the staff at Remington once worked for and with him at Enserch. That familiarity goes a long way in the various partnerships today. By June 30, 2002, Magnum's offshore proved reserves totaled 70 billion cubic feet equivalent (Bcfe). The company has interests in 135 federal offshore blocks, including those from the March 2002 sale. It also has a 25% net profits interest in 17 Shelf blocks through TEL. Remington is a partner in 74 blocks and Wiser Oil is in 41 of those. And Magnum operates 33 blocks 100%. Production now spans the Gulf from High Island to Main Pass. Net daily output has reached about 50 MMcfe, with working interests ranging from 100% in some wells to 10% in others, although typically it holds 25% to 30%. Since 1999 when it first got its feet wet, Magnum Hunter has reported a 17.8% rate of return and payout of 5.6 years for its proved offshore reserves. If one includes probable reserves, the rate of return is 36%, the company says. "Certainly the shallow-water Gulf is an important cornerstone for Magnum Hunter," says senior vice president of capital markets and corporate development Brad Davis, a former sell-side E&P analyst. "Offshore helped give us additional nearer-term growth. We view the shallow water as a strategic area for us, but by no means is it the whole company." The prominence of offshore spending rises or falls each year depending on capital allocation cycles. Last year, it commanded about 70% of Magnum's capital budget of $115 million because there was so much development drilling and infrastructure to be installed to solidify the successes of 2000 and 2001. Some $53 million was spent on exploration and $30 million on platforms, pipelines and development. Offshore capex will likely fall to 50% to 60% of the total in 2003, however, because the company sees immediate opportunity in its Morrow-Atoka play in southeast New Mexico, Davis says, and the hefty offshore infrastructure spending is behind it-at least for now. Finding and development costs in 2001 were about $2.20 per thousand cubic feet equivalent (Mcfe) due to the infrastructure spending. Too, a large portion of the reserves associated with new infrastructure could not be booked until they had been producing long enough to meet third-party engineers' booking requirements, Davis explains. "In 2002 it will be more like 70 cents per Mcfe, so we think the average is more in the $1.25 or $1.50 range, which we believe is competitive for this operating environment." In 2003, at least six recent discoveries are scheduled to go onstream, adding another 24- to 30 million cubic feet a day of production, net to the company. "Offshore allows you to grow your base production so much faster, and the rate of return can be excellent, especially with $3 gas and $26 oil," says Evans. "Our success rate in the Gulf has been 85% or so, so we have confidence in our team. Unlike Basin Exploration did, we don't plan to sell all of our onshore production-we will keep our size at this level and continue to pare our debt." Remington Oil and Gas Since president and chief executive James A. Watt joined the company in 1997, Remington has increased its role as operator, even though the company started at South Pass 89 Field in the 1970s. It now holds interests in 94 blocks, and about 80% of the reserves-and capital allocation-are offshore. The prospect inventory exposes it to at least 1 trillion cubic feet equivalent of net, unrisked reserves. With its vast 3-D seismic database, it relies more on internally generated prospects today. Rather than prospects, data drive the exploration program, says David Tameron, Houston-based analyst with ABN Amro. He initiated coverage with an Add rating in January 2002, citing the company's strong production growth profile for 2002 and 2003. "In 1997 we were a nonoperating, one-field company," says Watt. "Then we made the decision to generate our own prospects. We've brought nine platforms on in the last two years and had a significant amount of drilling activity." Chandra at Morgan Keegan adds, "Remington has been successful because it owned an existing interest in one of the most prolific producing properties in the Gulf: the South Pass complex. The purchase of seismic when few others were interested, in 1998, gave them a time advantage in finding prospects and securing acreage. Their fallback to this high-cash-flow property was their defining advantage." Analyst Frank D. Bracken of Jefferies & Co. believes the key to Remington's success has been its cost-conscious use of its comprehensive 3-D seismic database, which covers the shallow-water portion of the central Shelf nearly in its entirety. "It has registered a success rate of 75% in the past three years while achieving finding and development costs of $1.09 per Mcfe. And, it has amassed an inventory of 61 offshore prospects (many in the Deep Shelf)," he says. A few months ago, Remington became one of the few companies to increase its 2002 budget, by $18 million to $93 million. Some $46 million is now targeted to exploration, $43 million for platforms and development drilling, and $4 million for leasing and seismic expenditures. The reason? The company had a busy second half planned, with nine offshore wells to be drilled by December 2002, exposing it to net unrisked potential of nearly 400 Bcfe. That compares to year-end 2001 proved reserves of 195 Bcfe. But alas, in October, Tropical Storm Isadore and Hurricane Lili threw water on the plan. Drilling was suspended at South Marsh Island 24, a well with partner Magnum Hunter, because the casing was damaged. Repairs were under way at press time. Infrastructure repairs also are needed at South Marsh Island 35. The greatest impact was at the Eugene Island 302 platform. Either repairs will be done there, or production will be re-routed to an alternate facility early in 2003. These setbacks affect production, cash flow and earnings projections now, but they do not impede the longer-term outlook. Prior to the storms, Watt had told the Street production would be up 20% from 2001, to about 35 Bcfe. Watt estimates the company has two or three years of drilling inventory to work through at its current rate of three rigs running. The Wiser Oil Co. The offshore business is a key part of new chairman and chief executive officer George Hickox Jr.'s plan to turn The Wiser Oil Co. around and start growing again. About 15% of the small-cap's 2003 budget will be devoted to offshore activity, with onshore and Canadian operations taking the rest.After Wiser was recapitalized in May 2000, the board brought in Hickox in first-quarter 2001. He is a principal in the Philadelphia investment company and turnaround specialty firm Heller Hickox. The latter was searching for a vehicle through which to enter the Gulf of Mexico. Wiser was searching for help, if not survival. "There are several reasons Wiser chose to enter the Gulf," Hickox says. "When we came into the company there was very little prospect inventory on hand, and it was 70% oil, with a long reserve life (much of it in Appalachia). We wanted to reverse all those things, to bring in more gas production, bring down the reserve-life index and have more front-end-loaded cash flow. The Gulf solves these in one fell swoop. "Heller Hickox had Shelf success in the past, so we were comfortable that we could bring added value to our shareholders. We are excited because it gives us a chance to participate in some larger exploration targets with multiple 'bail-out' zones." First, Wiser took 12.5% in the drilling of five Remington offshore prospects. Four of those were drilled in 2001. In a second agreement, it agreed to bid with Remington at the March 2001 and 2002 central Gulf lease sales and take a 25% working interest. "Remington was obligated to show us whatever they were working on for bids and we then could choose to participate or not," says Hickox. Between the two sales, the partners were awarded 33 blocks. In addition to the four wells in 2001, the pair drilled another well (separate from the original agreement) that was an outgrowth of a successful lease sale in 2001. "Remington and Magnum Hunter have a broader portfolio in the Gulf than Wiser does, but you'll never see us in anything without Remington," Hickox says. "We like their track record. They are small enough to be nimble-they will switch plans around as new seismic data comes in-yet they are able to get production on quickly." Wiser also made a few Gulf-oriented M&A proposals last year and this year that did not include Remington, although to date it has not yet scored. Today Wiser has a portfolio of 32 offshore prospects with 270 Bcfe of net unrisked gas reserves. The order in which certain prospects are drilled is proposed by Remington, which operates. Wiser usually takes either a 12.5% or 25% interest. By year-end 2002, 5% to 10% of the company's gas production will come from offshore wells. "It's still a small percentage, but that's what you do in a turnaround situation," says Hickox. "You take it from zero to something else."