Those who like turnaround stories are finding compelling narratives in today's Gulf Coast, outer continental shelf and transition zone activity, thanks to application of new technology and oil priced at Brent levels.
But there is another turnaround story afloat in Louisiana's transition zone that involves the efforts of a seasoned management team to overcome commodity-price risk. The tale involves Saratoga Resources Inc., a Houston-based independent. For its success in overcoming obstacles and accelerating development of several of its legacy transition zone properties, it is Oil and Gas Investor's Best Turnaround for 2011.
To be sure, Saratoga sits on the cusp of good times. The company closed its third private-equity placement in May 2012, attracting an additional $20 million in new capital to further strengthen an already strong balance sheet and move to a two-rig program. The program will accelerate development of low-risk, multiple-pay objectives, exploit inexpensive behind-pipe recompletion opportunities, and convert newly identified PUDs(proved undeveloped reserves) into proved developed reserves.
Saratoga's portfolio includes 32,185 acres spread across several fields in the Main Pass/Breton area, plus Grand Bay and Vermilion 16 fields, all of which are held by production, 100% operated with all depths, and offer a balanced 4,000 barrels of oil equivalent (BOE) production profile split 60% for oil. The opportunity set ranges from low-cost natural gas as shallow as 900 feet to geopressured oily targets at 12,000 feet and below, to the ultra-deep Lower Tertiary Wilcox and Cretaceous Tuscaloosa plays.
That portfolio places Saratoga in the midst of a larger, underappreciated trend, as operators employ advanced 3-D seismic, directional drilling and sophisticated recompletion techniques to generate consistent free cash flow from mature conventional stacked-pay reservoirs in the Gulf.
"Our cash flow has always been strong and it has always been our salvation," notes Saratoga chief executive Thomas Cooke. "We didn't raise money because we were burning cash; we raised money because we wanted to expand our opportunities and bring forward reserves."
So, forget for a moment the headlines about capital-intensive, unconventional tight formation plays. There exists a world of opportunity in deploying sophisticated engineering and agile business models to conventional Gulf properties. Saratoga is among the vanguard of public independents such as Apache
Corp., Cimarex Energy Co., Swift Energy Co. (Lake Washington), Gulfport Energy Corp. (West Cote Blanche Bay), Petroquest Energy Inc., and several stalwart privately held firms, including Hilcorp Energy Co. and Helis Oil & Gas Co., that are leading the charge to revitalize the region.
The story line is not unfamiliar to energy industry observers. Recent events include Energy XXI's $1.01-billion purchase of ExxonMobil shelf properties in November 2010, and the first offshore foray of Oklahoma City-based Sand - Ridge Energy Inc., which purchased Dynamic Offshore Resources LLC for $1.28 billion in February 2012. The latter deal has allowed Sand Ridge to redirect free cash flow from oily shelf production toward development of its Mississippi Lime portfolio in Oklahoma and Kansas.
What's going on along the coast? Many of the original discoveries in the transition zone, on the shelf or in state and parish waters occurred in the 1950s or earlier and involved the major oil companies. Those discoveries predated 3-D seismic and modern completion techniques and were operated for decades in
harvest mode. Larger targets in deeper waters, or overseas, ultimately enticed the majors during the early 1990s to spin off their shallow-water holdings to smaller independents.
Today, a second wave of transactions is also revitalizing the region. In a business that favors unconventional resources, Saratoga and its peers are contrarian players, generating low-risk free cash flow in conventional legacy reservoirs through modern seismic technology and nuts-and-bolts geologic and engineering efforts.
Saratoga's Grand Bay Field, for example, was discovered in 1938 by Gulf Oil. Near the mouth of the Mississippi River, it has yielded 250 million barrels of oil equivalent in cumulative production from 64 individual reservoirs, with no dry holes in 70 years. Less than 5% of wells have been drilled below 13,000 feet, and only three have penetrated the 15,000-foot level.
Saratoga generates production from more than 30 wells that are 40-plus years old, as well as from much younger wells. It now plans to boost output by exploiting multiple targets at multiple depths.
"We've gone in with a comprehensive view and we think that this thing has hardly been touched as you get into geopressure below 12,000 feet," says Cooke. "There are high-value, conventional, deep drilling opportunities down to 20,000 feet. We go in and drill our shallow, proven reserves, set casing and put a 5,000- to 7,000-foot exploratory tail on those wells. We can move back uphole and complete three-million-barrels-of-oil-equivalent wells.
"The look at 16,000 feet is really a free look, and we've already got a very commercial well behind pipe. It virtually eliminates the economic risk."
Back from the brink
Things had never looked better for oil and gas producers than in July 2008, when Saratoga closed the cash and stock purchase of a portfolio in Louisiana's coastal transition zone with the Macquarie Group as principal financial partner. Macquarie previously approached Saratoga to work with a team of ex-Chevron production engineers operating as Harvest Oil and Gas LLC that created operating efficiencies in legacy fields through reduced costs and in creased production.
In 2007, Saratoga hired Andy Clifford, who serves as president and formerly was BHP Billiton's vice president of exploration, Western Hemisphere. He oversaw the evaluation of the Harvest holdings, reprocessed existing seismic, purchased additional 3-D seismic, and championed Saratoga's participation in industry and academic consortia.
For example, Saratoga was the first to reprocess the first second of seismic data, which also involved cased-hole logging of the first 3,000 feet of selected wells in its portfolio, ultimately identifying more than 50 billion cubic feet of natural gas shallower than 5,000 feet. Other efforts, which are ongoing, involve a thorough mapping of each of the 64 production zones and the underlying seismic structures to target production updip or behind pipe.
"We bought at the top of the market, but we were buying at $2 per Mcf (thousand cubic feet)," recalls Cooke. "It was very rich with unidentified PUDs and behind-pipe targets. The amount of money that we put into our full field studies and understanding these reserves was disproportionate for a small company."
The unprecedented collapse in global financial and commodity markets in late 2008 and early 2009, following on the heels of two large hurricanes, Gustav and Ike, that temporarily curtailed production, resulted in temporary declines in the company's revenues and profitability within the first six months of closing the acquisition.
As oil fell below $40, Saratoga's second lien lender declared the company in technical violation of loan convenants, triggering a freeze on Saratoga's senior debt. The same lender then proposed a hostile, pre-packaged bankruptcy that would have kept Saratoga management in place but wiped out shareholder equity, essentially transferring full ownership of the properties to the lender.
Saratoga management defensively sought to protect equity holders in a contentious Chapter 11 bankruptcy filing on March 31, 2009, in U.S. District Court, Western Louisiana. While senior management grappled with the legal imbroglio, Saratoga's professional staff worked diligently in the background to increase reserves and production, identify new drilling prospects and reduce operating costs in the high-cost coastal transition zone.
Those efforts paid off and Saratoga was declared solvent by the court. The company and its financiers agreed to restructure its debt, and Saratoga was allowed to pay creditors in full while permitting existing shareholders to retain their equity.
"Our company was never insolvent, never missed a scheduled payment to our lenders or our vendors, and was continuing to produce good operating cash flows, even with minimal capital investment. We had accumulated over $25 million in cash at exit in May 2010 and never had a need for debtor-in-possession (DIP) financing," Cooke recalls.
"We emerged from bankruptcy, having retained all of our assets and 100% of our equity, having paid all vendors, both secured and unsecured, 100%, plus interest and legal expenses."
There aren't many stories that involve a successful outcome for all parties following a Chapter 11 event. Cooke, an affable West Texan who was a pioneer in horizontal drilling in the Pearsall Chalk and an early participant in the core Barnett shale during a multi-decade career, is philosophic about the unusual turn of events.
"We never should have been in bankruptcy," he says. "We had no alternative but to seek protection under Chapter 11 because our lender was trying to wipe out equity. When you have a good understanding of your assets and your cash flow, then you can stand up for yourself, and that's what we focused on."
After emerging from Chapter 11, Saratoga reinstated its development program, invested in previously deferred infrastructure and maintenance, and grew production from 2,300 barrels of oil equivalent per day in 2010 to approximately 4,000 barrels equivalent per day currently. After the recent capital infusion, Saratoga is targeting an exit rate of 5,000 barrels equivalent daily for 2012. Its capex budget for the year is set at about $50 million to drill six development wells with multi-pay objectives using two rigs plus a workover rig.
Saratoga earned a listing on the NYSE Amex under the symbol SARA in July 2011, opening the door to an institutional following. GSO/Blackstone, Wellington Management, Pimco and Wamco are among the company's investors. The Macquarie Group has been one of Saratoga's largest shareholders since mid-2008. Also in 2011, the company issued $127.5 million in senior secured notes, replacing its pre-existing debt but reducing total debt by $18 million and extending the maturity to 2016.
Saratoga is also on the trend line in the ultra-deep shelf gas play. Its Vermilion 16 Field resides atop the central fairway that joins historic Wilcox production onshore with the Walker Ridge Lower Tertiary (Wilcox) in the deepwater Gulf. It is in discussions with McMoRan Exploration over a possible joint venture involving these ultra-deep rights.
"We like where we are," Cooke says. "We aren't in a hurry to chase acquisitions. Our emphasis is on keeping strong cash flow and positioning ourselves for any eventuality."