Zaza at the Crossroads

Less than a year after becoming publicly traded via a reverse merger, ZaZa Energy Corp. is emerging from a period of transition with its energies focused on two name-brand resource plays. The small upstart of three years past, with a flamboyant reputation for backing a drag-racing team and hosting the best (some would say loudest) industry parties, is hoping to parlay its entrepreneurial panache to build scale in either the South Texas Eagle Ford shale play, the East Texas Eaglebine (aka Woodbine), or both—depending. The first quarter of 2013 holds anticipated answers.

“We’ve taken less than $3 million and turned it into a $190-million market cap,” says cofounder, president and chief executive Todd A. Brooks. And that’s just the beginning, he believes. “Our vision is to be an unconventional developer and a first mover as we grow our way from the small-cap space to the mid-cap space.”

“We’ve got a great team and are opportunistic,” Brooks says. “These are fantastic assets. The Eaglebine today is what the Eagle Ford was in 2009. We’ve got the acreage to do it, and we’re in execution mode now with a drilling program that will catapult us to the next level.”

Today ZaZa, based in Houston, holds 72,000 net and largely derisked acres in the Eagle Ford, and 90,000 acres in the self-named and emerging Eaglebine play, with a year-end 2012 exit rate of 312 barrels of oil equivalent per day. It is evaluating positions in two early-stage additional undisclosed resource plays as well.

But since going public in February 2012, the journey has been bumpy. When the flashy private took control of French-based Toreador Resources, with assets in France’s Paris Basin, its new shares (Nasdaq: ZAZA) went for a tumultuous ride. The stock is down more than half since the merger.

Call it growing pains.

Soon after going public, the company unexpectedly split with its Eagle Ford shale industry partner—and primary source of capital—Hess Corp. It swapped out its unconventional French assets to Hess for Eagle Ford rights and cash and soon swapped out its new CEO as well. The shake-up left investors uncertain.

ZaZa’s Stingray A-1H in Walker County, Texas, set to come online in December 2012 , is delineating the Lower Eaglebine play with an estimated ultimate recovery of 980,000 barrels equivalent.

Adding to the uncertainty, the split left ZaZa

“We’re excited about our position in the Eaglebine,” says ZaZa Energy cofounder, president and chief executive Todd Brooks. “If you’re going to read about results from (northern) Walker County, they’re going to come from ZaZa.”

100% exposed to capital needs for the first time and temporarily cash deficient. Over the ensuing months, it would begin to mature as a public E&P and develop an operational and financial platform for its longer-term development strategy.

Grass-roots beginnings

Brooks formed ZaZa in 2009 along with South Texas oil and gas veterans John Hearn and Gaston Kearby. His credentials included a finance degree from Vanderbilt, a law degree, a stint as an investment banker, and experience as the fifth-generation manager of family mineral interests, for which he became a landman. So why start an E&P?

“It’s opportunistic—you can’t find better returns anywhere. That, plus the excitement of exploration, of making a new discovery, is special,” Brooks says.

The genesis for ZaZa began when Hearn, a South Texas geologist, and Kearby, a self-made oilman with an operating company called Omega, approached Brooks for funding for a McMullen County Wilcox prospect in 2007. Through that deal, the three became friends. When they caught whispers of the Eagle Ford shale, before it was a household name, Hearn quickly delineated a trend map of the formation from his deep knowledge of the region. The three pooled funds to acquire 13,000 acres in Lavaca County. With gas prices still at $12 per thousand cubic feet (Mcf), the position straddled the Edwards shelf, where they anticipated natural fracturing to occur, in what is now termed the wet-gas/condensate window of the play.

“With acreage prices set to go up in an emerging resource play, the days of being able to generate Wilcox prospects were over. Now, you’ve got to go beyond family and friends for capital. So we either had to go somewhere else to generate and develop conventional prospects, or adapt and embrace the capital-intensive nature of the play that was emerging, and that’s what we chose,” Brooks says.

No one anticipated the global economic collapse that followed shortly after, and finding institutional funding for an unproven management team to develop the position proved fruitless. Perhaps fortuitously, the three then sought an industry partner. Enter international major Hess.

ZaZa Energy executive vice president of operations John Richards custom designs the company’s wellbore laterals down to six-inch intervals. “By segregating stages based on the environment downhole, our placement is more efficient.”

Aside from a legacy position in the Bakken, Hess was otherwise shaleless in North America and looking to get in. Yet it didn’t have boots on the ground to execute a fast-moving program in an emerging resource play. The nimble ZaZa, with its starter Eagle Ford position and deep-rooted relationships in South Texas, became the tip of the spear for Hess. The two entered an area of mutual interest agreement, with ZaZa holding a 10% operated working interest in the arrangement, and went on an acreage-

buying spree with Hess’ funds. The team amassed 123,000 acres for $330 million, in which ZaZa received 10% cash back of the total spent as incentive to build the position.

In addition, as operator of the drilling and completions program, ZaZa was carried on its interest in wells drilled based on the total number of acres acquired, further incentivizing the acquisition of more acreage.

“The more acres we could buy, the larger our well carry,” Brooks says. “The well carry was more valuable to us than the cash uplift.”

The Eagle Ford position with Hess covered four prospect areas: Cotulla, with 51,000 gross acres in LaSalle, Frio and Dimmit counties; Sweet Home, with 39,000 acres in the gas-condensate window in DeWitt and Lavaca counties; Moulton, with 12,000 acres in the volatile oil window in Fayette, Gonzalez and Lavaca counties; and Hackberry Creek, which was more exploratory, with 25,000 acres in Lavaca and Colorado counties.

Drilling activity was concentrated in Cotulla. ZaZa spudded its first Eagle Ford well in November 2010, and drilled 30 wells while completing 18 with three rigs running by yearend 2011. Thirty-day results ranged from 400 to 800 barrels of oil equivalent (BOE) per day. As per the arrangement, operations of Cotulla were handed over to Hess after one year of spudding the first well.

Positioning to expand

While enjoying the fruits of a joint venture with an industry major in the Eagle Ford, ZaZa wanted to access the public capital markets.

“We looked at the joint venture with Hess as a springboard to bigger and better things,” Brooks says. “In the Hess JV, we didn’t have capital needs, but we anticipated the day that we would, when we moved into other plays. Access to capital and cost of capital drove us to go public.”

Rather than doing an initial public offering, the quicker route was to acquire a public company, especially one with a nonoperated interest in a U.S. resource play. Instead, France’s ban on fracing provided ZaZa the opportunity it was seeking. With that frac ban announcement, Toreador’s market cap plummeted from $600 million to $80 million, although the company held 5.5 million barrels of proved reserves and an average of 850 barrels per day of conventional production. “They had sold off to where they were being valued below the value of their producing conventional assets. We saw it as free upside on the French unconventional if the government were to ever allow fracing,” Brooks says.

Add to that, Toreador shared a 50-50 partnership with Hess in the unconventional French assets. A deal was struck, and Toreador chief executive Craig McKenzie took the helm of the combined company.

It was Hess that changed ZaZa’s best-laid plans. Hess and ZaZa initially planned to drill 100 Eagle Ford wells in 2012 and another 150 in 2013, but Hess changed strategies in early 2012 and wanted to direct more capex into its Bakken assets, cutting Eagle Ford activity to just 30 wells. “Take 10% of that and you’re down to three net wells” for ZaZa, Brooks says. “As a small public company, we don’t have the luxury of slowing down to that level of growth.”

The companies agreed to part ways. Hess kept the Cotulla project and ZaZa’s 50% interest in the Paris Basin unconventional assets, an area Hess considered large and strategic from a global standpoint. ZaZa kept an overriding interest in the French unconventional assets and 100% interest in the remaining Eagle Ford position, including three producing wells, plus an $84-million payment from Hess, bolstering its balance sheet.

“We went from 12,300 net acres in the Eagle Ford to 72,000 net acres, so we have a significantly larger resource base and working interest in the Eagle Ford now,” Brooks says.

The spoils included the Crab Ranch well in Gonzalez County on its Moulton acreage. The well has cumulatively produced more than 80,000 barrels in one year, and has an estimated ultimate recovery (EUR) of 500,000 barrels. “We consider the Moulton acreage completely de-risked,” he says.

The split, however, left the company holding the checkbook for all of its capital expenditures. Some $33 million of the Hess proceeds went to pay down debt, so to raise additional capital, ZaZa agreed to divest its French conventional assets, which were not part of the Hess partnership, for an additional $86 million. That deal was expected to close by year-end 2012.

With no Eagle Ford or Eaglebine shale experience, McKenzie parted ways once the French assets became non-core, and Brooks took back the helm.

Eaglebine treasures

As good as is the Eagle Ford, Brooks is more juiced about the prospectivity of its Eaglebine play, an area of East Texas where the Eagle Ford shale transitions into the Woodbine sands. Other industry players simply call the developing play the Woodbine, although Brooks describes the Woodbine proper as being shallower than ZaZa’s targets.

Using the $33-million cash uplift received from Hess for acquiring the Eagle Ford acreage, ZaZa in 2009 executed an Eaglebine leasing program concurrently while drilling the Eagle Ford. Today, it holds 88,000 net contiguous acres largely in northwestern Walker County, including a 40,000-net-acre farm-in with Range Resources Corp., which ZaZa operates.

ZaZa Energy executive vice president of geology and geophysics Tom Bowman identifies potentially three horizontal oil zones in the Eaglebine and a tempting commingled vertical zone in the deeper Lower Cretaceous.

Early successful industry results from the Woodbine play tend to be further west in Madison and Grimes counties. Why lease here?

“We’re excited about our position,” Brooks says. “Being a first mover, we could build our block anywhere that we wanted to be. But you

“These are fantastic assets. The Eaglebine today is what the Eagle Ford was in 2009. We’ve got the acreage to do it.” Todd Brooks

haven’t heard of any results out of northern Walker County because we have the whole northern part of the county leased. If you’re going to read about well results from the Eaglebine in Walker County, they’re going to come from ZaZa. The results will speak for themselves.”

The acquisition target was a thick, organically rich mini-basin coming off the Angelina Caldwell flexure with a gas-to-oil ratio of 4,000 to 6,000. “It’s two to three times thicker than the heart of the Eagle Ford,” Brooks says.

ZaZa subdivides this 500-foot-thick section into the Upper and Lower Eaglebine. It has drilled one well to date, Stingray A-1H, into the Lower Eaglebine, with a 4,700-foot lateral. First production was expected by mid-December, with 70% liquids anticipated. Using Schlumberger’s ELAN analysis, the company estimates total reserves in place to be 21 billion cubic feet (Bcf) of gas and 29 million BOE per section, or about 4 million BOE per well. “If you apply an 18% recovery factor to that, you’re looking at about 980,000 BOE EUR per well,” Brooks says. He calculates a 96% rate of return (ROR).

That’s in one zone. The ZaZa team also anticipates drilling horizontally into the Upper Eaglebine and the Harris Delta section above that. ZaZa executive vice president of geology and geophysics Tom Bowman says the Harris is a thick sand zone that has previously produced gas, but which he believes holds trapped oil after giving up early migration gas. “It’s very much oil prone.” That’s three oil zones.

Additionally, the team gets animated when talking about the Lower Cretaceous, the multi-horizon zone below the Eaglebine.

Neighbor Navidad Resources drilled a commingled vertical well into the Lower Cretaceous for $5 million that has cumulatively produced approximately 250,000 barrels in the first 12 months.

“Those economics are staggering,” Brooks says, estimating a 173% ROR. “We could have a vertical play in the Lower Cretaceous simultaneous with a horizontal play in the Eaglebine.” The company was to spud the Commodore in December, a vertical well in Walker County, to test the Lower Cretaceous.

Directional optionality

In October, ZaZa tapped the public debt markets for a net $35 million to bridge the 2012 funding gap. ZaZa chief financial officer Ian Fay says, “The offering gave us the opportunity to get going on our strategy. We wanted to immediately put the money into the ground.”

This included installing artificial lift on the Crab Ranch well in the Eagle Ford, which is expected to double production to 350 barrels per day, and drilling the Eagle Ford Boening well, the first well to de-risk the Sweet Home acreage. Also, the company was able to immediately move a rig and begin drilling its second well, the Commodore, on the Walker County acreage. A second horizontal well into the Lower Eaglebine will spud this month.

Proving up the Eaglebine acreage “is critical to the entire company,” says Ian Fay, ZaZa chief financial officer.

First-quarter 2013 holds several decision points for ZaZa, which has two resource plays needing capex funding. It has $75 million earmarked going into the year, with $50 million to operations, but that number assumes a transactional event.

Fay, who joined in August 2012, says while the company wants to be self-funded, it’s not interested in slow, low growth. “That’s not who we are. We’re entrepreneurial, and we’ve got a great land package.”

In the Eagle Ford, ZaZa has decided to focus on its Moulton and Sweet Home prospects, and is now marketing its 23,000-acre Hackberry/ Oakland position in northeastern Lavaca County, along with a 2,000-acre offshoot in southern Frio County, via PLS Inc. Once it has results from its Boening well, it will determine if it wants to seek a joint-venture partner or an outright sale of the Sweet Home position.

“We’re a small company with a large acreage inventory,” says Brooks. “We’ve got to prioritize it. The well results in Sweet Home will define what we do with that asset in the near term.”

Likewise, a joint venture in the Eaglebine is likely to take shape in the first quarter, with Jefferies & Co. advising.

“We will need to do something,” Brooks says. “The development of this Eaglebine play needs a partner. We have the ability to de-risk it, but to get into full-field development, we will absolutely need a joint-venture partner or divest part of it. ”

“Proving up the Eaglebine acreage is strategically critical to the entire company,” Fay says. The company plans six to eight wells here in 2013, concentrated on the existing development area with Range for maximum economic efficiency.

ZaZa is currently running one rig total, which is shuttling between the plays.

Brooks expects clarity by the end of the first quarter for the direction ZaZa will take its high-octane assets, and a fast ramp thereafter.

“We’ve got a great team and are opportunistic,” Brooks says. “These are fantastic assets. The Eaglebine today is what the Eagle Ford was in 2009. We’ve got the acreage to do it, and we’re in execution mode now with a drilling program that will catapult us to the next level.”