California's wait time for permits makes it a thorn in the side for the industry, but locally grown Citadel Exploration is finding opportunity where many fear to tread.

California is the third-largest state overall in terms of oil production, but tight regulations and long permit wait times have kept producers for the most part away from the Golden State. But the waiting time doesn't seem to bother Armen Nahabedian, chief executive officer of Citadel Exploration Inc. (OTCBB: COIL), a Newport Beach-based E&P company operating in the Salinas and San Joaquin basins. Rather, he and his chief financial officer Phil McPherson see it as an opportunity.

“If it wasn't so difficult to get things done in California, I'd have 30 Texans up here trying to do the same thing,” McPherson tells Oil and Gas Investor. “Texans come in and they hit a brick wall and they try to break through it. The California way is to go around it like the water. It takes longer. People want to get permits in two months and it takes us two years.”

He's not exaggerating. The company, which was founded by Nahabedian in 2011, recently got 15 permits in hand to develop Project Indian, a thermal recovery project in San Benito County in the Salinas Basin. The process took two and a half years, and legal fees made up a large part of the company's budget during that time, McPherson says.

“These are the first 15 permits issued in that county in several years,” he says. “There are only about 25 wells that have been drilled there, so it's pretty avant-garde.”

Soon, Citadel will see if its patience has paid off. The company hopes to begin drilling on Project Indian and two other projects soon and exit the year at 200 to 300 barrels per day, setting it up to develop the assets in 2014.

“My goal by the end of 2014 would be to hit that 1,000-barrel-per-day mark, which I think is kind of the line where most small-cap companies need to get to, to start getting bigger investors and bigger institutions to start looking at them,” McPherson says.


Citadel chief financial officer Phil McPherson (left) and chief executive officer Armen Nahabedian.

Family ties

Nahabedian is no stranger to the California way. In fact, he grew up with it, as did his father, his grandfather, and his great-grandfather. He's a fourth-generation oilman with roots in the Wild West. His great-grandfather, William Wallace Stabler, came to California from Pennsylvania as a teenager with aspirations of becoming a cowboy. He became a muleskinner instead, hauling pipe on wagons to the Los Angeles Basin, then the hub of the California oil boom. By age 16 or 17, he had acquired an interest in a well.

“I'm not sure if that was ever brought on production or not, but he certainly had the bug, and by 1923 he had drilled what was at that time the deepest producing well in the world at Huntington Beach,” Nahabedian says.

“That well came in at some 4,000 barrels a day at a depth of approximately 5,000 feet, which at that time was very cutting edge. He went on to develop Santa Fe Springs Oil Field, and he was by all means a true-grit wildcatter and set a very high bar for the family.”

Nahabedian's father formed Channel Exploration, which became a premier California exploration company in the 1980s, after discovering one of the largest onshore California gas plays for McCullough Oil Co. Channel went on to find one of the largest onshore oil discoveries at the time at Landslide, which has since recovered some 20 million barrels.

Nahabedian joined the family business after leaving the Marine Corps in 2003. He had served as an infantryman and an Arabic translator, and was part of the initial invasion in Iraq.

“At the time, I was looking for something much less exciting to do,” he says. He became a regional supervisor at Nahabedian Exploration Group, working alongside his father and brother, and became a partner in 2007. He wore many hats at NEG, and was involved in prospect generation, land acquisitions, business development and finance.

Obviously, through his family, Nahabedian was able to gain exposure and experience early on. But the family also offers something that many small independents simply do not have: four generations worth of data. The firm has 25,000 feet of warehouse space that houses all the well control data, 2-D seismic surveys and 3-D seismic surveys collected over 100 years.

“It really gives us a tremendous leg up when it comes to vetting any sort of potential project that comes to the table or any sort of exploratory program that we're looking at,” Nahabedian says. “It's pretty difficult for someone to show me an area of California that we don't have data on. And not only an understanding of, but a very thorough geologic interpretation of. I consider it our most valuable asset.”

After forming his own company in 2011, Nahabedian sought help from McPherson, then an analyst at Global Hunter Securities who had become an acknowledged expert on California E&Ps. McPherson gave Nahabedian free advice on capital structure while doing research on his family, and Nahabedian offered McPherson a job as CFO for Citadel in 2012.

“I left a much larger paycheck on the sell-side to come here, but it's much, much more enjoyable to be building a company than to be analyzing one,” McPherson says. When he entered the company a year ago, he built the foundation for a public company. “We upgraded our legal team, we upgraded our accounting systems, cleaned up a little of the float that was out there and put some investors in that I had known in my 12-year career on the sell-side.”

In February of this year, the company did its first capital raise to clean up the balance sheet and eliminate debt. Citadel sold 4.1 million shares at $0.34, totaling $1.4 million in proceeds. The company has approximately 30.5 million shares outstanding, including half a million warrants outstanding. There are also a million stock options for management.

“We've prided ourselves on keeping our capital structure simple,” he says. “My experience as an analyst was that small companies will usually take easy money, and then that easy money has hair on it and impedes your progress.”

Project Indian

Citadel recently finalized its permits with San Benito County and the state of California to begin operations at Project Indian, a 688-acre lease from Vintage Petroleum LLC, owned by Occidental Petroleum Corp.

“We're eager to get a rig out there by the end of the year, and anticipate that we'll be able to implement this pilot steam program at very little cost,” Nahabedian says. “We're using a rented steam generator instead of purchasing one in the first phase. The drilling and completion costs on the wells are only $75,000, on the high side, because they only have a max depth of 600 feet.”

McPherson says there are at least 100 million barrels of potential oil in place at a depth of 300 to 600 feet. He estimates Citadel could recover about 20% of the original oil in place, if the thermal recovery program is effective.

“The analogous field to the south, which is the San Ardo oil field, was discovered by Shell in the '60s, has since recovered 600 million barrels, and it is approaching a recovery level of 40% to 50%,” he says. “So we think 20% is conservative, we think the 100 million barrels is conservative; if we're able to prove our concept, that's 10 million barrels net to us after royalties and our working interest. For a company with a $25-million market cap, 10 million barrels of reserve exposure is a big deal.”

One of the nuances of calculating cost of steam injection is the steam-to-oil ratio. When McPherson started analyzing Berry Petroleum in 2002, its economic threshold for the steam-to-oil ratio was 3:1, which means for every three barrels of steam injected into the ground, one barrel of oil is extracted.

“Back then, you had $6 natural gas and $25 oil, and it takes about 1 Mcfe (thousand cubic feet equivalent) of gas to create a barrel and a half of steam,” McPherson says. “So in that case, Berry was spending $12 a barrel on natural gas to get $25 of oil out of the ground, and at the time heavy oil was selling at a discount to the $25 number, so they were probably getting $20 to $22 out of the ground. You fast-forward to today, and you have $3 natural gas and $100 oil, so the economics are very compelling.”

The company isn't worried about the formation rejecting the steam. Rather, McPherson says, the company is worried there might be too much permeability and the steam might dissipate. “To combat that we're going to start with a very conservative program where in this 200-foot column of oil we probably only steam about five to maybe 10 feet of it, try to isolate the best zones with as much steam as possible, and prove that we can make the oil mobile.”

The project has ample access to natural gas to create steam, as it sits less than two miles from a PG&E natural gas pipeline. It is a mile from an electricity line, which the company uses to power its machinery. The company will also have access to a rail-car facility about 35 miles away at San Ardo Field.

In the immediate future, Citadel is targeting a series of projects in the southern end of the prolific San Joaquin Basin. The company has a joint venture with Japanese conglomerate Sojitz on a 52,000-acre lease on the historic Tejon Ranch, alongside more OXY acreage. In addition, Citadel is starting exploration in the Yowlumne Field area, not far from the historic Landslide Field discovered by Nahabedian's father.

Given the recent trend of M&A in California-focused E&Ps, such as Plains Exploration's acquisition by Freeport-McMoRan and Berry Petroleum by Linn Energy, Citadel believes it provides a unique opportunity to access the oil-thirsty economics of the Golden State.