?Birmingham, Alabama-based Energen Corp., through subsidiary Energen Resources Corp., has steadily grown its E&P assets during the past 13 years. The gas-utility operator’s E&P business had proved reserves of 100 billion cubic feet of gas in the Black Warrior Basin in 1995. Today, its E&P business is the source of 85% of its revenues, and holds 1.6 trillion cubic feet equivalent of proved gas, oil and gas liquids reserves, with another 1.9 trillion probable and possible, placing it among the top 20 U.S. E&P independents.
Likewise, it has grown from a small market cap of about $200 million to approximately $2 billion today.
The company began growing outside its legacy coalbed-methane assets in the Black Warrior Basin of Alabama in the late 1990s, making a big expansion with its purchase of San Juan Basin properties in New Mexico from Burlington Resources. Energen also gained a substantial position in the Permian Basin through several purchases, and acquired assets in north Louisiana from Total SA.
More recently, Energen has built a net position of 330,000 acres in central and north Alabama, where it is exploring the Conasauga and Chattanooga shales.
Energen chairman and chief executive James T. McManus II sees the company as being well positioned to survive the current economic downturn. He spoke with Oil and Gas Investor: about the company’s outlook, the benefits of being in the gas-utility business and the challenges of working in the Alabama shale plays.
Investor: How is Energen faring in this new commodity-price environment?
McManus: Obviously, no one in our business is enjoying the lower prices, but the nice aspect about our particular story is that the company has significantly delevered itself over the past few years. We have a very significant hedge position in place for 2009 and 2010. For this year, we’re 68% hedged at attractive prices: gas at $8.70 and oil at $72.31. For 2010, we’ve hedged about 50% of our production at $9.12 and $96.85.
Investor: Tell us about your hedging program.
McManus: ?We have a history of hedging. A lot of companies engage in it as a money-making proposition. Our philosophy of hedging has always been that—if we can get very good prices, lock in our returns and protect our cash flows—we’re willing to take those good prices and give up the upside in order to protect our earnings and cash flow from the downside.
In the fall of 2007, as we looked at the supply situation in North America, we saw a potential risk that supply was going to outstrip demand. At that time, we also saw prices for 2009 and 2010 gas approaching $9. Since the actual average price for gas during the previous five years was only $8.60 at most, we thought $9 was a great price to take. At the same time, we took some oil off the table.
Then, of course, oil ran to $140 this past summer, and gas prices ran up despite a strong supply situation. It looked like we might have given up some upside. Then, the economy collapsed. The demand side fell apart, and today you’ve got a double problem with natural gas: lower demand and greater supply.
Investor: Will you need to raise capital this year?
McManus: No, not at all. Energen Resources is actually generating significant positive cash flow above capex and has a very healthy balance sheet. If, by the end of 2009, we don’t spend any of our free cash flow, only 10% of Energen’s capital structure will be debt.
We think cash is king right now and have been focused on preserving our cash for opportunities that may present themselves.
Investor: How is your work in the Conasauga and Chattanooga shales in Alabama going?
McManus: We drilled three test wells in Alabama in 2008, along with Chesapeake Energy. We didn’t generate positive results, but the results weren’t conclusive either. This year, we plan to invest some $10- to $15 million in Alabama shales. We plan to perform some completions in the existing Conasauga well and probably will drill a couple more wells, such as a horizontal in the Chattanooga.
Investor: What are the technical challenges in the Alabama shales?
McManus: There’s nothing quite like the Conasauga that we know of. The Chattanooga should be a little easier to figure out. We don’t know if we’re working with a problem of completion technique or if there’s something wrong with the rock itself that is not apparent from the core sample or by looking at other properties.
Investor: Are you experimenting with length of horizontals or number of frac stages?
McManus: No, the Chattanooga was completed with a combination of water and sand. We now believe that we would have been better served by using an energized frac like nitrogen instead of water. So we will change the frac technique, and it will be a horizontal well.
In the Conasauga, we encountered multiple shows but only completed the lowest zone. We want to go uphole and perform more vertical completions. We also may drill another Conasauga well and extend laterals into the shale instead of just doing vertical completions.
Investor: Any plans to expand beyond your 330,000-acre position?
McManus: No, we’ve got enough acreage. At this point, we would much rather spend our money on trying to make this commercial rather than on additional leasing.
Investor: Are your Alabama leases expiring soon?
McManus: We don’t have any significant expirations in 2009, and most of what we have can be extended and renewed. Most had three- to five-year renewals. We didn’t pay a lot for these leases to begin with; if we wind up finding something encouraging in 2009, then we can extend most of these leases if we need to.
Investor: Tell us about the status of your other E&P operations.
McManus: The bulk of our other assets is in the San Juan Basin. We have grown production there every year since we acquired the position from Burlington in 1997. We are the leading driller in horizontal wells in the Fruitland coal there. We’ve done 109 there—more than anyone else. And, 75% of our production is now coalbed methane, starting from none.
We’re drilling laterals in excess of 3,000 feet. We drilled a lateral under Navajo Lake in excess of 5,000 feet. So we’re really pushing the edge of horizontal drilling in the San Juan. We think these wells are economic at current strip prices. We’re going to continue to push in the San Juan. It’s been the company’s driver.
The Permian is also important to us, and we’ve been growing production there. It’s the source of our oil production. We will continue to push our waterfloods forward there.
Investor: Tell us about your East Texas/North Louisiana property.
McManus: It’s the Vacherie Dome area, and we do have 10,000 acres on which we hold the deep rights. But it’s not in the heart of what people have typically defined as the Haynesville play. If the play continues to expand, maybe someday our acreage will be included. But we are on the fringes of that play today.
Our primary targets are the Cotton Valley and Hosston. The bulk of what we have there is nonoperated.
Investor: What’s your capital budget for 2009?
McManus: We have cut our budget. In 2008, we spent about $450 million. The current 2009 capital budget is $225 million. Most of our acreage is held by production and we don’t have many leases expiring, so we can choose when to do some of that work and believe it’s prudent to cut back, wait and then produce in a higher-price environment.We can’t scale it back to nothing. We don’t want to let our production become anemic, but we have cut projects in light of current prices.
Investor: Are you worried about these low gas prices?
McManus: We would rather they be high, but a benefit of low commodity prices is that, once they’ve been in place for a while, it’s a good time to start buying assets.
Investor: Are you hoping to be a net asset buyer in 2009?
McManus: We’re going to be looking, absolutely. We are an acquire-and-exploit company, and we have built this business that way over the past 13 years. In the past two or three years, we’ve been pushing our organic inventory. We stayed out of the acquisition market because we didn’t think the quality was there for the price. Commodity prices were high then. This may be a good time to move back in.
Our focus will be on assets in the areas we are already in. We know those areas and won’t have as much overhead. But we would not be reluctant to move into a new area for the right size deal.
Investor: Does being in both the E&P and utility businesses help Energen?
McManus: Back in 1995, 85% of our earnings were coming from the utility company, Alagasco. Now, 85% comes from E&P, so we have effectively transformed the company.
The utility is easy to understand; it’s got steady and predictable earnings. Importantly, it funds the dividend that Energen pays. Our shareholders enjoy having a dividend as part of the overall benefit of owning Energen stock.