ROGER JARVIS - SPINNAKER EXPLORATION COMPANY (SKE)
CEO Interview - published 04/30/2001
DOCUMENT # MAD615
ROGER L. JARVIS is Chairman, President and CEO of Spinnaker Exploration
Company which is located in Houston, Texas. Spinnaker explores
exclusively in the Gulf of Mexico and currently owns license rights to
10,400 blocks of 3D seismic there. This includes some 2,600 blocks of
derivative products. Previously, Mr. Jarvis served as President and CEO
of King Ranch, Inc. and prior to that King Ranch Oil and Gas. Mr. Jarvis
was educated in Petroleum Engineering, graduating from Tulsa University
in 1976. He began his career with Amoco, attached to the exploration
group in the Overthrust Belt play.
Sector: oil & gas drilling & exploration
TWST: Could we start out with a little history and a quick overview of
Spinnaker?
Mr. Jarvis: Spinnaker began operations in December 1996 after 15 months
of business development. The company physically began to operate in
early 1997, and drilled its first wildcat in August 1997. Spinnaker is
really the product of a landmark seismic acquisition and provision
agreement between Spinnaker and Petroleum Geo-Services. In conjunction
with the data deal, an equity funding with Warburg, Pincus Ventures
totaling $75 million was closed. So the company has been in operation a
bit more than four years. We've drilled 40 successful exploratory wells,
including 35 discoveries in the shallow waters of the Gulf and five deep
water discoveries. We've never made an acquisition as a company, and
we've grown more or less at triple digit rates since inception.
Spinnaker is a data-advantaged, technology-advantaged independent,
focused exclusively in the Gulf of Mexico, and doing nothing but
exploration and development.
TWST: Why the Gulf?
Mr. Jarvis: The Gulf has proximity to market. It's a prolific basin with
a long history. It's a very complex basin, and complexity means numerous
traps. The basin itself lends itself to technical analysis. In fact, the
Gulf of Mexico has always been an incubator for geophysical
technologies. Additionally, it has a good commercial regime, if you
will. The oil and gas rights roll over every five years on the shelf,
and every eight to 10 years in the deep water. There's a lot of deal
flow. Additionally, the shallow water shelf has primarily been natural
gas prone. And of course, those markets are pretty strong right now.
TWST: What is your mix at this point?
Mr. Jarvis: Our production mix is 96% gas. Our reserve mix is a bit
lower than that, around 90% gas, 10% oil.
TWST: What is it that you bring to the Gulf that wasn't there before?
Mr. Jarvis: I think we bring a company that has many of the advantages
in information and technology enjoyed by the majors, but with the
mindset of an independent. So relative to our size, we have a large pool
of opportunity and a very technically driven process of prospect
selection. Spinnaker is one of the only remaining pure explorers in the
independent ranks, particularly in the Gulf of Mexico, yet we have an
engine size that has driven big growth. We're growing at rapid rates and
at high margins due to our concentration in the exploration phase of the
business. And that all positions us as a very unique company.
TWST: When you go in and bid for the leases in the Gulf, what do you
bring to that equation?
Mr. Jarvis: The first thing we bring is a lot of information. This
business has historically been defined as an iron and steel business '
asset dominated. But the reality is that it's an information and
technology business. The more you know, the bigger percentage of the
picture that one can see, the better decisions will ultimately be made
about individual prospects and the risks associated with those
prospects. At lease sale, we are in competition on every block we choose
to bid with other companies, but we have so much information that we are
able to cover a lot of geography. We're not indifferent to good
prospects, but we certainly have a lot of prospect ideas and we tend to
bid them statistically. This business is characteristically constrained
by prospect quality and prospect volume, and this is a company set up to
offset that inevitable disadvantage in a depleting resource business. So
we've got lots of opportunities; that makes us a good broad-based
bidder. It gives us access to the entire geography of the Gulf, so we
can manage our portfolio with a lot of diversity in risk, cost and
reward.
TWST: The information that you're bringing to this equation, is this
proprietary, or is it available to anybody?
Mr. Jarvis: It's available to anyone in its raw form. 98% of 3-D seismic
acquisition in the Gulf of Mexico is non-proprietary. However, we place
a big emphasis on reprocessing and upon seismic attribute analysis. So
we do quite a lot of processing internally. For instance, we now own
license rights to 10,400 blocks of 3-D seismic. About a quarter of that
database has been reprocessed. So we're taking essentially a non-
proprietary piece of information and broadly upgrading it.
TWST: Is that what gives you a competitive advantage?
Mr. Jarvis: In part, yes.
TWST: How do you quantify the benefits to the company? Have you had a
greater success rate in exploration?
Mr. Jarvis: Yes, we've drilled at about twice the industry average
success rate. Particularly on the shelf, we have found an average field
size that's three to four times the industry's experience in that same
period of time. So we've not only found fields more frequently in
percentage terms, but we've also found bigger fields. This is a product
of the information advantage. We view a trend in its regional setting,
and we have all the information typically available to us for an entire
geologic trend. So when we view that geologic trend, we can put the
risks and rewards in the proper perspective. That helps us not only find
a bigger field that's more subtle and less competitive typically, but it
also allows us to control the risk associated with that deeper,
inherently higher risk operation. In a very short period of time, we've
made five discoveries in the deep water. Our partner Murphy announced
the Front Runner discovery recently and gave some details about it
following the lease sale in March. It's probably a significant
discovery, although we still have a lot of work to do. By the way, the
model attracts great people ' the information advantage and the systems
advantage attract great people because those are their tools. We've
incentivized everyone at Spinnaker with equity. In fact, all the
original founding employees made an investment in Spinnaker alongside
the preferred shareholders and myself. So the people who are here are
committed. They also have the best tools.
TWST: As we look out over the next year or two, what's going to be the
corporate strategy?
Mr. Jarvis: Our strategy will be to continue to expand and extend our
advantage from an information and technology point of view. Practically
speaking, that means higher activity levels targeted for deeper, larger
prospects ' that's just the natural trend ' and more activity in the
deep water. By the way, none of those are new trends. At every
anniversary date, we've assessed our position and each year we seem to
have larger average prospect size and marginally are taking on somewhat
higher risk. We've also methodically increased our activity in the deep
water over time. I think those trends will just continue. Technically,
we will continue to invest heavily, and are, over the next two years,
significantly increasing our in-house processing capability. We're doing
a fair amount of this processing upgrade internally now, but you'll see
even a higher percentage of that in the future.
TWST: What will the drilling program look like?
Mr. Jarvis: We've announced about 36 wells for 2001. Spinnaker has one
of the more active exploratory programs in the Gulf. I think the program
will be pretty well diversified. There will be nine wells in the deep
water. We have three or four core areas on the shelf and will drill 10
or 12 of those wildcats in these areas. We'll also do some conventional
wildcatting; shallower things on the shelf that don't have big
potential, but have lower risk. And then we'll do six or seven, maybe a
few more true development or fault block type tests. So it's well
diversified. It's a mix of deep and shallow drilling on the shelf, and
it's a mixture of shallow water and deep water prospects.
TWST: What kind of capital spending will this entail?
Mr. Jarvis: $260 million in 2001. We've announced an initial expectation
of $275 million in 2002.
TWST: Is this being done out of cash flow?
Mr. Jarvis: Pretty much. It's all a question of commodity price, but at
year-end we were situated with about $85 million cash. I think most
analysts are projecting cash flow net to Spinnaker in 2001 of between
$225 and $265 million, and then increasing amounts in 2002. We can
maintain that spending expectation with a $3.50 gas price, which would
be a lower price than we have right now. We would get to the end of 2002
with around $70 million debt in that case. So that's worst case in our
mind; if gas price dropped $2 tomorrow and stayed there for two years.
Otherwise, we've got what looks to be ample capital to end 2002 with
little or no debt. Those programs also assume full development at Front
Runner and Zia, two deep water discoveries that will require their own
facilities, or 'hub' facilities in 2001 and 2002. Our budget assumption
is that all those funds are expended during the two-year period, and
none of the cash flow from those projects is realized until 2003.
TWST: What do you expect commodity pricing to do?
Mr. Jarvis: I'm not one of the industry bulls. I think that this is a
commodity. Time and time again, the consumers of this commodity have
shown themselves to be very flexible. Pricing creates a lot of
unintended result in our business. I think that's true of most
commodities, but oil and gas are so basic that consumption patterns
change pretty rapidly. The way I view it, gas-fired power generation is
going to become the highest and best use for natural gas. And some of
the natural gas-fired industries are going to be exported. That's my
view of the next five to ten years. However, for 18-24 months I'm not
sure that there's much that can be done to bring gas price below $4. The
areas in North America that have historically supplied most of our gas,
the shelf of the Gulf of Mexico and the Western Sedimentary Basin in
Southern Alberta, are fully developed from the standpoint of
infrastructure, and therefore decline rates are high. Those areas are
just not going to produce big production adds over the next couple of
years. LNG is a few years away. Arctic gas is a few years away. So for
the next couple of years I don't see that's there's any way to avoid a
fairly high commodity price. In the winter, and at times of peak demand
in the summer, we're going to see very high prices. After that, I view
everything ultimately gravitating to the price of residual fuels. So
beyond 2002, let's say, I think a reasonable expectation is $3.00-$3.50
per mcf. That's still an awfully good price when you view it
historically.
TWST: At those prices can you do pretty much what you want to do?
Mr. Jarvis: We currently have net operating margins of about 40% at a $3
gas price. If one has the luxury of cutting product prices by 40% and
still making 40% operating margins, you're doing okay. We are the low
cost producer in the Gulf of Mexico, which is extraordinary for a
company our age and size. We are very focused on the cost equation. We
do not want to acquire a cost structure now that is not going to work at
$3.
TWST: Are you going to remain conservative?
Mr. Jarvis: Yes.
TWST: Do you have the equipment you need to do this drilling program?
Mr. Jarvis: Yes. The reality is, however, that it's costing more to get
less. Operations are less efficient than they were a year ago and
they're more expensive. So we're concerned about that. Spinnaker does
have a luxury that a lot of our brethren do not. We could cut our
activity in half and maintain a majority of our growth because we have
these core areas, both in the deep water and on the shelf, that are
adding both rate and reserve. So if these rig rates go too much further,
we'll lay some rigs down. We don't want to do that, but we would. We're
a new company with largely new leases, so we could for a year, year and
a half, cut our activity substantially and still maintain our growth.
It's a cycle we've seen before and we're wary of.
TWST: Isn't there really only a limited amount you can do about it?
Mr. Jarvis: There's only a limited amount you can do about it. The
reality is that one must ultimately decide to either go with the flow or
be contrarian. Historically, we have been contrarian. We've invested at
times when costs and activity levels were lower. We've also got to
deliver growth. Let's face it, we're a public company. Our shareholders
buy us for growth. We've got great growth prospects, so there are
definitely some tradeoffs. We are going to continue to grow, but we're
not going to chase this cost environment unconsciously.
TWST: Since you mentioned growth, what should investors see from you in
the way of growth over the next two or three years?
Mr. Jarvis: Last year, our production grew from 13 bcfe, billion cubic
feet of gas equivalent, to 30.2 bcfe, so it grew two and half times. To
date, we've projected increases of 70% in our guidance from 2000-2001.
That would be one of the highest growth rates in our part of the sector,
and we would expect fairly large increases in 2002 as well. Front
Runner, and maybe Zia, if successful in the delineation phase, would
begin producing in 2003. Those two discoveries could double our size
both in rate and reserve. So it looks pretty good. We've still got some
slots to fill in, and it's not like we can quit paying attention, but
the growth prospects for this company are pretty extraordinary.
TWST: Are we talking internal growth here with no external acquisitions?
Mr. Jarvis: No acquisitions.
TWST: Are you likely to maintain that policy?
Mr. Jarvis: Yes, I think we are. I think our view is that exploration is
inherently a higher margin activity if you're successful at it.
TWST: Other than the commodity price, what's the risk here? What can go
wrong?
Mr. Jarvis: In the exploration business, you can always fail to find
hydrocarbons. I think our visibility, however, for production growth, is
very good. Fields that we found that are not yet producing should
provide some healthy growth rates. I do think that cost underlies all
this, and I don't think there are many people talking about this, but we
have been for a number of months. That's what keeps me awake. When I
have trouble sleeping, it's generally about the cost equation. To date,
this recovery has been very restrained from the E&P side. More of the
economic rent has stayed with the producer. But there's always a tension
there. For instance, it even affects how we guide the markets. We guide
conservatively. I think people know this. We say it. We do it for a
reason. We do it because we're young, we're concentrated and we realize
there's risk if something goes wrong; and it has a couple of times, but
we still made our numbers. The other reason we guide conservatively is
to avoid being locked into production forecasts that require us to
conduct activities at a time when service costs are out of hand. We're
not there yet, but I would just caution that we could get there. And if
we do, Spinnaker has guided the market toward goals that can be achieved
with less activity than we're currently conducting. So that's what
worries me, the cost side of the business.
TWST: Are there any signs of that occurring at this juncture?
Mr. Jarvis: To date, we've been immune. I don't think that we can do
that forever, but the industry's costs are going up across the board.
Finding costs will go up. Operating costs are going up. The only reason
you may see a break with that related to year-end 2000 is because a lot
of people got reserve upgrades by virtue of higher gas price, not
because they found more, or they found it more cheaply. Some properties'
economic limits were lowered by virtue of a higher commodity price.
That's not what happened to us, but it happens to some. But putting that
aside for a minute because that's just not new resource; it's already
there, and it's an accounting game; whether it's included or not
included in the numbers, right? I think the true finding cost associated
with new resource and the cost of operating those properties have gone
up. In our case, both operating costs and full cycle finding costs came
down in 2000, and they may come down for one more year because we're
adding fairly large new volumes in these core areas. But I think there
are signs that the industry is under stress from a cost point of view.
TWST: Being a relatively young company, do you have the management team
and structure in place that you need?
Mr. Jarvis: I think we've got a highly effective team. When I selected
these guys, I selected for character, experience and track record.
Additionally, they all had to have experience making a payroll;
investing time and effort and being part of startup operations. So we've
had a very unique, experienced, I think, steady-handed team. Startup is
not an easy thing, but this team is effective and respected in the
business, and I feel great about the people we have running Spinnaker. I
think it's one of the best teams in the business.
TWST: Is the balance sheet where you want it to be, or is there some
work to be done?
Mr. Jarvis: It's in great shape. We had $85 million cash at year-end.
We've got no debt. We've got rapidly increasing cash flows. It is the
best balance sheet in the sector for companies of our size. Our balance
sheet gives us a lot of flexibility. And very honestly, we built it with
that in mind. We paid an insurance premium at the end of the summer last
year to do a secondary offering, $150 million roughly. We didn't
absolutely need it, but we said to the market, 'Look, we're buying an
insurance policy, and the reason we are is because we're an exploration
company.' We drill 30 exploratory wells a year and that's inherently
risky. We will explore with equity. Secondly, we're greatly exposed to
the deep water. We don't want to be another small company that has a
little success in the deep water, and then says, 'Well, now what do we
do?' This is a company that people have come to believe can associate
itself with these kinds of projects and not create a question mark in
terms of the financing.
TWST: How do you feel about the value that the market is currently
putting on the company?
Mr. Jarvis: I think the market has trouble valuing us, but I think the
institutional investment community likes Spinnaker. It's unique, and
it's doing something a little different, and it's doing it on a broader
scale than most in its size category. In terms of cash flow multiple, we
are very reasonably priced. Price/earnings ratio projected for 2001 is
probably around 12, cash flow ratios in the high 4's. Based upon net
asset value, we look expensive, but that's true for any high growth
company. However, if you look back on those metrics, say, to a year ago,
you would say on an NAV basis today Spinnaker was a steal a year ago. So
I think that's the problem inherent in any high quality fast-growing
company. We would like to be higher; but who wouldn't.
TWST: What does the market have trouble coming to grips with?
Mr. Jarvis: I think the market has embraced the Spinnaker story, but if
there's anything it struggles with, it struggles with sustainability.
There has never been a company constructed quite like this. So the
question becomes yes, well, you did it last year, but can you do it next
year? And the market should be cautious because there have been more
stories in the E&P business of failure than of long-term success. But
this is a company with a little bit different construction. The data and
technology advantage is basic. It pervades everything we do, and it
creates an advantage that I don't think the institutional community is
used to seeing.
TWST: So is it a little bit of show me?
Mr. Jarvis: Yes, and we keep showing them, and that's okay. We don't
have to be paid for everything up-front. We've been honest with the
markets. We've never missed a number. We've tried to manage expectation,
and we don't mind being paid as we go along for the results that we
achieve. We don't have to get it all up front. But I think that makes us
a good long-term core holding for a lot of people.
TWST: If you were sitting down with some potential longer-term investors
today, what two or three summary reasons would you give them to put
their money in Spinnaker?
Mr. Jarvis: Spinnaker has an information and technology advantage. It's
a company with a basic competitive advantage. It's also a very focused
company, and it's balance sheet is the best in its sector.
TWST: Thank you. (TM) |
