Pinedale Anticline: 10-acre visibility delayed, with no change to upside for UPL, STR, WGR Goldman Sachs May 10, 2005
We were surprised by the Wyoming Oil and Gas Conservation Commission's decision to deny Ultra Petroleum's request for 10-acre spacing throughout the Pinedale Anticline. However, we still believe in the potential for 10- acre spacing down the road pending results from already-approved 20-acre wells from other operators. Because we had not assumed any incremental 10- acre wells would be drilled for 10 years, not only are we maintaining our estimated peak values for Ultra, Questar Corp. and Western Gas Resources, but we also believe that there remains a very strong probability that 10- acre spacing will ultimately be approved. Approval, however, may not happen until 4Q 2005 at the earliest, which could impact momentum investors that had until May 10 bid up Ultra shares. We are reiterating our OP/A rating on Questar and believe that further weakness represents a buying opportunity for Ultra.
ULTRA CAUGHT FLAT-FOOTED, WHICH COULD ADD TO NEAR-TERM WEAKNESS
We believe that the Street's contentment with Ultra's aggressive style could erode somewhat following the commission's denial of Ultra's request for 10-acre spacing throughout the Pinedale Anticline. Ultra, supported by prior commission approvals for 10-acre spacing and 5-acre pilots at neighboring Jonah field, believed the commission would support 10-acre spacing at Pinedale even without receiving approval for 20-acre spacing or 10-acre pilots. In denying Ultra's request, the commission seems to believe that the company was too quick to ask for full 10-acre spacing without either requesting more limited 10-acre pilots or waiting for more results from 20-acre wells. This is one of the first bumps in the road for Ultra for some time, and while we believe it is just that - a bump - the company's shareholder base of growth and momentum investors could perceive this slightly more negatively than we do. We are worried that the Street's confidence in Ultra's management style could at least temporarily erode slightly.
WE STILL BELIEVE 10-ACRE SPACING SHOULD BE APPROVED OVER TIME, THOUGH LIKELY NOT BEFORE 4Q 2005
We do not believe that the commission has taken the view that 10-acre spacing will -not- work at Pinedale. Rather, the commission (bolstered by opposition to Ultra's request from Shell) prefers to seek more data from companies that are producing at 20 acres (Questar, Shell, Yates Petroleum, Anschutz). Since we had confidence that 20-acre spacing would be successful at Pinedale prior to the hearing based on the success at Jonah, we continue to believe that it will today, leading to our continued belief that 10-acre spacing will eventually be approved. We expect the commission to receive an update on timing of other 20-acre wells at its June 14 meeting. We then expect Ultra to submit requests for 20-acre spacing/pilots and 10-acre pilots on its Pinedale acreage in time for the commission's July 19 hearing. Even if it receives approval at that meeting, the company would still need permits to be approved by the Bureau of Land Management and get wells drilled and completed, with firmer results expected in early 2006. However, if the commission receives more tangible results from other companies' 20-acre drilling, Ultra's request for 10-acre spacing could be approved in 4Q 2005 in our view.
WHAT 10-ACRE SPACING MEANS TO THE STOCKS
While we believe that 10-acre spacing will ultimately be approved, we continue to look at how Ultra, Questar and Western should be valued if the Pinedale is developed only at 20-acre spacing versus 10-acre spacing. Implicit in our estimated peak values is the assumption that additional wells from 10-acre spacing versus 20-acre spacing do not get drilled until 10 years from now (i.e. no drilling acceleration). For Ultra, we continue to see upside to a split-adjusted peak value of $30 per share assuming 10-acre spacing, versus $23 per share assuming only 20-acre spacing. At Questar, we assume a peak value of $76 per share at 10 acres versus $67 per share at 20 acres. And at Western Gas, we assume a peak value of $42 assuming 10 acres versus $38 at 20 acres. Our valuation of the Pinedale would rise by about 10% per year, and drilling acceleration would improve present value.
ULTIMATELY WE BELIEVE THIS CREATES A BUYING OPPORTUNITY
We would continue to buy shares of Questar and believe that further weakness represents a buying opportunity for Ultra. As noted above, because we do not anticipate that drilling 10-acre locations would in itself accelerate drilling in the Pinedale, we are assuming that the additional wells from 10-acre spacing versus 20-acre spacing do not get drilled until 10 years from now. We are confident that the combination of technology and 20-acre results will allow for 10-acre downspacing to be approved sometime in the next decade, though certainly as highlighted it could and should happen much, much sooner. At Questar, we not only see the potential for growth in Pinedale at 20-acre and 10-acre spacing but believe the E&P business is being overlooked and undervalued in the midst of midstream and regulated assets. At Ultra, further weakness as momentum investors reconsider positions would create an opportunity to buy a company that is best-in-class at growth and returns. We continue to rate Western Gas Underperform, as we see the company as the riskiest among its unconventional gas peers due to greater controversy over potential success from the Powder River Basin.
Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Brian Singer, Arjun Murti. |
