Arena Resources (ARD) Stock Falls 17.5% on Infrastructure Collapse, Furman-Masco

The image portrays the complex geology of its Furman-Masco leases where Arena Resources has “bet the farm.”










Arena Resources (ARD) stock closed on 1 March 2010, at $42.69 and then collapsed $7.47 to $35.22, as company released fourth results and answered questions during its conference call.

Arena Resources has never made my list of worthwhile stocks because it is not involved in any of the hot oil booms and because its founders appear to be promoters rather than real oilmen. Below is the blurb from Arena’s website on the background of these two men.

Lloyd T. (Tim) Rochford, Chairman of the Board / Co-founder For the past 35 years, Mr. Rochford has managed both public and private oil and gas operations. His expertise has resulted in the formation and ultimate sale and merger of 3 oil and gas companies, one of which was listed on the NYSE.

Stan McCabe, Director / Co-founder, For the past 29 years, Mr. McCabe has secured oil and gas leasehold interests, drilled numerous wells, and managed their operations. His expertise was critical in the formation and development of a public oil and gas operator which was listed on the NYSE.

Executive Bonuses: The oilfield is full of promoters; some of them stumble into the big time. Even blind boars find a black gold acorn once in a while. To add executive insult to stockholder injury, during the fourth quarter, Arena Resources executives paid themselves “stock based compensation” of $1.0 million when the earning of the firm were only $9.3 million. Stock compensation was 10.8% of earnings. This is in addition to regular executive compensation.

Fuhrman-Mascho Infrastructure Collapse: The Furman-Mascho is Arena Resources’ great little property where they can still drill hundreds San Andres zone, sour gas (H²S) wells per year. The Furman-Masco is Arena’s main asset; its production is 85% of ARD’s total production.

In the oil patch, infrastructure refers to items necessary to carry supplies to wells and carry production away; these include: roads and electric lines into the field, and natural gas sales pipelines and oil pipelines out of the field.

During the forth quarter of 2010, Arena Resources’ oil purchaser cut them off, its gas purchaser broke down and was down for 21 days, and its electric supply shortages worsened. Combined, these disasters cost ARD a large portion of its revenue. Arena is building a new oil sales pipeline and has already connected a number of their wells to it.

The gas-sales situation will take 18 months to rectify. Apparently, the current purchaser of this sour gas is operating old, junky, and unreliable pipelines and processing plant. The $16 million that it will cost Arena Resources to build their own gas-gathering system and plant is money well spent, but it’s like buying a gun after your store has been robbed.

Their electricity supply horror story sounds like something out of Mexico or even Zimbabwe rather than West Texas. Every time that ARD connects another well to the system, it adds one more 50 horsepower motor. In 2008 they added 221 wells and in 2009 they added 176 wells. In 2010, they will add about 300. Those 697 50-HP motors require a huge amount of electricity.

The electricity supplier’s substation is too small, and it refuses to build a bigger one. I’ve never heard of such a thing. In any event, Arena’s solution, which is probably the correct one, is to spend $4 million to build their own substation. Of course, during the 18 months it takes to build the substation Arena Resources will continue to face the brownouts (and lost production) that it has faced for the last several years. Right solution, but too late.

Bakken Boondoggle: What really burned me up about Arena Resources’ web conference was that at the end of the question and answer period, Arena Resources volunteered that they are considering entering the Bakken play.

Arena knows nothing about the Bakken, and the players already in that league include: (1) giants like ConocoPhillips (COP) that have endless cash to invest, (2) huge aggressive independents like EOG Resources, and (3) a host of smaller highly-Bakken-focused niche players like Brigham Exploration (BEXP). Entering the Bakken four years after the pros entered, would follow Arena’s pattern of being late.

Arena Resources’ Strength: ARD drills shallow San Andres zone gas wells on its Furman-Masco property for about $500K each. These wells have an “estimated ultimately recoverable” (EUR) of 28,000 equivalent barrels of oil. That’s enough to make Arena a great little company, if they stick to it. Concho Resources (CXO) follows a somewhat similar low-risk, medium-reward strategy and does quite well at it.

Present Value of Reserves: For the exciting exploration stocks that I usually cover, present value of reserves discounted at 10% (PV10) is unimportant. For a purely development firm like Arena Resources, PV10 is more important.

ARD’s market capitalization (at last night’s close of $35.22) was $1.36 B, down from $1.65 billion at the previous closing.

ARD’s reported PV10 at $38.30 per barrel of oil is $0.65 billion, and at $57.63/Bbl is $1.12 billion. PV10 calculations assume no oil price increases in the future.

With NYMEX crude selling for about $80 this morning, Arena looks interesting, as the value of the reserves – assuming no long term oil price increases – probably exceeds the price of the stock. I may buy some ARD, if it falls more. If it recovers, I’ll sell taking a trader’s profit. If it does not recover, I hold the stock.

In the long run, owning oil in the ground in Andrews County, Texas, is better that having dollars in the bank or gold buried in the garden.

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Miscellaneous information on Arena Resources:
The company has very little debt; it’s not going to go broke.
Insiders own only 2% of the stock; institutions own 91%.

Wildcat Bob's Investment Philosophy

Why Oil & Gas E&P: Oil exploration and production stocks are important to every American who has discretionary income, because much of our non-discretionary income is spent on gasoline. If gasoline prices go up, you are hurt, unless you own oil stocks.

Oil stocks are your most important personal hedge: U.S. (domestic) E&P stocks are a good hedge against inflation, high oil prices, oil shortages, and a weak dollar. Some of you spend more on food than on gasoline, but I’ve never found a good way to hedge against high food prices.

In my view, oil stocks are a more important hedge than owning gold.

Peak oil or just short supply with high prices? I don’t know whether “peak oil” has occurred or if it will occur within the next few years. I do strongly believe that increased demand for oil and increasingly hard to find oil will result in higher oil prices. In my view, the peak-oil question is irrelevant to the decision to own oil stocks.

Domestic, Foreign, or Offshore? I focus only on U.S. onshore petroleum companies. Offshore (even in the Gulf of Mexico) is harder to analyze and more subject severe weather. Foreign exploration is harder to analyze, subject to political risk, war risk, and risk of sabotage.

Integrated versus E&P. The huge firm – like ConocoPhillips (COP) and Exxon Mobil (XOM) – are not oil exploration and production firms. They are huge, international conglomerates that are involved in refining, plastics, oil pipelines, natural gas-gathering systems, plastics, retail gasoline stations, credit cards, and a host of other things in many countries. Finding oil in the U.S. occupies less of their top executives’ time than does lobbying in Washington.

I generally don’t invest in super-large independent oil firms such as XTO Energy (XTO, market capitalization $26 billion) or Chesapeake Energy (CHK, MktCap = $17 Billion). They are too big to give much information on individual wells or lease holdings in various exploding oil fields. Also, these firms are natural gas heavy and oil light. I do study what they say, and they are potential takeover targets for the integrated oil firms. Exxon recently moved to acquire XTO.

Firms like Petrohawk (HK, MktCap = $6 billion) are about as big as I go.

Diversified portfolio versus accepting non-systematic risk. Except for cash, I don’t own anything but oil stocks. Yes, that subjects me to what professors call non-systematic risk. I bet on oil stocks and the professors bet on “the market,” as represented by the S&P 500 or the Dow Jones Industrial Average (DJIA). I am negative on the long-term prospects for the economy. Why should I invest in banks stocks, retail stocks, etc. when I think their long-term prospects are poor!?!

This focus allows me to actually learn something about the stocks I own.

Non-Technical Analysis: I am not a technician. All those graphs are pure gobbledygook to me.

Non-fundamental Analysis: I’m not a fundamentalist. I do not look at PE’s, try to predict earnings, etc. The only financial thing I look at for these small oil exploration companies is whether or not they can cover their CapEx E&P budget. Most of them are experts are predicting and adjusting CapEx to fit cash flow. I also do not look at proved reserves; the Wall Street geeks study this and I believe it is built into the price of the stock.

What I do Focus on: An oil company leases unique land, drills, and it either hits oil or it does not. If its new wells are excellent, the stock will go up. I focus evaluating their claims for leasing, discoveries, and production. Leasing and drilling are the blocking and tackling for oil companies.

I listen to all the management webcasts (often I listen to it twice) and try to evaluate management quality. Are they real oilfield guys or just promoters? In a webcast, they must handle themselves well, be knowledgeable, and honest. This is subjective.

For objective analysis, I study the firm’s “presentations” on their websites, and their press releases. They present past leasing and drilling success and their plan for the near-term future.