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Ernie Park

EAC AT A GLANCE

P/E ► 4.12 LOW EV/EBITDA ► 3.05 AVG ROA ► 14.7% HIGH ROE ► 34.8% HIGH Debt to Equity ► 1.58 AVG Current Ratio ► 0.844 AVG Interest Coverage Ratio ► 10.6 AVG

 

 

 

 

 

 

Revenue, Net Income, and Net MarginRevenue, Gross Profit, and Gross MarginOperating IncomeEbitIncome Before TaxesNet Income from Continuing OpsInterest vs Continuing IncomeInterest CoverageOperating ExpensesSG&AAmortization & Depreciation

Encore Acquisition Company (NYSE: EAC) is an independent oil & gas company that operates in the famed Bakken Shale - rumored to have up to 400 billion bbls of recoverable petroleum.^[1] In 2007, Encore also had 231MMBOE^[2] of proved reserves (81% oil, 19% natural gas) and produced 13.54MMBOE.^[2]

Record oil prices have driven record revenues all throughout the oil industry and Encore is no exception; while EAC was selling oil at $58.96/bbl^[2] in 2007, Q2 of 2008 saw oil reach $116.64/bbl^[3] which helped push first half revenues to $486.69M^[4], well over half of its 2007 revenue. Despite these revenues however, Encore's use of derivatives to hedge against the price of oil lost the company $259M^[5] in potential revenue halfway through 2008.

To stay strong against competition, Encore has been exploiting many of the projects that it discovered in 2006, including the Bakken Shale in North Dakota and Montana. As the United States tries to lessen its foreign energy dependence, the Bakken has enormous potential, which Encore is in a position to exploit.

[edit] Company Overview

Encore's plans in 2007 were to sell its assets in areas where it was not the dominant player, refocus its energy on the Rockies, and develop projects with strong potentials. ^[6] The plan was a success in terms of a 20% increase in production. ^[6] Increased production in conjunction with record oil prices have led to record revenues for Encore through its oil and gas sales which totaled $712.924M^[2] in 2007 - a 44.52% increase over the previous year. Encore's main customers are major oil companies such as Eighty-Eight Oil which accounted for 14%^[7] of its total sales in 2007, as well as Shell Trading Company, ConocoPhillips (COP), and others.

In 2007, Encore sought to be bought out as it believed its assets were undervalued; however on August 6, 2008, management took the company off the market. ^[8]

A spike in oil prices through the first half of 2008 have driven Q1 and Q2 profits to a record $486.69M^[4]; however, Encore's net income has decreased to only $13.04M^[4] due to a $259M^[5] loss in potential revenue due to the use of derivatives to hedge against the price of oil. Nevertheless, Encore continues to increase production with an average of 38,214 BOE/d in Q2 of 2008, up from 36,842BOE/d.^[9]

[edit] Segments by Geography

Breakdown of Total Proved Reserves by Region as of 12/21/07^[10]

• The Cedar Creek Anticline (50%^[11] of Total Proved Reserves, 4.409MMBOE^[11] Production in 2007) is Encore's most valuable region in terms of proved reserves. Located by the border of Montana and North Dakota, it contained approximately 3.3Bbbl^[12] of oil when discovered. Average daily production was 12,640BOE/D^[10] in 2007.
• The Permian Basin (20%^[10], 2.703MMBOE^[10]) includes properties in West Texas and New Mexico. In West Texas, Encore invested over $120M and drilled 66 gross wells to develop its properties in 2007. ^[13]
• The Rockies (22%^[10], 3.622MMBOE^[10]) encompasses Montana, North Dakota, Wyoming, and Utah. Most notable in this region is the Bakken Shale formation, a relatively new oil field in Montana and North Dakota that is estimated to have upwards of 400BBbl^[1]of recoverable oil. Significant acreage acquisitions in this area have led to an increase in average daily production from 978BOE/d to 6363BOE/d^[14] from 2006 to 2007.
• The Mid-Continent (8%^[10], 2.560MMBOE^[10]) includes properties in Oklahoma, Arkansas, East Texas, Kansas, and North Louisiana. Encore sold properties in the Anadarko and Arkoma fields in 2007 which contributed to a decrease in production from 30,430Mcfe/d to 8,555Mcfe/d^[15] from 2006 to 2007.

[edit] Trends and Forces

[edit] Encore's Business is Tied to Oil Prices and Derivatives

Since 2003, the price of a barrel of crude oil has risen from $33 to over $120 in 2008 (adjusted for inflation). ^[16] Encore and its competitors have benefited significantly from the spike in prices; in Q2 of 2008, Encore was selling oil at $116.64^[3] a barrel compared to $51.92^[3] at the same time in 2007. Furthermore, 2008 first half oil revenues were $507.45M^[17], 133% more than the $218.2M made in 2007. In addition, first half revenues in 2008 were $630.236M^[18] compared to $320.185M^[18] in 2007.

Encore uses derivatives in order to hedge against the price of oil. However, in 2008, the price of oil peaked and Encore sold oil for much less than its market value. The sum of Encore's fair-value loss in derivatives totaled $259M^[5] in the first half of 2008. Subsequently, despite record revenues, Encore lost $55.92M^[5] in Q2 of 2008.

[edit] Alternative Energy and High Oil Prices Lower Demand

While high oil prices have driven record revenues for Encore, it is potentially a double-edged sword for oil companies. Despite increased demand in developing countries such as India, the United States demand for oil has declined due to decreased affordability for consumers. Subsequently, since a peak in July of $147/bbl, oil plunged to $110.97^[19] in September of 2008.

High prices in conjunction with concerns over the environment have driven the alternative energy industry that is attempting to alleviate dependence on oil. Solar panels, wind turbines, nuclear reactors, biofuels, and other sources of energy are threatening the long term sustainability of the oil industry. More and more economically conscious consumers are purchasing cars that rely on energy besides oil and decreasing their energy consumption.

This is also tied to the concept of peak oil; since oil is a finite resource, there is a point in time where production will peak and then decline until there is no more oil left. Once the peak has been surpassed, oil prices will skyrocket because of less production and greater demand due to the natural increase in global population. This will only further increase the need for alternative energy sources. Estimates for peak oil range from 2000 to 2025. ^[20]

In August of 2008, oil deliveries to the United States (which is a barometer for demand) dropped 3% from 2007 despite a drop in crude prices from the beginning of the summer.^[21] Lowered consumer confidence and a weakened economy have contributed to the decrease in demand.

[edit] The Bakken Shale Formation is Booming and Encore is a Player

Encore has put emphasis on acquiring properties in the Bakken and owns 178,000 acres^[22] there; the U.S. Geological Survey estimates there are upwards of 400 billion barrels^[1]of recoverable oil in the Bakken- an amount that is sufficient to meet US oil needs for 20 years.^[23] Stretching across parts of North Dakota, Montana, and Southern Saskatchewan^[23], better technology and techniques such as horizontal drilling are giving way to the development of the full Bakken Formation; higher oil prices also make drilling there more economical.

Drilling in the Bakken has been successful for Encore thus far and has spurred an acceleration in the drilling of wells to increase production^[6]. Surpassing original plans to have three rigs in the Bakken by January of 2009, Encore will have four rigs in place by that time.

[edit] Competition

Encore competes with several other companies in many of the same fields and regions to produce and acquire gas and oil. Main competitors include:

• Whiting Petroleum (WLL) operates in the Permian Basin, Rockies, Mid-Continent, Gulf Coast, and Michigan ^[24] and has 78% of its 250.8MMBOE^[25] total proved reserves in oil. Whiting is a player in the Bakken formation with 96,500 net acres ^[22]
• Continental Resources (CLR) has properties in the Rockies, Mid-Continent, and the Gulf Coast. ^[26] 77% of its 134.6MMBOE^[26] of proved reserves is crude oil. Continental competes with Whiting in the Bakken with 271,667 net acres^[27] in the North Dakota Bakken as well as 64,536 acres^[27] in the Montana Bakken, all undeveloped.
• XTO Energy (XTO) has properties in the Eastern, North Texas, San Juan, Permian & South Texas, Mid-Continent, and Rocky Mountain regions. In May of 2008, XTO purchased 352,000 net acres in the Bakken for $1.85B. ^[22] 12.82%^[28] of its total reserves were oil in 2007.
• Denbury Resources, Inc. (Holding Company) (DNR) owns properties in Eastern and Western Mississippi, Texas, Alabama, and Louisiana. 69%^[29] of its reserves is oil.

• Note: Some companies have other forms of reserves beyond oil and natural gas.

[edit] References

1. ↑ ^{1.0 1.1 1.2} Bloomberg Special Report: Dakota Oil Fields of Saudi-Sized Reserves Make Farmers Drillers
2. ↑ ^{2.0 2.1 2.2 2.3 2.4 2.5 2.6}
3. ↑ ^{3.0 3.1 3.2} EAC 10-Q Q2 2008, "Results of Operations", Page 33
4. ↑ ^{4.0 4.1 4.2 4.3 4.4} Google Finance: EAC
5. ↑ ^{5.0 5.1 5.2 5.3} EAC 10-Q Q2 2007, "Consolidated Financial Statements", Page 12
6. ↑ ^{6.0 6.1 6.2} EAC 2007 Shareholder's Report
7. ↑ EAC 10-K 2007, "Major Customers", Page 82
8. ↑ Seekign Alpha: Encore Acquisition Takes Itself Off the Market
9. ↑ EAC Q2 2008 Results
10. ↑ ^{10.0 10.1 10.2 10.3 10.4 10.5 10.6 10.7} EAC 10-K 2007, "Properties", Page 16
11. ↑ ^{11.0 11.1} CCA 10-K 2007, "Properties", Page 18
12. ↑ Forbes: Down and Dirty
13. ↑ EAC 10-K 2007, "Properties", Page 19
14. ↑ EAC 10-K 2007, "Properties", Page 21
15. ↑ EAC 10-K 2007, "Properties", Page 20
16. ↑ Forbes: Crude Oil Prices 1861-2008
17. ↑ EAC 10-Q Q2 2008, "Results of Operations", Page 38
18. ↑ ^{18.0 18.1} EAC 10-Q 2008, "Consolidated Statements of Operations", Page 2
19. ↑ Yahoo Finance: Oil prices rise before US Inventory Data
20. ↑ Peak Oil
21. ↑ Energy API: US Oil Demand and Prices Slip in August 2008
22. ↑ ^{22.0 22.1 22.2} Investopedia: The Bakken Shale Story
23. ↑ ^{23.0 23.1} Wealthy Daily: The Bakken Oil Field
24. ↑ WLL 10-K 2007, "Summary of Oil and Gas Properties and Projects", Pages 27-31
25. ↑ Whiting Petroleum 2007 Annual Report
26. ↑ ^{26.0 26.1} CLR 10-K 2007, "General", Page 1
27. ↑ ^{27.0 27.1} CLR 10-K 2007, "Bakken Field", Page 8
28. ↑ ^{28.0 28.1} XTO 10-K 2007, "Selected Financial Data, Page 26
29. ↑ ^{29.0 29.1} DNR 10-K 2007, "Selected Financial Data", Page 29
30. ↑ WLL 10-K 2007, "Production History", Page 32
31. ↑ WLL 10-K 2007, "Selected Financial Data", Page 38
32. ↑ WLL 10-K 2007, Proved Reserves", Page 9
33. ↑ Google Finance: XTO
34. ↑ Google Finance: DNR
35. ↑ CLR 10-K 2007, "Production and Price History", Page 11
36. ↑ CLR 10-K 2007, "Management's Discussion and Analysis of Financial Condition and Results of Operation", Page 32