Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale - Bloomberg

9/8/14, 11:26 PM Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale - Bloomberg
Page 1 of 12 http://www.bloomberg.com/news/2014-09-08/halcon-s-wilson-drills-more-debt-than-oil-in-shale-bet.html
Drillers Piling Up More Debt Than Oil Hunting
Fortunes in Shale
Floyd Wilson raps his fingertips against the polished conference table. Hes just
been asked, for a second time, how he reacted when his Halcon Resources Corp.
(HK) wrote off $1.2 billion last year after disappointing results in two key
prospects.
Wilson once told investors that the acreage might contain the equivalent of 1.2
billion barrels of oil. He fixes his interlocutor with a blue-eyed stare and leans
forward. At 67, he bench-presses 250 pounds (110 kilograms) and looks it. Outside
the expansive windows of his 67th-floor executive suite, downtown Houston steams
in its July smog.
He responds, unsmiling, with a one-syllable obscenity: F---.
Photographer: Michael Friberg/Bloomberg
Markets
Halcon Resources Corp. Chief Executive
O!cer Floyd Wilson sold his previous
company,... Read More
Wilson has reason to curse, Bloomberg Markets magazine will report in its October
issue. On the wall behind him hang framed stock certificates of the four public
energy companies hes built in his 44-year career. The third, Petrohawk Energy
Corp., discovered the Eagle Ford shale, now the second-most-prolific oil formation
in the country. He sold Petrohawk three years ago for $15.1 billion.
Then came Halcon. Since Wilson took over as chairman and chief executive officer
in February 2012, the companys shares have dropped by about half, trading at
$5.67 on Sept. 5.
Halcon spent $3.40 for every dollar it earned
from operations in the 12 months through June
30. Thats more than all but six of the 60 U.S.-
listed companies in the Bloomberg Intelligence
North America Independent E&P Valuation
Peers index. The company lost $1.4 billion in
those 12 months. Halcons debt was almost $3.2
billion as of Sept. 5, or $23 for every barrel of
proved reserves, more than any of its
competitors.
Uh-Uh
Wilson is undeterred. What do you do if youre
wrong? You go home and cry? he asks. He
shakes his head. Uh-uh.
A decade into a shale boom that has made
fracking a household word and Wilson a rich
man, drillers are propping up the dream of U.S. energy independence with a
mountain of debt. As oil production hits a 28-year high, investors and politicians
are buying into the vision of a domestic energy renaissance.
Companies are paying a steep price for the gains. Like Halcon, most are spending
money faster than they make it, an average of $1.17 for every dollar earned in the 12
months ended on June 30. Only seven of the U.S.-listed firms in Bloomberg
Intelligences E&P index made more money in that time than it cost them to keep
drilling. (Results for two companies included only the first six months of 2014.)
Cash Shortfalls
Photographer: Michael Friberg/Bloomberg
Markets
Roughnecks connect pipe that's attached to
a drill bit 12,000 feet underground at a...
Read More
These companies are plugging cash shortfalls
with junk-rated debt. They owed $190.2 billion
at the end of June, up from $140.2 billion at the
end of 2011. (Six of the 60 companies that
didnt have records available for the full period
werent included.)
Standard & Poors rates the debt of 41 of the
companies, including Halcons, below
investment grade, meaning some pension funds
and insurance companies arent allowed to
invest in them. S&P grades Halcons bonds
CCC+, which the rating company describes as
vulnerable to nonpayment.
Money manager Tim Gramatovich sees disaster
looming in the industry.
I have lent money to nobody in this space, and
I dont plan to. This thing is absolutely going to blow sky-high, says Gramatovich,
chief investment officer of Peritus Asset Management LLC in Santa Barbara,
California. The firm manages investments of about $1 billion, including the debt
and equity of oil and gas companies that arent drilling shale.
Proved Reserves
Halcons recent lousy run shows how quickly a bright future can dim. Like many of
its peers, Halcon uses two sets of numbers to describe its outlook. To the U.S.
Securities and Exchange Commission, the company reports whats known as
proved reserves.
The SEC requires an annual tally and limits these calculations to what the firm is
reasonably certain it can extract from existing wells and other properties scheduled
to be drilled within five years, based on factors such as geology, engineering and
historical production.
To investors and lenders, Halcon also highlights a much higher figure that it calls
resource potential. These estimates, while loosely defined by industry guidelines,
dont follow the SEC rule or timeline, as Halcon discloses at the beginning of its
presentations. In fact, as Halcon notes, the SEC forbids companies from making
resource-potential claims in official reserve reports. The agency doesnt regulate
what companies say at investor conferences, in press releases or on their websites.
No one does.
Honored Tradition
Discrepancies between proved reserves and resource potential are common in the
industry, and investors can get duped, says Ed Hirs, a managing director at
Houston-based Hillhouse Resources LLC, an independent energy company, who
also teaches energy economics at the University of Houston.
Theres a lot of ways to make money in the oil and gas business, and not all of them
involve drilling for oil, he says. You just drill investors pocketbooks. When
investors are willing to throw money at you, you can just make money on that. Its a
time-honored tradition.
Halcons August investor presentation for EnerCom Inc.s Oil & Gas Conference
in Denver illustrates how far apart the figures can be. The company told investors it
had resource potential equal to 1.3 billion barrels of oil. Thats almost 10 times the
proved reserves it reported to the SEC at the end of 2013.
Asked in the July interview how much faith investors should put in resource
estimates, Wilson says: They shouldnt put hardly any in them. They should just
put in the idea that theres some upside there. And if the practitioners are good at
what they do or lucky, that upside might get turned into value.
Spectacular Success
It would be easier to dismiss Halcons optimistic estimates if Wilson hadnt
succeeded so spectacularly in the past. Born on a U.S. military base in Georgia, he
earned a bachelors degree in engineering from the University of Houston and
started in the oil business in 1970.
Wilson says he made a poor employee, so he struck out on his own. He sold the first
company he took public, Hugoton Energy Corp., to Chesapeake Energy Corp.
(CHK) for $326 million in 1998, SEC records show. His second, 3TEC Energy
Corp., was bought by Plains Exploration & Production Co. for $417.6 million in
2003, SEC records show.
Wilson moved on to Petrohawk in 2004, confident hed sell the company in three
years. When he didnt, he led Petrohawk into new and untested shale plays. The
gamble paid off.
Rewarding Shareholders
In 2008, while under shareholder pressure to cut spending and reduce debt, Wilson
and his team made the discovery of a lifetime -- the Eagle Ford formation, now
pumping 1.5 million barrels of crude and 6.5 billion cubic feet (184 million cubic
meters) of natural gas every day.
His sale of Petrohawk in 2011 to BHP Billiton Ltd. was the second-largest
transaction in North Americas oil and gas industry in more than five years, trailing
only Exxon Mobil Corp.s $35 billion purchase of XTO Energy Inc. in 2010,
according to data compiled by Bloomberg.
Ive done really well for all the shareholders every single time, Wilson says. Those
numbers are out there in the public. I dont have to prove it.
Buoyed by the Petrohawk triumph, Wilson and his partners put up $55 million and
took over Tulsa, Oklahomabased RAM Energy Resources Inc. in February 2012.
A further $550 million came from EnCap Investments LP, a private-equity firm that
had previously backed Wilson. In honor of their recent success, Wilson and his
partners renamed the company Halcon, Spanish for hawk.
Biggest Prospects
Six weeks later, in April 2012, Wilson told investors attending the Independent
Petroleum Association of America conference at the Sheraton Hotel near New
Yorks Times Square that Halcons companywide resource potential was 1.4 billion
barrels. The number was striking because it was 66 times higher than the proved
reserves Halcon reported to the SEC in March 2012.
The Halcon slide show outlined the two biggest prospects: 875 million barrels in the
Utica shale, which stretches across Pennsylvania, Ohio and West Virginia, and a
further 306 million in the Woodbine in East Texas. Footnotes say Halcon had yet
to drill a single well in either location.
Investors were eager to back Halcon. It raised $2.1 billion in bonds in the 12 months
following the April presentation. The Canada Pension Plan Investment
Board, a $227 billion fund that manages retirement assets for 18 million
Canadians, paid $300 million for an 11.4 percent equity stake in October 2012. Mei
Mavin, a spokeswoman for the pension board, declined to comment.
Really Excited
As the months passed, Halcon had trouble turning the potential into proved
reserves. Wilson sounded optimistic. During an August 2013 conference call, he
says, Were really excited about our Utica/Point Pleasant asset.
Wilson says a Halcon well was one of the most important in the play and, though
some of its acreage was goat pasture, the company was preparing for full-scale
development of the Utica.
Three months later, the company reported a write-off of $1.2 billion, largely related
to the Utica and Woodbine plays. Halcon sold its Woodbine acreage for $450
million in February 2014. After almost two years of drilling, Halcon reported to the
SEC in March 2014 that it had 16.4 million barrels of proved reserves in the Utica
and Woodbine -- the same acreage that Wilson had said in April 2012 contained the
potential for 1.2 billion. The estimated bonanza had simply evaporated -- eliciting
Wilsons four-letter obscenity.
Resource potential, which means Who knows? he says in the July interview. But
its possible. Resource potential down in the Eagle Ford of south Texas increased
10-fold over time. So our business can be rough. It can go either way.
Blackland Prairies
Halcons latest prospects lie beneath the oak woods and blackland prairies north of
Houston, in its El Halcon prospect, and under the arid plateaus of western North
Dakota, where the company is drilling the Bakken shale. The two plays account for
most of Halcons production.
Wilsons biggest gamble is on 315,000 acres (127,000 hectares) of unproven
Tuscaloosa Marine Shale, known as the TMS, a layer of rock stretching from
Louisianas western border to southwestern Mississippi.
It has to work for them, says Leo Mariani, a senior analyst at RBC Capital
Markets LLC in Austin, Texas. If the acreage doesnt work out and they cant get
the costs down, theyre going to be in big trouble.
Engineering Challenge
Squeezing oil from the TMS is an engineering challenge. The formation is 2 miles
underground through rock interlaced with rubble and sand. On a humid July
morning, a sign in the red clay of Wilkinson County, Mississippi, announces
Halcons Fassmann 9H-1 well. A Helmerich & Payne Inc. Flex3 rig rises above
the clearing. A monitor in the air-conditioned supervisors trailer shows the drill bit
has reached a depth of 12,000 feet (3,660 meters).
Progress is slow. In the rig operators cabin 30 feet up, one man steers a circulating
bit screwed to the end of 2 miles of pipe, monitoring progress on a bank of flashing
screens. The bit must pierce the TMS horizontally in the right spot. His margin of
error: 5 feet.
Gibbous Moon
He misses. Frustration is thick as the temperature climbs to 91 degrees Fahrenheit
(33 degrees Celsius). The hours slip by, measured in feet of pipe. As a near-full
moon rises, a relief crew dressed in fire-retardant jumpsuits emerges, already
sweating, from bunkhouses at the edge of the clearing. Heat lightning flashes in
purple clouds to the south. Its after 9 p.m. when a supervisor gets a message. The
drill has veered off course. Its time to try again.
At more than $13 million apiece, Halcons wells in the TMS are the companys most
expensive. Halcon abandoned its first well, the Broadway H1, after an underground
casing failed. It has two producing wells in the play. Three others are in progress.
Wilson says Halcon has enough cash to keep trying and no imminent debt
payments. Funds associated with Apollo Global Management LLC (APO), a
New Yorkbased private-equity firm, committed as much as $400 million in June
to help Halcon pay for drilling in the TMS in exchange for a 12 percent return and a
4 percent royalty on whats produced. Thats reduced to 2 percent after a threshold
return has been met, Apollo says.
Might Work
I dont know how many times you can be wrong, Wilson says. Ive never been
wrong that many times. If your concept is that the Tuscaloosa Marine Shale might
work or might not work, theres a lot that feel that way in the industry. But theres
also quite a few that think it will work.
Wilson doesnt need to look far to see what happens when things go wrong. His
office used to belong to executives of once-bankrupt electricity wholesaler Dynegy
Inc. (DYN), which emerged from Chapter 11 in 2012. The custom wood paneling,
fancy for his tastes, has been papered over with colored maps of drilling prospects.
Taken together, Halcons 1 million acres could cover Rhode Island. Wilson asks a
visitor not to look closely; he doesnt want to give away his next move.
Resource Potential
Wilson says proved-reserve numbers arent as important as the companys resource
potential.
Its whats in the future that really matters to us, he says. So the resource
potential is what were all about.
If the TMS works, Halcon predicts an enormous payoff. In September 2012, a
presentation for the Barclays Capital CEO Energy-Power Conference showed the
resource potential of Halcons TMS properties equaled 373 million barrels of oil.
Wilson says the estimate is much higher now. The company says it no longer gives
resource estimates by play.
With the U.S. bent on energy independence and investors chasing riches from the
fracking boom, theres one other number to consider. Halcons proved reserves
from the TMS reported to the SEC: zero.
To contact the reporter on this story: Asjylyn Loder in New York at
aloder@bloomberg.net
To contact the editors responsible for this story: Bob Ivry at
bivry@bloomberg.net; Michael Serrill at mserrill@bloomberg.net Gail
Roche, Jonathan Neumann

Drillers Piling Up More Debt Than Oil Hunting Fortunes in Shale - Bloomberg

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