7 Oil and Gas Stocks With Continued Upside: Part VI

As the sixth installment of stocks with continued upside, I will focus on companies with a market cap of 2.7 billion or greater. Unit Corp. (UNT) has three sections of business:

1. Unit Petroleum Company: Oil and Gas Exploration and Production
2. Unit Drilling Company: Contract Drilling
3. Superior Pipeline Corp.: Mid-Stream

I wrote an article on Unit's contract drilling business, found here. Unit's petroleum company also stands to benefit from the run-up in oil price. It has proven reserves of 104 MMBoe and 80% is proved developed. Unit's 122 rigs are what make the difference here. Its petroleum company doesn't have to wait to contract rigs, nor does it have to worry about increasing contract prices.

The integration of these two businesses creates an interesting synergy. Since 2001, Unit has had a 191% average production replacement. Unit has reserve life of approximate 10 years. Unit has begun to increase its liquids production significantly. By the end of this year, Unit estimates it will be producing 38% liquids or 7% more than 2010. It will be focusing on oil plays in the Granite Wash, Marmaton, and Segno. 70% of its rigs are horizontal-capable with average HP of 1200. The combination of Unit's ability to increase reserves and production, while increasing liquids exposure, bodes well for this company.

Forest Oil Corp. (FST) is beginning to look promising. It has prime areas for oil development:

• Eagle Ford: 105000 net acres
• Granite Wash: 101000 net acres
• East Texas/North Louisiana: 169000 net acres
• Deep Basin: 131000 net acres
• Evi/Red Earth: 41000 net acres

Forest has thousands of identifiable locations:

• Eagle Ford: 1015 gross locations
• Granite Wash: 1034 gross locations
• East Texas/North Louisiana: 3270 gross locations
• Deep Basin: 744 gross locations
• Evi/Red Earth: 213 gross locations

80% of Forest's capex is going to liquid-rich horizontal plays. The Granite Wash is the most significant investment, followed by Evi/Nikanassin, and then the Eagle Ford. Forest has stated it will invest significantly more in the Eagle Ford, depending on success. 50% of total capex will be spent on the Granite Wash with a six-rig program. This should equate to an approximate 40 horizontal wells.

The Eagle Ford seems to be the biggest variable for success, with two rigs drilling in 2011. The first well will be completed sometime this quarter, with eight wells planned. Forest has stated it will employ significant capital, pending results. The entire acreage is in the oil window. In summary, it is difficult not to like this company. It has 15456 identifiable drilling locations. Forest has over 500000 net horizontal shale acres in North America. Due to the high level of possible oil reserves, production can be increased significantly.

Brigham Explorations (BEXP) is one of my favorite stocks. Its Williston Basin drilling program is largely de-risked with an approximate 205300 net core acres. Brigham has achieved an average peak rate of 2884 Boe/d with respect to its 56 ND Bakken/Three Forks long laterals. This core acreage has 724 net developed locations. There is an opportunity to grow 1209 net developed locations based on Rough Rider Three Forks potential. Brigham estimates each well will generate an NPV of $12 million. An undiscounted payback of 1.2 years is expected.

By September of 2012, Brigham will increase its rig count from seven to 12. This will create a gross well annual run rate of 132. Oil volumes grew 81% and reserves increased 141%.

Brigham wells continue to have the top IP rates in the Bakken. With what may be the best acres in the Bakken/Three Forks, and a large inventory of locations to drill, Brigham will grow fast. For a more in-depth look at the company, see here.

SM Energy (SM) is a solid company with several promising shale plays in the United States. SM had a great year in 2010. It experienced a record net income, and near record production. SM grew 35% in net production from the fourth quarter of 2009 to the fourth quarter of 2010. I like the prospects of the oil window in the Eagle Ford for SM. SM has delineated geology and secured services for take out capacity and completion and production services. SM also continued its success in the Bakken. Horizontal testing of its Granite Wash and Niobrara properties were completed. SM also accomplished a down spacing pilot in the Wolfberry play.

In 2010, proved reserves grew 27%. It had a drilling replacement of 349%. SM has stated it will continue to increase oil and rich gas production. It is aiming for 20% production growth this year. It plans to invest in the Eagle Ford and Bakken/Three Forks to accomplish this. SM's capex program will be funded by cash flow and asset sales. Total drilling capex for this year is estimated to be $840 million. 90% of this capital will be invested in liquids; 60% will be invested in the Eagle Ford, with an additional 20% going to the Bakken. SM has 250000 net acres in the Eagle Ford, with all in either the oil or rich gas window.

Currently there are three rigs running, with another three to be added sometime this year. Nine rigs are currently in the non-operated areas of the Eagle Ford. A tenth will be added in the second quarter of 2011. It has 85000 net acres in the Bakken/Three Forks. SM has an additional 120000 net acres in its legacy plays. It has two rigs running, with a third to be added sometime this year. 34 gross wells are planned to be drilled in 2011. For a more in depth explanation of this company, see here.

Plains Exploration and Production Company (PXP) is trying to make a change in production from gas to liquids:

• 2009: 7% of capex was spent on oil and liquids.
• 2010: 34% of capex was spent on oil and liquids.
• 2011: An estimated 73% of capex will be spent on oil and liquids.

Capital allocation in 2011 is estimated to be:

1. 23% Eagle Ford
2. 23% California
3. 20% Other Capital
4. 18% Haynesville
5. 16% Granite Wash

In California, Plains has 211 MMBoe of net reserves. The average well will cost $1.2 million and will have an EUR of 135 MBoe. Plains has 60000 net acres in the Eagle Ford oil and gas condensate windows. Plains will have up to six rigs running there in 2011. Plains has a possible 500 net locations in the Eagle Ford. The estimated well cost is $7 million with an estimated gross resource per well of 483 MBoe. Plains has 54000 net acres in the Mowry shale play and is drilling its first well here. The Monterey oil shale play contains 86000 net acres for Plains. Exploratory wells will begin after the 3D seismic is completed and analyzed.

Potential resource for Plains is large. Haynesville has potential reserves of 1000 MMBoe, while the other six plays have a total of 690 MMBoe. This is still a gas-heavy company, but the gas is low cost and its oily holdings are long term assets. It also holds 51 million shares of McMoRan Exploration (MMR). Plains believes it can increase reserves 15-20% per year for the next three years. It also believes it can grow production 15-20% per year over that same time frame.

SandRidge Energy (SD) has several locations of consequence:

• Permian: 210000 net acres, 7700 locations, 16 rigs
• Mid-Continent Mississippian: 880000 net acres, 3400 locations, 12 rigs
• West Texas Overthrust: 500000 net acres

SandRidge has total proved reserves of 546 MMBoe. 88% of this is oil. Current production is 63 MBoe/d. Its current reserve life is 24 years. SandRidge has a possible of 19226 locations. 11188 of these locations are oily. This company has a large portion of its resource in the Mid-Continent and Permian. When SandRidge identified oil would be more profitable than gas, it made a major shift which has significantly improved its business. Currently it has 100% of its rigs dedicated to oil. To put this into perspective, SandRidge has more land rigs drilling for oil in the United States then any other company, with the exception of EOG Resources (EOG) and Occidental Petroleum (OXY).

The Permian Basin is in the third-largest oil producing area in the United States and SandRidge is the most active driller. Not only are the economics good, but SandRidge has seen a large appreciation in value per acre. SandRidge has 16 of the 42 rigs drilling and the mixture is estimated at 79% crude. Total cost is $760M/well. If the Nymex strip is used as of 3/18/11, it would equate to a 97% ROR. Since SandRidge bought this acreage at a discount, net investment costs are roughly $11.55/Boe. The costs here are low, so money invested can be recovered over a shorter time frame.

SandRidge's Mississippian oil economics are interesting. These horizontals have an IRR of 152% using strip prices from 3/18/11. It is estimated that these wells with have an EUR of 409Mboe/well. It is $2.7 million to drill and complete these wells. SandRidge's 2011 drilling forecast is 811 wells in the Permian, and 138 wells in the Mid-Continent. SandRidge has 8038 potential gas resource locations. that will be drilled when prices increase. In summary, SandRidge is one of my favorite oil producers. It development of shallow, low cost, and low risk conventional carbonate reservoirs, isn't as sexy as the Bakken but it will make money just the same.

Linn Energy (LINE) is a play on natural gas liquids. Linn increased production 22% in 2010. It replaced 321% of production through organic activities. Linn purchased $1.4 billion worth of oil and natural gas properties. Most importantly, this company is 100% hedged through 2013. Although Linn seems to be a little late to the party, it made significant additions. It spent $196 million on entry into the Bakken/Three Forks. Linn spent $238 million on additions to its Permian acreage. These purchases were 90% liquids and added 3000 Boe/d.

Linn's Bakken position is non-operated with a possibility for additional acreage. This purchase adds 8 MMBoe in total proved reserves. It added 1350 Boe/d of production. It also adds 400 possible drilling locations. Its Permian acreage has 88 MMboe of proved reserves. This area is 78% liquids and provides 12000 Boe/d. The Permian is 19% of Linn's total proved reserves and has 102000 net acres in this location. Linn is the largest public MLP/LLC and is 54% oil and natural gas liquids with 11000 productive oil and natural gas wells. Although hedged, Linn receives 30 cents for every dollar increase in the price of oil through puts and collars. 17% of production is LNG, and since it is unhedged there is upside. In July of 2010, LNG was selling for a little higher then $35/barrel. By March of 2011, it was almost $60. Its Granite Wash production should create an increase in LNG. Linn's large size and good balance sheet allow it to make large acquisitions, which it seems ready to continue with.

From this group, SandRidge and Brigham both look attractive. These have very good management teams and interesting leaseholds. Although SandRidge seems cheap on valuation compared to Brigham, I like Brigham's growth prospects.