PDC Energy (NASDAQ: PETD) is an oil and natural gas exploration and production company with operations focused primarily in the Wattenberg Field of Colorado, including the horizontal Niobrara, the Marcellus Shale development in West Virginia and the Utica Shale in Ohio.

Company Snapshot (May 4, 2012):

Ticker: PETD
Market Capitalization: $741 million
Enterprise Value: $1.27 billion
2011 Average Production: 130.1 MMcfe/d
2011 Proved Reserves: 1,015 Bcfe
Natural Gas Weighted Reserves: 66%
Proved Undeveloped Percentage (PUD%): 54%

Recent Financial Performance:

On May 10, 2012, the company announced Q1’12 operating and financial results for the period ended March 31, 2012. PDC reported Q1’12 net income of $15.8 million, or $0.66 per share, compared to a net loss of $19.9 million, or $0.85 per share during Q1’11. The company’s Q1’12 revenues increased 93% to $100 million, compared to $52 million during Q1’11. Revenues in the quarter are the highest Q1 amount since 2010.

Production increased 25% year over year to 13.1 Bcfe compared to 10.5 Bcfe. The quarterly production rate is the best in the company’s 43-year history. Approximately 36% of Q1’12 production was crude oil and liquids. The company’s cash margin in Q1’12 was $14.22 per BOE, an improvement of 43% compared to 2011’s corresponding quarter.

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OAG360 notes that PDC, like many other oil and natural gas companies, has been diversifying its production stream by targeting oil and liquids rich plays. PDC reported Q1’12 crude oil production and NGL production increased 73% and 54%, respectively compared to Q1’11. Oil and NGLS now make up approximately 36% of PDC’s total production mix. This shift in production mix contributed to a year over year increase in adjusted EBITDA of 26.7% to $74.7 million despite low natural gas prices. In addition to realizing a 2.7% higher realized price from shifting the production mix to an oilier base, the company was able to reduce their operating and general and administrative expense per unit to $15.54 per BOE in Q1 2012 from $18.48 per BOE in Q1 2011, a 15.9% year over year decrease.

Debt continues to be a significant factor for investors looking at the E&P space. As of March 31, 2012, PETD had $414.8 million in total debt compared to $532.2 million at year-end 2011, a 22% reduction. During the quarter, PETD divested the remaining Permian Basin assets for $184 million and used proceeds to reduce outstanding borrowings under its revolving credit facility. We also note that on May 4, 2012, the company’s borrowing base on its revolving credit facility increased to $425 million from $400 million. Pro forma for the May 4 redetermination, PETD has $82 million drawn on its $425 million bank credit facility, $115 million 3.25% convertible debentures that mature in May 2016 , and $203 million in 12% Senior Notes due 2018 which are currently trading at $107.75 with a 10.2% yield. The 12% Senior Notes are callable after February 15, 2013 at $106.00. Analyzed differently, PETD has zero debt due and payable between now and May 2016.

What’s Driving the Oil and Liquids Growth?

The horizontal Niobrara play in the Wattenberg Field of Colorado is not only driving the company’s current total production levels, it is driving PDC’s oil and liquids volumes. During Q1’12, PDC shifted from drilling horizontal and vertical Niobrara wells, to only horizontal wells which resulted in fewer wells being drilled. However, production from PDC’s Wattenberg field itself grew 30% compared to Q1’11, and approximately 54% of PDC’s total production is coming out of the liquids rich Wattenberg.

PDC is currently drilling its 27th horizontal Niobrara well and the company reiterated its estimated ultimate recovery range of between 300 MBOE and 500 MBOE with well costs of approximately $4.2 million per well. PDC mentioned on its earnings conference call that the last 11 wells were trending in the 350 MBOE range. In the earnings presentation, using a 1/31/2012 NYMEX strip price, PDC estimates a 350 MBOE well to have a 96% estimated IRR.

Oil & Gas 360® applied a conservative price deck to calculate an IRR for a 350 MBOE well. Using a price deck of $3/MMBtu for natural gas, $70/barrel for crude oil (and using a 50% of WTI crude oil price for liquids production) Oil & Gas 360® calculated an IRR of 19%. If we give $0 value for the associated produced natural gas, we calculate a Niobrara well on PDC’s acreage needs a $64.84/barrel WTI price to generate a breakeven 10% IRR.

Those familiar with the Wattenberg Field are familiar with the field’s stacked pay zones. E&P companies have drilled vertical wells through the J-Sand, Codell and Niobrara formation and comingled the zones to produce oil and gas for decades. New technology unlocked the horizontal Niobrara which has proven successful. PDC mentioned on its conference call that they have drilled their first horizontal Codell well which shows results “fairly close in line with the horizontal Niobrara” providing an additional future catalyst in the Wattenberg Field.

OAG360 notes that both Noble Energy (NYSE: NBL) and Anadarko Petroleum (NYSE: APC) have drilled horizontal Codell wells in Northern Colorado. NBL said on its Q1’12 conference call that the company drilled its first horizontal Codell well in a section where 31 vertical Codell/Niobrara wells have been producing. NBL noted that although it is early in the process, the initial results on the well are promising – promising enough to drill an additional six to eight similar wells this year.

Anadarko was referenced in a recent research report from Johnson Rice mentioning Anadarko has announced five horizontal Codell wells with initial production rates of 627 BOEPD (APC’s Niobrara average is 735 BOEPD).

PDC Energy plans to add a second horizontal rig to the Wattenberg Field in Q3’12 to accelerate its drilling program and has allocated additional capital from its Wattenberg re-frac program to focus on new drill horizontal Niobrara locations. The company anticipates spudding 37 horizontal Niobrara wells in 2012 as it transitions to a pad-drilling system in the Wattenberg. To date, the company has experienced 100% drilling success in the liquid-rich horizontal Niobrara Core Wattenberg drilling program.

Re-Upping on Horizontal Niobrara/Codell – Wattenberg Field Acquisition Provides Room to Bloom

PDC Energy announced on May 14, 2012, the purchase of approximately 35,000 net acres, primarily in the core Wattenberg Field (Weld and Adams Counties, Colorado), for $330.6 million – or $9,446 per acre. The effective date is April 1, 2012 with closing currently scheduled for June 29, 2012. To fund a portion of the deal, PDC announced an underwritten public offering of 6,500,000 shares of common stock at a public offering price of $26.50 per share. The offering is expected to close on May 21, 2012, subject to certain customary conditions. The Company has also granted the underwriters a 30-day option to purchase up to 975,000 additional shares.

Based on the acquired assets current production of 2,800 BOEPD and estimated proved reserves of 29.2 MMBOE (54% proved developed and 58% oil and liquids), the transaction is valued at $118,071 per flowing BOEPD and $11.32 per proved BOE. OAG360 notes that as of May 11, 2012, according to EnerCom’s U.S. E&P database of 90 companies, PDC Energy was trading at an enterprise value to trailing twelve months production and enterprise value to 2011 proved reserves of $59,802 per flowing BOE and $7.56 per proved BOE, respectively.

Pro forma the acquisition, PDC has approximately 109,000 net acres in the Wattenberg Field (103,000 in the “Core” Wattenberg Field) with approximately 546 gross horizontal Niobrara drilling locations that is held by production. PDC’s net production level and net proved reserves in the Wattenberg increased to approximately 15,600 BOEPD (60% liquids) and 106 MMBOE (60% liquids) of proved reserves respectively. 2012 net production is expected to increase to approximately 54.5 Bcfe from continuing operations as a result of the newly acquired assets. OAG360 notes that PDC’s 2012 non-acquisition capital budget guidance remains approximately $284 million.

Applying the transaction valuation above to the 109,000 net acres prospective for the Niobrara formation values PETD’s DJ Basin acreage at approximately $1.0 billion. PDC’s market capitalization on May 11, 2012, was $752 million.

Liquids Production Potential from the Utica Shale in Ohio

PDC made its early entry into the Utica shale in September 2011. Currently, PDC continues to firm up its title on up to 45,000 net acres in Utica Shale play primarily in the wet gas and oil windows in Southeastern Ohio. The company drilled a vertical test well to hold less than 1,000 acres in Belmont County which was a dry gas well that encountered 100 feet of pay. PDC is drilling its 2nd Utica vertical test in Morgan County. This well is central to one of its largest positions making the core analysis and data obtained from the Point Pleasant formation vital for the company’s evaluation After this well is evaluated, PDC plans to drill two horizontal Utica wells in Guernsey County, Ohio.

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