drillers piling up more debt than oil hunting fortunes in shale - bloomberg

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Drillers Piling Up More Debt Than Oil HuntingFortunes 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 steam

in its July smog.

He responds, unsmiling, with a one-syllable obscenity: F---.
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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 Octobe

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 AmericaIndependent 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 itscompetitors.

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 productionhits a 28-year high, investors and politician
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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 1

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


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Photographer: Michael Friberg/Bloomberg

Markets

Roughnecks connect pipe that's attached

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 periodwerent included.)

Standard & Poorsrates 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 bondsCCC+, 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 o

its peers, Halcon uses two sets of numbers to describe its outlook. To the U.S.

Securities and Exchange Commission, the company reportswhats known as

proved reserves.
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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 schedule

to be drilled within five years, based on factors such as geology, engineering and

historical production.


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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 makingresource-potential claims in official reserve reports. The agency doesnt regulate

what companies say at investor conferences, in press releases or on theirwebsite

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

time-honored tradition.

Halcons August investor presentationfor EnerCom Inc.s Oil & Gas Conferenc

in Denver illustrates how far apart the figures can be. The company told investors

had resource potential equal to 1.3 billion barrels of oil. Thats almost 10 times the
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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 fir

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, Wilso

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
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transaction in North Americas oil and gas industry in more than five years, trailin

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. Tho

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 th

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 billio

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 th

Utica shale, which stretches across Pennsylvania, Ohio andWest 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 monthfollowing 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. Me

Mavin, a spokeswoman for the pension board, declined to comment.
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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 relate

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 th

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. Bu

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 o

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 fomost 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
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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. Flex3rig rises above

the clearing. A monitor in the air-conditioned supervisors trailer shows the drill b

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. Thedrill has veered off course. Its time to try again.

At more than $13 million apiece, Halcons wells in the TMS are the companys mos

expensive. Halcon abandoned its first well, the Broadway H1, after an undergroun
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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 withApollo 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 resourc

potential.

Its whats in the future that really matters to us, he says. So the resource

potential is what were all about.
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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

[email protected]

To contact the editors responsible for this story: Bob Ivry at

[email protected]; Michael Serrill at [email protected]

Roche, Jonathan Neumann
mailto:[email protected]:[email protected]:[email protected]

drillers piling up more debt than oil hunting fortunes in shale - bloomberg

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