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April 21, 2015 CARRIZO OIL AND GAS CRZO/NASDAQ Initiating Coverage: “Key Largo, Carrizo, baby why don’t we go…” Investment Rating: Market Perform PRICE: $54.44 S&P 500: 2,100.40 DJIA: 18,034.93 RUSSEL 2000: 1,264.92 Significantly reduced capital expenditures in 2015. Focus on low cost Eagle Ford assets to weather economic downturn. Slow production on Niobrara, Utica, and Marcellus in current economic conditions. Good hedges in place and financial flexibility for 2015 Our 12-month target price/range is $58.77 Company Information: Location: 500 Dallas St, Houston TX, 77002 Industry: Independent Oil and Gas Exploration Description: Carrizo Oil and Gas is an independent exploration and production company that focuses on onshore and shale drilling activities in the Eagle Ford, Utica, Niobrara, and Marcellus shales. Key Products & Services: Production of Crude Oil and natural gas. Web Site: Freeman Analysts Brennan Brignac Song Gao Difei Sun John Woolley FREEMAN Reports Please Note: Freeman Reports are produced solely as part of an educational program of Tulane University’s A.B. Freeman School of Business. The reports are not investment advice and you should not and may not rely on them for making any investment decisions. You should consult an investment professional and/or conduct your own primary research regarding any potential investment. Valuation 2014A 2015E 2016E EPS $4.90 $3.31 $5.31 EBITDA $532.98 $487.94 $621.06 EV/EBITDA 3.60x 3.94x 3.09x CFPS $11.08 $9.44 $12.37 P/CFPS 3.75x 4.41x 3.36x Market Capitalization Stock Data Equity Marekt Cap(MM) $2,800.80 52-Week Range: $31.70-$70.49 Enterprise Value(MM) $4,141.30 12-Month Stock Performances 0.61% Share Outstanding(MM) 51.45 Divid end Yield: N.A. Current Floate(MM) 47.90 Book Value Per Share: $23.92 6-Mo. Avg Daily Volume 1,264,537.12 Bata: 1.26

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  • April 21, 2015


    Initiating Coverage: Key Largo, Carrizo, baby why dont we go Investment Rating: Market Perform

    PRICE: $54.44 S&P 500: 2,100.40 DJIA: 18,034.93 RUSSEL 2000: 1,264.92

    Significantly reduced capital expenditures in 2015. Focus on low cost Eagle Ford assets to weather economic downturn. Slow production on Niobrara, Utica, and Marcellus in current economic conditions. Good hedges in place and financial flexibility for 2015 Our 12-month target price/range is $58.77

    Company Information:

    Location: 500 Dallas St, Houston TX, 77002 Industry: Independent Oil and Gas Exploration Description: Carrizo Oil and Gas is an independent exploration and production company that focuses on onshore and shale drilling activities in the Eagle Ford, Utica, Niobrara, and Marcellus shales. Key Products & Services: Production of Crude Oil and natural gas. Web Site:

    Freeman Analysts Brennan Brignac Song Gao Difei Sun John Woolley

    FREEMAN Reports

    Please Note: Freeman Reports are produced solely as part of an educational program of Tulane Universitys A.B. Freeman School of Business. The reports are not investment advice and you should not and may not rely on them for making any investment decisions. You should consult an investment professional and/or conduct your own primary research regarding any potential investment.

    Valuation 2014A 2015E 2016EEPS $4.90 $3.31 $5.31EBITDA $532.98 $487.94 $621.06EV/EBITDA 3.60x 3.94x 3.09xCFPS $11.08 $9.44 $12.37P/CFPS 3.75x 4.41x 3.36xMarket Capitalization Stock DataEquity Marekt Cap(MM) $2,800.80 52-Week Range: $31.70-$70.49Enterprise Value(MM) $4,141.30 12-Month Stock Performances 0.61%Share Outstanding(MM) 51.45 Divid end Yield: N.A.Current Floate(MM) 47.90 Book Value Per Share: $23.926-Mo. Avg Daily Volume 1,264,537.12 Bata: 1.26

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports


    Figure 1: 5-year Stock Price


    Source:Yahoo Finance (As of 4/20/2015)


    Our Freeman Reports analyst team gives Carrizo Oil and Gas a Market Perform rating, and projects a 12-month target stock price of $58.77, a 7.95 percent increase from its April 20, 2014 stock price of $54.44. To reach our target price our team used a weighted average of our PV-10 intrinsic valuation (60 percent), multiple valuation using EV/EBITDA (20 percent), and multiple valuation using P/CF (20 percent). Our projections are based on Carrizos historical performance, industry outlook, and management guidance.

    Carrizos ability to generate returns for shareholders stems from its ability to find, drill, and extract oil for positive net present value (NPV) projects. Cost control is imperative in the current low oil price environment. In the coming years, Carrizo plans to focus on its large Eagle Ford Shale position because it offers well established distribution networks, easily drillable land, and reasonably consistent production numbers based on estimated reserves, and high quality oil, all of which will keep costs down. If oil prices remain low, Carrizo plans to divert capital and assets allocated to other plays to produce more of their existing reserves in the Eagle Ford play because of its cost effectiveness. For 2015, Carrizo has good hedges in place, high concentrations of properties in low cost oil plays, no near term debt obligations due, no upcoming leasehold obligations, and significant liquidity available from its revolver. Carrizo is in a solid financial and operational position to weather the economic downturn in oil.

    Carrizos biggest challenge is low oil prices in 2015. The Niobrara, Utica, and Marcellus plays are uneconomical to produce as a result of low oil prices. The Marcellus play is primarily natural gas, which currently has even weaker pricing than oil. The Niobrara play offers large upside potential for Carrizo, however, the distribution network in the Niobrara play is not developed and the company has no cost effective way to

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports transport its product. In addition, oil prices have significantly impacted operating profit to the firm and as a result Carrizo has had to drastically cut capital expenditure, limiting its ability to explore for and drill new reserves in less developed plays. Carrizo plans to develop its existing reserves in the Eagle Ford play using a three drill rig program in 2015 because the play is the most cost effective. Management plans to focus on the Eagle Ford Shale and keep oil production flat at Q4 2014 levels until oil prices rise, equating to a 17 percent increase in oil production year over year.

    Figure 2: Carrizo Asset Portfolio

    Source: Carrizo Scotia Howard Weil 2015 Energy Conference Presentation


    As an E&P company, Carrizos value is driven by its ability to explore for new reserves, drill new wells, and increase production year over year by replacing the natural decline in well production with new producing wells. Because, Carrizo is currently a price taker in an economic downturn, the companys profitability is dependent on its ability to maintain current production levels at lower well costs. In order to stay profitable, the company will grow production while using a significantly smaller amount of capital expenditure in 2015 than in the previous year. Management plans to drill horizontal wells and produce more from its existing developed plays in order to cut costs while increasing production. Carrizo will cut expenditure on new plays in 2015 in order to whether the oil pricing downturn.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Figure 3: Carrizo CAPEX Budget

    Source: Carrizo Scotia Howard Weil 2015 Energy Conference Presentation

    Significantly Reduced Capital Expenditures in


    As a result of the depressed oil price environment, Carrizos operating profits have decreased leaving the company with less capital to explore for, drill, and produce new reserves. Carrizo has significant liquidity in its revolver with only $210 million drawn from the $800 million revolver in place. However, taking on additional debt in a precarious pricing environment is risky. Carrzio, like many other E&P companies, was forced to cut capital expenditures by nearly 50 percent in 2015. Management provided capital expenditure guidance of $496 million for 2015, down 42 percent from $857 million in the previous year. $377 million (76.17 percent) of Carrizos capital expenditure plan has been allocated to the Eagle Ford Shale because of its cost efficiency.

    The majority of capital expenditures allocated to plays other than the Eagle Ford Shale, is dedicated to exploratory and experimental programs. Carrizos allocation of capital to alternative plays shows that it is looking ahead to when oil prices recover.

    Focus on Low Cost Eagle Ford Assets

    to Weather Economic Downturn

    Carrizo will primarily focus its production efforts on its Eagle Ford assets in 2015. Carrizo has previously developed mature operations in the Eagle Ford Shale. To cut costs, the company plans to drill near existing infrastructure. In an effort to increase production, Carrizo is testing 330 foot downspacing between wells in the area. The company has already reduced the per well cost 21 percent in Q1 2015 compared to FY2014. Carrizo management expects oil prices to recover in the near future and is using this play to keep production stable while waiting for a recovery. Carrizo has 260.5MMBoe of probable reserves in the Eagle Ford valued at $3.11 billion using an SEC PV10 valuation at the end of FYE2014. Carrizo has one rig online in Eagle Ford and plans to bring on two additional rigs in early 2015. Carrizos current Eagle Ford reserves have a SEC PV10 of over $6 billion with a three rig drilling plan according to Management. Management is counting on additional Eagle Ford reserves

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports to drive target growth of 17 percent production year over year. In addition, Carrizo assumes that its probable reserves in the Eagle Ford will be producible. According to management, more than 50 percent of Carrizos undrilled locations are economic (IRR>10 percent) if oil is below $50/Bbl. Specifically, over 80 percent of Eagle Ford Shale locations have a break even cost below $44/Bbl. If price depression lasts through 2016, Carrizo plans to divert assets from other plays to drill in the Eagle Ford shale to continue production growth. Our intrinsic valuation is based on $55/Bbl oil. At that price level, Carrizos Eagle Ford assets generate a rate of return of 29 percent.

    Figure 4: Operating Cash Flow By Region

    Source: Carrizo Scotia Howard Weil 2015 Energy Conference Presentation

    Slow Production in Niobrara, Utica, and Marcellus in

    Current Conditions

    Carrizo plans to aggressively cut capital expenditures, exploration, drilling, and production efforts in its Niobrara and Utica plays. The company is prepared to cut production and turn off wells in the event that the price of oil drops further. Conversely, if oil prices recover, Carrizo is positioned to continue production in its other plays. Carrizo regards operational flexibility as an important competitive advantage in this low oil pricing environment.

    In 2015, Carrizo plans to drill one well and frac two wells in the Utica play, which is a historically low drill count. Most of Carrizos capital expenditure allocated to Utica is allocated to securing leaseholds that will be used two or three years in the future when commodity prices are expected to recover.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Good Hedges in Place and Financial Flexibility for 2015

    Carrizo has $590 million in liquidity available on its revolver and an elected commitment of $685 million at FYE2014. Carrizo has a debt/EBITA ratio of approximately 2.3x which is relatively low in the highly leverage E&P industry. Management guidance states that the company plans to keep debt/EBITDA under a 3.0x target ratio during 2015.

    On 4/14/2015 Carrizo announced that it replaced $600 million in senior bonds with $650 million in new bonds. Carrizo lowered the interest rate on its bonds from 8.625 percent to 6.250 percent, saving the company over $11 million a year in interest expense. The increase in bond offering reflects the companys financial strength and its ability to take advantage of the low interest rate environment.

    In Q1 2015, Carrizo entered into hedging positions to lock in $166.4 million of cash flows, using costless collars for March 2015, through December 2015. The hedges will provide Carrizo with downside protection on prices below the floor of $50/Bbl and allow Carrizo to benefit from an increase in prices up to a ceiling of $66.46/Bbl.

    Specifically, Carrizo has approximately 55 percent of its oil production hedged at a weighted average floor price of $56.91/Bbl and 40 percent of its natural gas production hedged at a weighted average price of $4.29/MMBtu.

    VALUATION The 12 month target price for Carrizo Oil and Gas is $58.77, a 7.95 percent increase from the $54.44 closing price as of 4/20/2015. As a result of the increase in Carrizos expected stock performance, Carrizo Oil and Gas has a Market Perform Rating. Carrizos target price was reached using three valuation methods: PV-10 valuation, multiple valuation using EV/EBITDA, and multiple valuation using P/CF.

    PV-10 Valuation

    A PV-10 valuation is a commonly used discounted reserve valuation for E&P companies. A PV-10 measures the revenue a company would earn on its reserves if it were to stop acquiring new acreage today and produce the rest of its current reserves through their useful life. The cash flows from this process are then discounted at a 10 percent discount rate to find the NPV and NAV of an oil companys reserves. Major drivers in Carrizos PV-10 valuation are estimated production, capex, commodity prices, recovery rates, natural decline rates, and lease operating expense. This methodology accurately reflects the current fundamental value of an E&P company as it currently stands. Our base case intrinsic valuation assumes 50 percent of Carrizos probable reserves will be produced in addition to our PV-10 discounted proved reserves. Our high case, includes 100 percent of PV-10 proved reserves, 50 percent of probable reserves, and 50 percent of possible reserves. In addition, Carrizo is assumed to produce considerably less than estimated probable reserves in less

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports profitable plays, such as the Utica and Marcellus shales. The final intrinsic value price was reached using an average of the base case and high case to yield a stock price of $56.89.

    Table 1: Intrinsic Valuation

    Multiple Valuation

    Oil and gas companies commonly use multiple valuations because net income is unpredictable and financial statements do not reflect an E&P companys actual future expected cash flows. Our multiple valuation examines Carrizos enterprise value, EBITDA, discretionary cash flow, and share price in comparison to its peers.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Peer Group EV/EBITDA

    Enterprise value (EV) over earnings before interest expense, taxes, depletion, and amortization (EBITDA) uses a peer group average multiple to determine a companys enterprise value based on the expected future EBITDA of the company being valued. Carrizos peer group consists of five E&P companies similar to Carrizo in operational focus and market capitalization. E&P companies use EV/EBITDA ratio valuation for two important reasons. First, the ratio excludes the effect of leverage, which is typically very high in E&P companies and varies depending on the company. Second, EBITDA measures profits before interest, non-cash expenses, and depletion and amortization, which can have a large impact on an E&P firms earnings but does not impact EBITDA. Applying the peer group EV/EBITDA multiple of 8.72x to Carrizos FY2015E EBITDA yielded a stock price of $63.73.

    Peer Group P/CF Oil and gas analysts commonly use the price to cash flow multiple because cash flow is hard to for management to manipulate as opposed to net income. The cash flow in this case is operating cash flow, which excludes exploration expenses and adds back non-cash expenses, depreciation, amortization, deferred taxes, and depletion which have a material impact on a companys earnings. When commodity prices are low, multiples expand, and when commodity prices are high, multiples contract. Applying Carrizos peer group P/CFPS multiple of 6.3x to Carrizos FY2015E CFPS we arrived at a stock price for Carrizo of $59.46.

    Table 2: Multiple Valuation and Price Comparison

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Figure 5: Valuation


    As a Houston-based Independent Energy Exploration and Production (E&P) company founded in 1993, Carrizo Oil and Gas Incorporated (CRZO/NASDAQ) operates through its wholly-owned subsidiaries, such as Carrizo (Marcellus) LLC. Within the upstream segment of the oil and gas industry, Carrizo conducts nearly all of its business within the U.S. Carrizo focuses its oil and gas exploration, production, and development efforts on its proved reserves in the Eagle Ford, Niobrara, Marcellus, and Utica shale plays. Within these plays, Carrizo reports 151 million barrels of oil in proven reserves on an equivalent basis with an additional 480 million in probable reserves. In these four areas, the company has 259 developed wells producing 33 thousand barrels oil a day on an equivalent basis. Currently, 67 percent of Carrizos production and reserves are oil based.


    Carrizo initially went public in 1998 on the NASDAQ. Carrizo has focused on horizontal drilling and the completion of unconventional resource plays over the last ten years. In 2010, Carrizo announced the initiation of oil focused horizontal development programs in the Eagle Ford Shale in South Texas and Niobrara Formation in Northeastern Colorado. As of 2011, the company accumulated proved oil and gas reserves of 935.6 billion cubic feet equivalent comprised of 728 billion cubic feet of natural gas, and operated 349 gross producing oil and gas wells, making it a market leader. As of December 31, 2014 Carrizo recorded 900 billion cubic feet equivalent in reserves with 259 net producing wells. For the fiscal year 2014, Carrizo had record production of 37,696 Boe/d. Carrizo performed well due to the company's previously developed Eagle Ford shale assets and continues to improve production in

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports the new Texas acreage acquired from Eagle Ford Minerals LLC (EFM) last year.

    Latest Developments

    In October of 2014, Carrizo announced the successful acquisition of additional producing properties in the Eagle Ford Shale for $250 million in cash. The transaction included 6,280 net acres located in LaSalle, McMullen, and Atasoca Counties in Texas, increasing Carrizos position in the Eagle Ford Shale to 82,000 net acres. Estimates of property assets include 16.7 MMBoe net proved reserves consisting of 82 percent oil. The company financed the transaction with a private debt offering of $300 million. The company does not traditionally purchase producing properties, however, management felt that the acquisition was beneficial because of its low price, high production estimates, positive impact on cash flows, and potential increases in earnings per share. Management expects a 17 percent increase in oil production from 2014 to 2015.

    Despite rapidly dropping oil prices at the beginning of 2015, analysts continue to rate Carrizos stock highly because of its Eagle Ford Shale acquisition. Of the 21 analysts that cover the company, 14 give Carrizos stock a buy rating, 6 give the stock a hold rating, and only 1 gives the stock a sell rating. Positive sentiment for Carrizos stems from its Eagle Ford Shale operations, which resulted in record Q4 oil production increase of 70 percent year over year, with 26 percent increase in revenues year over year despite falling oil and gas prices.

    Properties Currently, Carrizo principally operates in four areas, including the Eagle Ford Shale in South Texas, the Niobrara Formation in Colorado, the Marcellus Shale in Pennsylvania, and the Utica Shale in Ohio, and the company has offices in each state. Management intends to focus their operations on the plays which yield the highest oil to gas ratios, primarily the Eagle Ford

    Eagle Ford Shale As part of Carrizos strategy for shifting its operations towards crude oil, management launched a land acquisition program in early 2010 targeting the Eagle Ford Shale play in Texas. Carrizo restricted its land acquisitions to the volatile oil window in the central area of the Eagle Ford Shale. As of February 25, 2014, the company has accumulated approximately 65,500 additional net acres in the Eagle Ford Shale, producing 12.6 MBoe/d. Carrizo currently reports 122.5 MMBoe of proved reserves on 82,000 acres in this location. Currently, Carrizo has 176 wells producing approximately 21 thousand barrels of oil a day on an equivalent basis in this area with 220 waiting to be developed. The companys wells in the Eagle Ford area come online with a daily production rate of 625 barrels of oil per day, shown in the Figure 6 below.

    In the future, Carrizos management intends to focus the majority of capital expenditures on this area because of the high production rate in

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports comparison to the other three shale plays. Horizontal drilling remains the focus of the drilling efforts in the Eagle Ford area.

    Figure 6: Eagle Ford Type Curve

    Source: Carrizo Scotia Howard Weil 2015 Energy Conference Presentation

    Niobrara Formation Carrizos land position in the Niobrara Formation is located in Weld and Morgan Counties. Currently, Carrizo has 54 wells producing approximately 2.6 thousand barrels of oil a day on an equivalent basis in this area with 11 waiting to be developed. Additionally, the Company is currently developing and testing for more drilling potential in this area. As of December 31, 2014, the company accumulated approximately 35,900 net acres in the Niobrara Formation. Carrizo currently has 5.6 MMBoe of proved reserves in this area. Going forward, the Niobrara formation remains Carrizos secondary focus behind the Eagle Ford due to a lower percentage of gas production coming from the Niobrara compared to the Utica and Marcellus areas.

    Marcellus Shale The Marcellus Shale, one of the most active and economical natural gas plays in the America, extends from New York to Eastern Ohio and West Virginia. Most of Carrizos land position in this area rests in West Virginia and northeastern and central Pennsylvania. In 2007, Carrizo launched a leasing program in the play, and currently owns an interest in approximately 33,400 net acres. Drilling in the Marcellus shale is predominately horizontal. Carrizo has net production of approximately 8.4 MBoe/d with 22.2 MMBoe of proved reserves in this acreage. Production in this area comes from 27 producing wells. Because of depressed natural gas markets and a high concentration of natural gas in the Marcellus formation, Carrizo intends to reduce capital expenditures in this area moving forward.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Utica Shale Carrizos leasing and drilling activities in the Utica Shale are primarily in Guernsey and northern Noble Counties, Ohio. The Company currently owns more than 120 net potential drilling locations on 28 thousand acres in the Utica Shale. Carrizo currently estimates 0.7 MMBoe in proved reserves in the Utica. The company currents operates only two developed wells producing less than one thousand barrels of oil a day on an equivalent basis without any wells waiting to be developed. Carrizo plans to scale back all capital expenditures in this formation to more effectively focus assets in the Eagle Ford Shale play.


    Carrizo operates within the global oil and gas industry. Specifically, Carrizo is a U.S. upstream company which operates strictly on land. The segments of the oil and gas industry include:

    Service Companies Upstream Companies Midstream Companies Downstream Companies Fully Integrated Companies

    Service companies supply upstream companies with anything they may need to extract oil and gas from the earth, including everything from drill bits to supply boats. Upstream companies specialize in locating crude oil and natural gas (including liquids), leasing/buying land, and extracting the commodities from beneath the earths surface and ocean floor. Investors refer to these companies as exploration and production companies (E&P). Midstream companies transport the oil or gas from the well to the plant or storage facility. Downstream companies buy the raw oil or gas, process it into usable end products, and sell it to the public. Integrated companies operate within all of the above sectors. The super majors are the five largest publically traded, fully integrated oil and gas companies.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Figure 7: Production and Profit

    Source: Thomson Reuters (As of 2015)

    The United States is the worlds third-largest petroleum producer, with more than 500,000 producing wells and approximately 4,000 oil and natural gas platforms operating in U.S. waters. Together, oil and gas supply 65 percent of U.S. energy. The nations 144 refineries process more than 17 million barrels of crude oil every day. Oil and gas production facilities include 16,000 establishments with a value of shipment of $134 billion. The oil and gas industry employs 9.8 million people. According to their annual reports, the five super majors reported a combined $1.53 trillion in revenue in 2014. As seen in Figure 7, the revenue of any oil and gas company within any segment is highly correlated with the prices of crude oil and natural gas.

    Crude Oil and Natural Gas Pricing

    Commodity prices have dropped more than 50 percent since June 2014, and the U.S. oil and gas industry has been through an extended economic downturn. The most recent WTI price is around $55(ICE) and Brent price is around $63(ICE).The natural gas price is $2.59(NYMEX). The above oil and gas prices are low compared to recent historical levels.

    Supply and demand determine crude oil and natural gas prices. Global energy consumption is the basis of worldwide oil demand and macroeconomic factors influence the total usage of oil. As the gross domestic production of a country increases, so too will its energy consumption. When U.S. GDP growth is slow and supply is high, prices decline dramatically. Heating is the main driver of natural gas demand in the U.S., making the demand, and therefore prices, seasonal. The macroeconomic side of the natural gas demand is influenced by energy usage abroad and some domestic consumption. The amount of oil produced, called the supply side, is influenced by two key factors. First,

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports oil and gas are difficult to find and extract, making technological advances a key factor in the success of E&P companies. Second, once reserves are located, the producer can choose how much to extract and sell. At this point geopolitics come into play. Several Middle Eastern countries own oil and gas companies, and because they control nearly 40 percent of the worlds supply, artificially regulating supply is in their best interest. Oil producing nations created Organization of the Petroleum Exporting Countries (OPEC) to decide how much oil and gas they should produce.

    In 2014, the balance between supply and demand tipped in the opposite direction. Prices for crude oil shifted dramatically from June 2014 to the beginning of 2015 because of several macroeconomic factors. The U.S. shale revolution, through the usage of hydraulic fracturing and horizontal drilling, enabled the United States to produce as much crude oil as Saudi Arabia, the number one producer in the world, causing a large increase in supply. Around the same time, the market experienced large declines in GDP from Asian and European countries, causing a global decline in demand which affected energy prices in the US. Extended declines in GDP caused the European Union and other countries to enact quantitative easing measures, causing exchange rates to fall to pre-housing crisis levels. Crude oil is priced in U.S. dollars around the globe. The strength of the dollar causes foreign consumers to import less crude oil, further weakening demand. Given decreased demand, OPEC acted uncharacteristically by refusing to decrease production in order to reach equilibrium, in an effort to strengthen their market share.

    Equilibrium theories predict that the amount of oil demanded by customers is exactly the same as the amount being produced by oil and gas companies. With no significant decrease in production on the horizon, demand must increase in order for crude oil prices to rebound. In a recent microeconomic trend report, Goldman Sachs asserted that China is set to take over as the number one fossil fuel consumer in the world in the near future, but its demand for oil is relatively low. In addition, the report stated that oil consumption in emerging markets is slow. This could create a new equilibrium price for oil that is much lower than prices over the last decade. A recent study from the U.S. Energy Information Administration (EIA) projects that oil consumption worldwide will remain relatively flat over the next three years.

    The Nature of the Production Process

    E&P companies usually have four operational phases: exploration, acquisition, development, and production. In the exploration phase, E&P companies search for potential oil and gas through geological fieldwork, geological modeling, seismic imaging, and exploratory drilling. Successful exploration plays a key role in maintaining reserves and future revenue for E&P companies. If E&P companies detect oil and gas, they will start the acquisition phase, which usually involves leasing land to drill wells on target properties. Drilling wells is risky because it requires

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports large amounts of capital, labor, technology, and environmental regulation compliance. To share risk, many companies tend to enter into joint ventures with well-funded partners at this phase. Oil and gas drilling is a speculative activity that involves numerous risks and could have a significant impact on the operational and financial position of a company. An E&P company drills oil and gas wells and connects them to pipelines for distribution. After this phase, oil and gas can be extracted and transported to downstream companies. Finally, oil refineries refine crude oil into various marketable end products including gasoline, diesel fuel and jet fuel. Companies will continue to produce at a particular well as long as its output is economically viable. Figure 8 shows the process of oil and gas production.

    Figure 8: Oil and Gas Production Map

    Source: Energy Information Administration

    In the past, U.S. E&P companies have utilized technological innovations in drilling techniques such as hydro-fracking in the development of oil shale, horizontal drilling in the development of the natural gas shale plays, and environment friendly methods like pipeline maintenance and repair. As previously discussed, oil and gas companies must consistently produce new wells to grow production. E&P companies also innovate renewable energy resources such as converting water into snow, and solar power, to streamline operations.

    Customers and Suppliers

    Oil exploration and production is a complex process that involves specialized technology and equipment. Owning production equipment is costly and requires extensive maintenance, so most oil companies utilize oilfield services companies that supply the infrastructure, equipment, and technology to explore for, extract, and transport crude oil and natural gas

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports from the earth to the refinery, and eventually to the consumer.

    Oilfield services companies provide five key roles in the market.

    1. Oilfield equipment suppliers build rigs and supply hardware for rig maintenance and upgrades.

    2. Oilfield disposal services suppliers provide saltwater disposal and transportation services for oil and gas companies.

    3. Oil exploration and production services contractors deal in seismic imaging technology or provide drilling services.

    4. Oil and gas pipeline companies build onshore pipelines to transport oil and gas between cities, states, and countries.

    5. Oil and gas maritime transportation companies supply the tankers and services to transport large quantities of oil and gas across the ocean.

    The oilfield service market is a highly competitive environment. E&P companies have bargaining power in this market because they can switch to other suppliers if current suppliers do not make competitive offers. Table 3 presents customers that account for more than 10 percent of Carrizos oil and gas sales for each year respectively.

    Table 3: Carrizos Major Customers

    (a) Revenues from the customer were below 10% during the year. Source: Carrizo 2014 Annual Report

    As other purchasers are available in all areas of Carrizos operations, Carrizos sales will not significantly deteriorate from the loss of any one current customer.

    Carrizos Position in the Industry

    Carrizo owns a small share of the market. In 2014, Carrizo realized oil and gas revenues of $720.2 million and production is 12.0 MMBoe. Table 4 illustrates a comparison between Carrizos production and the total production of U.S. energy industry.

  • Carrizo Oil and Gas (CRZO) April 21, 2015


    FREEMAN Reports

    Table 4: Carrizo Production against Entire U.S. Energy Industry

    Source: Energy Information Administration (As of 2015)

    Carrizos discretionary cash flow for 2014 was $512 million. Discretionary cash flow is an important metric for E&P companies because they often carry large amounts of debt, capital expenditures, and depreciation on their books making net income a less accurate measure of cash flow. Discretionary cash flow is an important measure of whether or not a company will be able to service its debt and expand cash flow in the future.

    Carrizos replacement ratio for 2014 was 513 percent. The reserve replacement ratio shows whether an E&P company is replacing reserves or depleting them. The ratio is important for oil and gas companies because reserves are constantly in natural decline and E&P companies must consistently add reserves to its books to grow effectively.

    Porters Five Forces

    Porters five forces is a framework for evaluating the strategy, development, and weaknesses of a given industry. Each force is rated as either low, medium, or high from the perspective of the company being analyzed.

    Threat of entry: Medium E&P firms such as Carrizo must overcome large capital requirements because the costs associated with startup are high. According to Wood Mackenzie, U.S. upstream operations spent $140 billion in 2014. Carrizo, a relatively small company, had a capital expenditure budget upwards of $690 million in 2014. New companies face large financing and liquidity stress in developing the infrastructure required for finding and developing new wells. In addition, locating and developing oil and gas reserves requires interrelated technical expertise and human capital. E&P firms need specialists in geography, legal teams, petroleum engineering experts, and operations specialists to perform competitively. Exploration requires extensive capital because it includes the process of finding usable reserves, licensing land, drilling wells and obtaining distribution channels. Labor cost is usually considered a fixed cost in the E&P industry. Geopolitical factors and high fixed costs also make entering this industry difficult because exploration is time consuming and expensive, and regulatory requirements are strict.

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    FREEMAN Reports Bargaining Power of Suppliers: Low Carrizos suppliers mostly consist of oil and gas field services suppliers such as Halliburton. These companies assist Carrizo in logistical activities such as surveying properties, drilling wells, and cementing wells. Carrizos suppliers charge the company a day rate to rent equipment such as drilling rigs and hydraulic fracturing equipment. Concentration in the oil and gas field services industry is relatively low meaning that there are several competitors, but there are few large companies that own expensive assets that Carrizo must rent in order to produce oil and gas.

    Bargaining Power of Buyers: Low In the oil and gas industry, buyers have no bargaining power because the price of oil is determined by supply and demand in the worldwide market. Future and spot prices driven by the global exchange of oil as a commodity play a significant role in determining the price of oil. Oil prices are quoted as a differential between the premium quality products and the products oil companies are actually producing. WTI and Brent, which are traded on the NYMEX, are the benchmarks for oil prices. Figure 9 shows the WTI and Brent index over the last 15 years and demonstrates the price determined by the spot market. The differential between the benchmark and the price that a company receives is a function of oil quality and distance from major processing hubs.

    In addition, oil and gas companies hedge against oil price fluctuations with futures contracts that guarantee a specific price for the oil they produce. Through the use of hedging, companies have more predictable plan for the future and ensure that buyers have less bargaining power over the price of oil.

    Figure 9: World Oil Index Movement due to Arbitrage

    Source: Thomson Reuters (As of 2015)

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    FREEMAN Reports Availability of Substitutes: Low Fossil fuels are the most widely used sources of energy. External competition stems from hydro, solar, wind, and nuclear power; however, competition is minimal because alternative power sources cannot generate energy on a large scale. According to the Institute for Energy Research, oil accounted for 95.1 percent of transportation energy consumption and 67 percent of electricity generation in 2014.

    Competitive Rivalry: High Competition in the exploration and production industry is high and the trend of competition is steady. The exploration and production industry is fragmented and the four largest companies account for only 25 percent of industry revenue. Oil and gas companies compete on a price basis; however, because oil prices are previously determined by macroeconomic factors, they compete on a basis of cost. Companies compete by lowering extraction costs thereby bolstering margins. Oil companies also compete on a quality basis because higher quality oil and gas is valuable.

    PEER ANALYSIS Carrizos peer group consists of six upstream, onshore focused firms which are independent and similar in terms of the areas in which they operate and their market capitalization. Carrizos peers are Chesapeake Energy, Range Resources, Rosetta Resources, SM Energy, and Southwestern Energy. The companies operate inside the U.S., primarily within the Eagle Ford, Barnett, Utica, Marcellus, and Bakken shale plays. As shown in Table 5, all six companies are within the midcap range in terms of market capitalization.

    Table 5: Peer Data

    Source: Bloomberg and 2014 Company Annual Reports

    Chesapeake Energy Co. (CHK/NYSE)

    Chesapeake is an independent oil and gas exploration and production company and the 11th largest producer of oil and NGLs in the U.S. The company holds a large portfolio of unconventional onshore assets in major shale plays across the U.S. including properties in the Barnett, Eagle Ford, Utica, Haynesville, and Marcellus Shales. In Q3 of 2014 the company produced 726 MBoe/d, of which 70 percent was natural gas. In 2014 Chesapeake spent $5 billion in capital expenditures to increase production on existing properties and increase leaseholds in the Marcellus Shale as well as Utica Shale. Chesapeake is forecasting 10 percent overall production growth for 2015.

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    FREEMAN Reports

    Range Resources Corp. (RRC/NYSE)

    Ranges headquarters are in Fort Worth, Texas. Range has producing upstream wells in the Marcellus, Mid-Continent, and Southern Appalachian regions. Ranges capital expenditure for the 12 months ending on September 30, 2014 was $1.13 billion. Revenue for the same period was $1.2 billion. In 2014, Range produced 425 Bcfe in total, and early in 2015 the company announced that its proved reserves have increased 26 percent to 10.3 Tcfe.

    Rosetta Resources Inc.


    Rosetta operates strictly out of the Eagle Ford Shale and the Permian Basin formation. The company expected to spend $1.2 billion in capital expenditures in 2014. Total production for for 2014 was 63 - 66 Mboe per day and in 2015 the company expects to produce 76 82 Mboe per day.

    SM Energy Co. (SM/NYSE)

    SM Energy is an independent exploration and production company that focuses on oil and gas resource plays in North America. SM Energys primary producing properties are 144,000 net acres in the Eagle Ford Shale and 238,000 net acres in the Bakken Shale. In addition the firm leases property in the Rocky Mountain, Mid-Continental, and Permian regions. In Q3 of 2014, the company produced 143 MBoe/d of which 54 percent was gas and only nine percent was oil. In 2014, SM Energy put a $1.9 billion capital budgeting plan into effect to increase its position in the Eagle Ford and Bakken Shales. The company expects to grow revenues by approximately 15 percent in 2015. In 2013, SM Energy had estimated reserves of 428.7 MMBoe.

    Southwestern Energy Co.


    Southwestern has offices in Spring, Texas and Conway, Arizona. Current upstream operations are located in the Marcellus, Fayetteville, Arkoma, East Texas, Brown Dense, DJ Basin, and New Brunswick plays. Southwesterns capital expenditure for the 12 months ending on September 30, 2014 was $2.24 billion. Revenue for the same period was $3.98 billion. Southwestern also has a mid-stream segment which supports its exploration and production strategy. In 2014 Southwestern produced 758 764 Bcfe. After a recent acquisition from Statoil and WPX energy, Southwestern increased its proved reserves to 9.5 Tcfe and expects to produce 2.5 Bcfe/d in 2015.


    Carrizos management team, including veterans and experienced newcomers, plays a key role in the companys operations and focuses on stable growth rate, excellent assets, and operational flexibility. The top executives collective experience and expertise in the E&P industries form a strong foundation for Carrizos strategic success.

    As shown in Table 6, Carrizos management team has improved ROIC by more than its peer average since 2010, excluding Rosetta because of its much smaller market cap. Carrizo has reported a positive ROIC every

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    FREEMAN Reports year since 2010. The companys success is a result of its active pursuit of new opportunities such as the new acreage acquired in the Eagle Ford Shale in 2014.

    Table 6: ROIC

    Source: Bloomberg (As of 4/20/2015)

    S.P. Chip Johnson

    President and Chief Executive Officer(58) S.P. Chip Johnson, a co-founder of Carrizo, has served as President, Chief Executive Officer, and a director since December 1993. Prior to joining Carrizo, Mr. Johnson worked as Operations Superintendent, Manager of Planning and Finance, and Manager of Development Engineering at Shell Oil Company for 15 years. From 2003 to January 2011, he served as a director of Pinnacle Gas Resources, Inc. Currently he is also a director of Basic Energy Services, Inc., an oilfield service provider. Mr. Johnson is a Registered Petroleum Engineer and holds a B.S. in Mechanical Engineering from the University of Colorado.

    Brad Fisher

    Vice President and Chief Operating Officer(53) Brad Fisher has served as Vice President and Chief Operating Officer since March 2005. Starting in July 2000, he served as Vice President of Operations, and he served as General Manager of Operations from April 1998 to June 2000. Prior to joining Carrizo, Mr. Fisher spent 14 years with Cody Energy Services. He held various managerial and technical positions at Ultramar Oil & Gas Limited, last serving as Senior Vice President of Engineering and Operations. Mr. Fisher holds a B.S. in Petroleum Engineering from Texas A&M University. At Carrizos 2015 Analyst Conference, Mr. Fisher showed that the operations team had a good track record of meeting production goals and Capex guidance. The company will enter the learning curve at a much higher point in the coming year.

    David Pitts

    Vice President, Chief Financial Officer, Chief Accounting Officer and Treasurer(47) David Pitts has served as Vice President, Chief Financial Officer, Chief Accounting Officer, and Treasurer since August 2014. Mr. Pitts had previously worked as Carrizos Vice President and Chief Accounting Officer since January 2010. Prior to joining Carrizo, Mr. Pitts was an audit partner with Ernst & Young and a Senior Manager at Arthur Andersen. Mr. Pitts is a CPA and holds a B.S. in Accounting and

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    FREEMAN Reports Business from Southwest Baptist University.

    Dick Smith

    Vice President of Land(56) Dick Smith has served as Vice President of Land for Carrizo Oil & Gas since August 2006. Prior to joining Carrizo, Mr. Smith held the position of Vice President of Land for Petrohawk Energy Corporation from its inception in January of 2004 through August 2006 and was responsible for managing the entire corporate land function. Mr. Smith was with Unocal Corporation where he held the position of Land Manager for the U.S. Gulf Region with areas of concentration in the OCS, Onshore Texas, Louisiana, and Louisiana State Waters from April, 2001 through the end of 2003. Mr. Smith is a Certified Professional Landman with a BBA in Petroleum Land Management from the University of Texas at Austin.

    Gregg Evans

    Vice President of Exploration(64) Gregg Evans has served as Vice President of Exploration since March 2005. Prior to joining Carrizo, he worked as Vice President North America Onshore Exploration for Ocean Energy from 2001 to 2003. From 1996 to 2000, he worked at Burlington Resources where he served as Chief Geophysicist North America, Gulf of Mexico Deep Water Exploration Manager, and Geoscience Manager for the Western Gulf of Mexico Shelf. Prior to that, Mr. Evans served as Division Exploration Manager of the Rocky Mountain Region and the Gulf Coast area and also held various other technical and managerial positions with Burlington Resources. Mr. Evans holds a B.S. in Geophysical Engineering from the Colorado School of Mines and received the Cecil H. Green award for outstanding geophysical student.

    Andy Agosto

    Vice President of Business Development Andy Agosto has been involved with the oil and gas industry for 30 years. In 2003, Mr. Agosto joined Carrizo Oil & Gas as Vice President of Business Development to develop and manage its efforts in the Barnett Shale and Eagle Ford Shale plays. Prior to joining Carrizo, Mr. Agosto was Chief Operating Officer for CCNG, Inc. focusing on the midstream and service side of the energy business. Mr. Agosto earned his B.S. in Chemical Engineering from Texas A&M University. At Carrizos recent 2015 Analyst Conference, Mr. Agosto talked about valuation benchmarking for the company and showed investors how the company compares to its competitors operating in the Eagle Ford Shale.


    Carrizo oil and gas is subject to a number of risks including operational, regulatory, and financial risks that are systematic in the exploration and production industry. These risks may significantly impact Carrizos ability to generate cash flows, raise capital, and plan new drilling projects.

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    FREEMAN Reports

    Operational Risks Operational risks for E&P companies include reserve longevity, commodity price volatility, technological risks, drilling risks, capital requirements, and reserve estimates. Drilling and producing oil is a speculative activity that has inherent uncertainties and therefore risks that may have an adverse impact on Carrizos business.

    Reserve Longevity The primary focus of an E&P Company to ensure long term success is the ability to replace oil and gas production and sales with additional proved reserves. If an E&P company continues to produce without replenishing its reserves, the company will run dry and cease to operate. Carrizo can increase reserves in two ways. First, Carrizo can buy property bearing proved reserves, which can be expensive. Second, Carrizo can also explore for and produce oil and gas itself by leasing the land and equipment, which yields higher margins if successful. Operational inputs, such as land and equipment, determine the cost of production for oil and gas but, no individual company can determine the price paid for the final product. Carrizo faces the risk of failure in finding new wells to replace depleted reserves and grow production.

    Commodity Price Volatility In Carrizos 2014 10-K, management outlines volatile oil and gas prices as the primary risk for the company. E&P companies have more price risk than the midstream and downstream segments because they are price takers. Carrizo must sell its product at prices which the market determines. Oil and gas prices change with global supply and demand. These prices can be cyclical. Gas is in higher demand during the colder months than in warmer months, making it seasonally cyclical. There is a direct link between oil prices and demand via the gross domestic production of energy consuming nations, making demand economically cyclical. Uncertain prices affect the companys ability to forecast revenue, profitability, cash flow, and could impact the firms ability to borrow funds and obtain additional financing. Carrizo uses hedging to lock in the price of future production and guarantee the feasibility of certain projects. E&P companies benefit most from hedging when prices decline in a sharp manner. The 50 percent decline in energy prices from June to December 2014 is a perfect example of a situation in which hedges become profitable. Management emphasizes that as a result of recent volatile oil and gas prices, the company is particularly dependent on the production and sale of oil, but current economic conditions may force the company to curtail operations. The company also emphasizes that certain wells that were once profitable to drill no longer meet Carrizos internal rate of return requirements and are no longer economically viable.

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    FREEMAN Reports

    Technology The technological feasibility of producing oil and gas is essential in terms of a companys success. Although Carrizo does not invest money directly into research and development, the equipment and methods Carrizo uses to find and extract hydrocarbons from beneath the Earths surface, are extremely expensive to develop. Service companies spend millions of dollars inventing and procuring efficient tools and processes to discover and produce oil and gas, such as drill bits and hydraulic fracturing rigs. The more technologically advanced these products become, the more Carrizo must pay in day rates to the service companies to use them. Carrizo prices the inherent risks of operations into the projects the company takes on. In addition, many of Carrizos competitors are large fully-integrated oil companies with large amounts of capital resources. E&P companies are heavily dependent on technological advances and Carrizo may not have access to technology as advanced as its competitors, which gives larger companies a competitive advantage.

    Drilling Risk Carrizos growth strategy is based on a growth through the drill bit principal, but drilling for oil and gas is a speculative activity that carries significant risks. One of the major risks in drilling for oil is the possibility that the company will not establish commercially productive oil or gas wells. Drilling costs are substantial and even after drilling is completed and production begins, a well may not be commercially productive and economically viable. In addition, volatile oil prices may force Carrizo to delay or cancel drilling projects in several locations, which will lead to lower cash flows, lower production, and difficulties expanding the business.

    Reserve Estimates E&P companies estimate oil and gas reserves using volumetric analysis but these estimates may be inaccurate. Carrizo clearly states that reservoir engineering is a subjective and inexact process of estimating oil and gas that cannot be measured in an exact manner. As of February 2015, 57 percent of Carrizos proved reserves were undeveloped, and when production begins, proved reserves are subject to upward or downward adjustment. Finally, all oil wells are subject to natural decline, a well may suffer from a natural decline rate much steeper than projected and as a result, management may miss its production target rates.

    Capital Requirements Exploration and production is an extremely capital intensive industry that requires large amounts of investment for a business to grow. For 2015, Carrizo anticipates the need for additional outside funding to successfully continue operations. Because of the recent downturn in oil prices, most

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    FREEMAN Reports exploration and production companies have significantly cut capital expenditure by an average of 50 percent. The company may not be able to acquire additional capital under its existing credit facilities in the current oil environment. With less capital, Carrizo will have to severely limit its development drilling programs, which means that the company may not be able to keep pace with natural decline and will struggle to grow revenue.

    Industry Regulation E&P companies are subject to heavy regulation from local, state, and federal sources. Carrizo must adhere to laws that cover drilling permits, well testing, plug and abandonment, and well spacing, which can cost the company millions of dollars. As environmental regulations have become more stringent, compliance costs for companies like Carrizo have become significantly higher in recent years.

    Greenhouse Gas Emissions Increased scrutiny of the E&P industry may occur as a result of the EPAs 2011-2016 National Enforcement Initiative, Assuring Energy Extraction Activities Comply with Environmental Laws, increasing attention in the United States and worldwide to the issue of climate change and the contributing effect of GHG emissions. Concerns about emissions may affect operations by limiting drilling opportunities or imposing materially increased costs on E&P companies including Carrizo.

    Hydraulic Fracturing The EPA has asserted federal regulatory authority over hydraulic fracturing under the federal Safe Drinking Water Act, and has released draft permitting guidance for hydraulic fracturing operations. Several states, including states where Carrizo operates such as Colorado, Ohio, and Texas, have proposed or adopted legislative or regulatory restrictions on hydraulic fracturing through additional permit requirements, public disclosure of fracturing fluid contents, water sampling requirements, and operational restrictions. Those ongoing changes could reduce the volumes of oil and gas that the company can economically recover, which could materially and adversely affect revenues and results of operations.

    Pipeline Regulations Although most E&P firms do not own or operate pipelines or facilities under direct regulation of the FERC, the FERCs regulations of third-party pipelines and facilities could indirectly affect Carrizos ability to market production. Beginning in the 1980s, the FERC initiated a series of major restructuring orders that required pipelines, among other things, to perform open access transportation. The FERCs changes substantially increased competition in the natural gas market. The effect the FERCs other activities will have on access to markets, the fostering of

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    FREEMAN Reports competition and the cost of Carrizos daily operations, remains to be seen.

    Tax Laws In addition to environmental legislation, the U.S. Congress is currently debating significant changes to oil and gas tax laws. Proposed changes may reduce certain tax deductions that are currently available with respect to oil and gas exploration and development. Any such change can negatively affect Carrizos financial position and operations.

    Financial Risk Carrizo operates in a capital intensive industry and certain financial risks arise when the company takes on debt to finance operations. Financial risk is particularly relevant today because the current low price of oil has forced E&P companies to cut capital spending and limit drilling projects.

    Cash Flow Risk The current ratio and quick ratio are indicators of a companys short-term liquidity. As Figure 7 shows, Carrizos current ratio is 0.66, which is marginally lower than its peer average; however, its quick ratio is 0.65, which is marginally higher than its peers. The companys current and quick ratios suggest that Carrizo will be able to service current liabilities on its balance sheet using resources that are immediately available.

    Credit Risk Drilling for oil requires large sums of money, which E&P companies usually use debt to finance. The more debt a company uses to support operations, the more the company has to pay in interest on a percentage and total basis. Therefore, debt heavy E&P companies are sensitive to interest rate changes. Higher debt levels increase the probability of a company going bankrupt if production and/or prices fall. Debt-to-Asset Ratio and Debt-to-Equity Ratio measure a companys leverage and credit risk. As Figure 7 shows, Carrizos Debt-to-Asset Ratio and Debt-to-Equity Ratio are significantly higher than its peers, which means Carrizo has more credit risk than its peers. In addition, Carrizo has an interest coverage ratio of 16.4, marginally lower than its peers, which means that Carrizo is less capable of paying interest expense obligations from its operating income than its peers. Carrizos cash generated-to-cash required ratio is 0.4, among the lowest of its peers, showing the companys cash on hand has been significantly reduced because of the downturn in oil. In addition, as Figure 8 shows, Carrizos Debt-to-Asset Ratio had low fluctuation in the past five years, which is an indication of the companys stable credit management.

    Hedging Carrizo hedges a portion of its forecasted production to manage exposure to commodity price risk. As of March 24, 2015, Carizos hedge positions for 2015 were comprised of 30,000 MMBtu/d of natural gas and 12,200 Bbls/d of crude oil. From March 2015 through December 2016, Carrizos

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    FREEMAN Reports hedging position provides the company with solid downside protection on 12,200 Bbls/d in 2015 and 4,000 Bbls/d in 2016 of crude oil at prices below the floor of $50.00 per Bbl yet allow it to benefit from an increase in crude oil prices up to the ceiling of $66.46 per Bbl in 2015 and $76.50 per Bbl in 2016. Carrizos hedging program helps ensure stable cash flow and reduces financial risks.

    Table 7: Financial Risk Ratios

    Source: Bloomberg (As of 4/20/2015)

    Table 8: Carrizo Historical Leverage

    Source: Bloomberg (As of 4/20/2015)


    As of April 20, 2015, Carrizo Oil and Gas has 90 million shares authorized, 51.45 million shares outstanding and 42.8 million (92 percent) of which trade as public float. Institutional investors own 69 percent, mutual funds own 28 percent, and insiders own 7 percent of the companys equity. Carrizo has not issued dividends in over a year and has not announced plans to do so in the immediate future. The company has not repurchased common stock in recent years. Investors are currently selling 4,110,000 shares short which is about 9.80 percent of the float. Short selling on Carrizos stock has decreased by 20.92 percent over the last quarter as a result of falling oil prices. According to Morningstar data on mutual fund investing styles, 49 percent of funds bought Carrizo as a growth stock while only 7 percent bought Carrizo as a value stock. Investor perception that Carrizo is a growth stock reflects high expectations for the companys recent investment in the Marcellus and Eagle Ford Shale.

    Institutional Shareholders

    Institutional investors own over 97 percent of Carrizo Oil and Gas equity. Table 9 shows the top ten institutional investors that control 38.74 percent of the company. Individual investors favor an ownership structure of this type because of the managers overseeing managers effect. Large institutional investment companies watch over Carrizos board carefully because they have a stake in Carrizos success. Individual investors look favorably on the additional third party oversight of Carrizos management. The total number of shares owned by these ten

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    FREEMAN Reports highly involved institutions has increased by approximately three percent since 2014, which indicates confidence in future stock performance.

    Table 9: Top Ten Institutional Investors

    Source: Bloomberg (As of 4/20/2015)

    Insider Shareholders

    As of April 21, 2015, insider holdings represent 7.69 percent of total shares outstanding, a decrease of 7.8 percent since February 2, 2014. Over the past six months, Carrizo reported 36 insider transactions, including 29 selling and 7 buying. On the open market, four insider shareholders sold a total amount of 83,292 shares, but no insider shareholder has made any open market purchase since August 2014. Steven A. Webster, the largest insider shareholder of Carrizo, did not report any position change over the past six months. Table 10 lists the top five insider shareholders.

    Table 10: Top Five Insider Shareholders

    Source: Bloomberg (As of 4/20/2015)

    Corporate Governance

    Carrizos current leadership structure is Mr. Johnson serving as Chief Executive Officer, Mr. Webster serving as Chairman of the Board, and Mr. Parker serving as Lead Independent Director. Mr. Parker is a Financial Advisor for multiple companies in the Houston, Texas area. He has owned and operated Parker Investments since 1984 and has been involved in structuring private and venture capital investments for the past 15 years. Table 11 shows a brief summary of the board and its sub-committees.

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    FREEMAN Reports

    Table 11: The Board and Sub-Committees

    Source: Bloomberg (As of 4/20/2015)

    Since the company became a publicly traded company in 1997, several separate individuals have held roles of Chairman of the Board and Chief Executive Officer. Because todays company directors have more oversight responsibilities than ever before, having a separate Chairman who has the responsibility of leading the Board is beneficial. In addition, by having an independent director serve as Chairman of the Board, the companys Chief Executive Officer is able to focus on leading the company. The companys Lead Independent Directors responsibility is to preside over meetings at which the Chairman is not present, to serve as a liaison between the Chairman (and management) and the independent directors. The Lead Independent Director has the right to call meetings of independent directors and vote for the companys decision, which benefits both the companys operation effectiveness and shareholder interest.

    The Audit Committee mainly takes responsibility for the appointment, retention, compensation and oversight of the independent registered public accounting firm for the purpose of preparing the Companys annual audit reports or performing other audit, review or attest services for Carrizo. The Board has determined that all of the members of the Audit Committee satisfy the independence standards under the NASDAQ Listing Rules and Rule 10A-3 of the Securities Exchange Act. In addition, the Board has determined that Mr. Parker is an audit committee financial expert who is a certified public accountant and served as partner at a major accounting firm.

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    FREEMAN Reports

    The primary responsibilities of the Compensation Committee are to review and approve the compensation of the Chief Executive Officer and other executive officers and oversee and advise the Board on the policies that govern Carrizos compensation programs. The Nominating and Corporate Governance Committee works on identifying, evaluating and recommending, for the approval of the entire Board of Directors, potential candidates to become members of the Board of Directors. It also recommends membership on standing committees of the Board of Directors. Overall, Carrizo has an optimal management with independent Board members and regulated Board sub-committees structure, which are well prepared for the companys operating efficiency.


    Our Teams Projections for Carrizos financial performance are heavily dependent on the current low oil pricing environment and cost effectiveness of shale oil plays as oil prices change. Carrizos ability to thrive in the current oil pricing environment, differentiates it from its peers.

    Production Based on company presentations and management conversations we assumed that Carrizo would have a fairly flat run rate from Q4 2014 production into 2015 with slow growth in the three years following as commodity prices slowly improve according to our price deck. We assume the majority of Carrizos drilling efforts will be focused on the Eagle Ford Shale for the next four years and no other material production will be added during that time. In addition, we Carrizos gas production will decrease year over year and its oil production will increase as the company moves assets from its gas plays to its oil based sweet spots.

    Carrizo gave guidance that it plans to drill 54 new wells in 2015 and exit 2015 with the same number (22) wells waiting to be completed as 2014. Therefore, guidance for total wells completed in 2015 is 54. In Q1 2015, only 1 rig will be operating in Eagle Ford therefore production numbers will be lower than the following three quarters. In the February press release, CZRO stated average quarterly production for 2015 will be fairly close to Q4 2014. Also, total year-over-year growth from 2014 to 2015 will be 17 percent due to Q4 2014 being the strongest of the four trailing quarters.

    In the following years we assumed that if commodity price remain depressed, Capex will be similar to the $495 million laid out in 2015 moving forward. Management will drill a similar amount of wells and continue to focus on Eagle Ford. Three rigs will be operated and production will be evenly spread across four quarters and production will remain stable. Farther into the future, our team assumed that management will need to move assets from other gas and uneconomical oil plays to the Eagle Ford play in order to keep up with current production.

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    FREEMAN Reports

    Oil & Gas Pricing Assumptions

    The pricing forecast used in our intrinsic valuation is based on the NYMEX oil prices for WTI oil as of April 20, 2015, which was $55/Bbl. At $55/Bbl oil pricing, Carrizos Eagle Ford assets generate a rate of return of 29 percent. Our gas price projections are based on a Henry Hub price of $3/Mcf. We used a 30 percent discount to the price of oil and gas to account for Carrizos unsuccessful drilling projects that would occur in the event the company attempted to produce its remaining proved, probable, and possible reserves at current commodity prices.

    Operational Expenses

    SGA will decrease by five percent every year after 2015 because as oil prices decline Carrizo will be forced to cut costs. Interest expense will increase by five percent every year after 2015 because the company will draw down debt on its RLOC and have to pay interest on that debt. We assume that Carrizo will pay a consistent percentage of stock based compensation based on total compensation in next three years because stock. Total compensation is tied to overall company performance, the current oil and gas price environment, and Carrizos commitment to cost reductions. We assume Income tax rate is 36 percent and that all taxes will be deferred during 2015 and in perpetuity.

    Lifting Costs will stay in the range of $6.75 and $7.50 in 2015 according to management guidance. We project lifting costs will remain stable thereafter. Production taxes are four percent of production which is the average of last four quarters. Ad valorem taxes will remain fairly in line with the previous period minus a small differential because ad valorem taxes are based on the value of the minerals a company is leasing, and reserve property value will fall with falling oil prices.

    Gain/Loss on derivatives is based on a four quarter trailing average because this number will be a large gain until Carrizos existing hedges expire and new, less profitable hedges take effect. DD&A will be roughly $25.50 per barrel of oil equivalent in production. Because Carrizo plans to scale back its capex we assumed this percentage will remain flat.

    Financing Our major assumptions were that Carrizo would need to draw down $65 million in debt in each quarter of 2015 which will come directly from Carrizos revolving line of credit (RLOC). This is the amount that Carrizo will need in cash to be able to continue its operations. After 2015, Carrrizo will decrease its borrowing to $50 million per year in order reduce total debt. The debt needed above is based on our cash on hand projections and will come from Carrizos revolving credit facility as well. This cash will be used to fund drilling and production operations. In addition, we assumed that there will be no change in income tax percentage and that all taxes will remain deferred for all periods projected.

    Carrizo will remain 60 percent hedged in gas and NGL, and 44 percent hedged in oil for 2015. Carrizo has approximately 20 percent of 2016 oil

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    FREEMAN Reports production hedged with no other gas or oil hedges in place thereafter. In addition we assumed that the company differentials from the benchmarks will remain the same for the next four years.

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    FREEMAN Reports Carrizo Oil & Gas Inc. (CRZO) Annual and Quarterly Income Statement

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    FREEMAN Reports Carrizo Oil & Gas Inc. (CRZO) Discretionary Cash Flow

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    FREEMAN Reports Carrizo Oil & Gas Inc. (CRZO) Annual and Quarterly Balance Sheets

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    FREEMAN Reports Carrizo Oil & Gas Inc. (CRZO) Annual and Quarterly Statement of Cash Flows

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    FREEMAN Reports Carrizo Oil & Gas Inc. (CRZO) Ratios