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REMARKS TO DREXEL BURNHAM LAMBERT
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Mesa is becoming very easy to understand. . .both the assets and philosophy have been in place for over 30 years.
At year-end 1988 Mesa had:
— 100 million barrels of oil and liquids
— 2.25 TCF natural gas
— 2.85 TCF equivalent, 80% natural gas
— 15th largest holder of domestic natural gas
80% of total reserves are associated with our two primary areas of interest:
— Hugoton — the largest gas field in U.S.
— Panhandle field located just north of Amarillo.
The key to Mesa and the credit quality of Mesa bonds is the concentration of high quality, long life, low cost gas production.
High quality:
— Our core properties have been producing for over 30 years.
— We have a lot of history, no engineering risk.
— They are quality reservoirs
[Handwritten addition: excellent permeability in large contiguous reservoirs, with very good deliverability characteristics]
Long Life:
— Reserve life index, which is calculated as total reserves divided by the current production rate, of over 14 years.
— Industry average for natural gas is less than 10 years, so we are 40% longer.
We are a low cost producer, which is very important in a commodity business.
— One reason is that our production is from shallow wells, concentrated in large fields.
— Mesa’s production cost company wide in 1988 was only $.50/Emcf, which includes $.11 of production taxes, one of the lowest
in the industry.
— Only APC lower — they are virtually all gas, no liquids.
— Shallow production means minimal mechanical risk.
— You’re not dealing with fractured reservoirs two or three miles deep. Our major production is in large reservoirs, only
half a mile deep. We can replace a well in a week.
— You’re not dealing with fractured reservoirs two or three miles deep. Our major production is in large reservoirs, only half a mile deep. We can replace a well in a week.
In addition to our presently proved reserves of 2.8 Tcf, we have great opportunities to add to reserves by further development on our properties.
In total, Mesa has 900 development locations to which incremental reserves have not been assigned. We think that drilling these new wells can add about 25% to our reserve base.
It is very important to understand what kind of wells we are talking about. We are not wildcatting here. These are the same type of wells on which we have had better than a 95% success rate in each of the last three years.
Reserves for these 900 wells are not yet booked; with the exception of the infill program, these locations will be drilled after market turns.
Now lets look at 1988 and 1989:
— 1988 was another lean year for the industry. Oil averaged $14.50 per barrel. Mesa’s overall gas price was about $1.80.
The most significant achievement for Mesa in 1988 was the purchase of the Tenneco Mid-Continent division.
— The purchase closed in December 1988.
— We bought the properties for $700 million and promptly sold a portion for $110 million.
— Intend to sell another $100 of these properties in 1989.
This was truly a unique purchase for Mesa.
— 60% of the reserves in the Tenneco package were in the Hugoton field.
— These were properties that Mesa operated and already owned a 1/2 interest in.
— Unlikely we will see anything like this again “leave no more than 10% on the table.”
— In addition to the presently proved reserves, we also picked up about 160 development locations in the deal.
One effect of the Tenneco purchase is that we incurred more debt and in the MLP structure we have tried to avoid high debt levels.
Top priority for 1989 is to reduce debt through asset sales of up to $300 million, (which would represent about 10% of our
reserves).
— We will probably sell $100 million more of MidContinent properties and up to $200 million of Mesa properties.
There’s a saying in the business that the good properties get better, marginal properties get worse.
— Throughout our history, we have bought and sold properties, constantly upgrading the quality of our core holdings.
We know our assets well, and work them very hard to get the most value out of them.
We operate with a lean, but very capable and dedicated group of employees.
We have 2.85 Tcf and only 650 employees:
— Over 4 Bcf of gas and $4 million in assets per employee.
— Maxus, by comparison, has barely one Bcf and less than $1 million in assets per employee.
We have the best management group at Mesa that we have ever had.
— Led by Paul Cain, who is the president and chief operating officer.
— Paul has 25 years of oil industry experience and is the best operating and administrative executive I’ve ever had.
— Management structure has only a couple of layers; we get more work done that way.
Now let me give you my current views on oil and gas prices and the future of our industry:
— We’ve had a very strong move on crude oil since last fall, from $12 to $20 per barrel.
— OPEC and non-Opec are finally getting their acts together.
— We have had a weak winter on gas prices.
— But, the gas “bubble” is clearly diminishing. The drilling rig count is at 40-year lows; only 766 rigs were drilling last
week, compared to 935 a year ago, and 4,500 rigs at the peak in 1980 (81?)
— Only 40% of annual production is being replaced on an industry wide basis.
— Demand for natural gas has increased 6% in each of the last 2 years.
— As the gas market approaches equilibrium, prices become very sensitive to demand.
— Any forecast that predicts a steady percentage increase in prices isn’t useful because gas is a commodity and commodity
markets just do not work that way.
— In early February, during the arctic cold snap, we saw $3.50+/Mcf.
— So as the market balances, you’re going to see a strong move in prices.
— Gas will trade at parity with crude oil for the first time in my career.
This concept of Parity between oil and gas deserves special attention.
— The economic value of a barrel of oil or of a thousand cubic feet of gas is the energy that it can generate. On a Btu basis,
it takes about 6 Mcf of gas to produce the same energy as one barrel of oil.
— So, given an even playing field, a thousand cubic feet of gas should sell for about 1/6 of what a barrel of oil sells for.
— But that’s not the case. Right now, with crude oil at $20 a barrel and spot gas at $1.50 an Mcf, you have a price ratio
of 13:1, more than twice the energy equivalent ratio of 6.1.
— This disparity will not last. Natural gas and crude oil are going to trade at parity with each other.
— When this happens, $20 crude oil will mean $3.30 gas.
— And you can add 10-15% for gas being a premium fuel. It burns much cleaner than oil.
— There will be a sharp jump: In the winter of 1989, I think you have a 1 in 4 chance of a price jump; in 1990, your chances
are probably even money; in 1991, I believe you improve to a 4 to 1 chance.
— We can afford to wait because we have the long life reserves.
So there it is — really a simple story:
— 15th largest holder of natural gas in the U.S.
— Our reserves are located in shallow, duality fields, which have a long production profile.
— We are a low cost producer, which is very important for a commodity business.
We strongly believe that the value of natural gas will be upgraded.
— Whether it’s 1989, 1990, or 1991.
— We’ve been around for over 30 years and we’ll be there when the turn comes.
[Handwritten addition: Introduce SLT — 9 years.]
SLT Financial
Boone emphasized the importance of long-life reserves
— I have a few charts to illustrate why long-life properties are so important in today’s low price environment.
Created an example of two 100 Bcf natural gas fields.
— First one has a short reserve life — 7 years, which means that its current production rate is about 14 Bcf per year.
— Second one has a 14 year reserve life, the same as Mesa’s average reserve life.
This chart shows the profile of remaining reserves as the property produces
— the short life property has a much faster decline rate.
— in the first five years, 56% of the reserves are produced
— The long-life property produces 32% in the first five years, and has 68 Bcf left.
— So the long-life property has over 50% more gas left at the 5 year mark.
In the current environment of low prices, and more importantly, the uncertainty of when prices will turn, having this profile is very important.
The next slide compares the FNR and PV of our short life and long-life property in a case where it takes 5 years for gas prices
to improve.
— We assume gas prices stay flat at $1.75 for five years, then increase to $3.00 per Mcf, held constant forever after.
Left side of chart shows FNR and PV at 1/1/89.
— Long-life property has higher MR, because more gas is left to be sold at the $3.00 price.
— But it has lower PV because the revenues are produced over a longer time frame.
Right side shows FNR and PV at 1/1/94, after five year of production.
— The long-life property has 60% more FN R.
— Remember that the short life property produced off more than half of its reserves during the five years of low prices.
— The long-life property only produced one-third of its reserves in the first five years.
Notice that the present value at 1/1/94 of the short life property has decreased 26% while the PV of the long-life property
has actually increased.
— The long-life property produced off one-third of its reserves and still had a higher PV than when we started.
So in today’s environment, with uncertainty as to when the gas bubble will be gone, long-life properties offer a clear advantage.
— You can afford to wait.
— And whether price increases come in 2 years, 3 years, or even 5 years, you will get the benefit because your reserves are
still there — they haven’t all been produced away.
— You can imagine what a better result the long-life properties give if you escalated prices from the $3.00 number we used.
This next slide applies this principal to Mesa to show the gas price that is needed at each year-end to maintain our present
SEC PV of $1.9 billion.
— This chart assumes that Mesa never adds another Mcf of gas — no discoveries, no development, no purchases, nothing.
Each year we produce off a portion of our reserves and this gas price maintains the value.
This chart gives us great confidence, and as bond holders gives you great confidence, that the values in Mesa do not deteriorate even in a period of weak prices.
Selling bonds to match financing with the Tenneco assets recently purchased.
— Acted as our own bridge.
— Want to restore flexibility.
Current (12/88) Debt/Equity based on Net Debt of $1.18 billion and Equity of $953 million is 1.2 to 1.
Whole idea of MLP is to not get too leveraged, so our goal now is to reduce debt.
First we anticipate asset sales in 1989, and
Revolver goes to term in 1991, requires amortization from 1991-95.
Three years of historical data show strong cash flows/coverage ratios.
— Nature of the business is such that cash operating earnings represent a high percentage of revenues.
— Though coverages have declined slightly, due to gas price reduction, still plenty of comfort.
— Important to note net interest vs. gross interest.
Earlier we illustrated the impact on our property values if gas prices took 5 years to recover. Now, I’d like to illustrate
the price leverage that Mesa’s assets have when prices increase:
— This chart demonstrates the standard SEC values of Mesa’s reserves as of year end 1988, given our long-life production profile,
at various prices.
— As you can see, a move of a little over one dollar in price would add more than a billion dollars of value to our existing
reserve base.
— Also, we illustrate the resulting asset coverage ratios given these same prices.
— From $1.84 to $3.00 for spot gas, asset coverage ratio increases from 1.5X to 2.5X.
— We certainly understand that gas prices aren’t going to hit $3.00 tomorrow or the next day; but we d o have confidence that
we’ll get there sometime over the next few years.
— And as we have tried to make clear here today, when we do achieve these price levels, the vast majority of our reserves
will still be in the ground, our value intact.
That’s why we feel we have a good security to offer you:
— Proven assets that generate cash flow and show great promise for the future.
— And we have the management to get us there.