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Comstock and KKR in Eagle Ford JV

Comstock Resources Inc.'s second quarter results took a beating from "extraordinarily low natural gas prices," but the company continues to shift to oil in a big way and just sealed a joint venture (JV) for its "growth engine" Eagle Ford Shale acreage. Comstock expects good things to come from the Permian Basin and plans to hold on to its Haynesville-Bossier Shale acreage in anticipation of better days for dry gas.

Comstock and Kohlberg Kravis Roberts & Co LP and affiliates (KKR) signed an agreement for KKR to participate in the company's development of its Eagle Ford shale acreage in Atascosa, Frio, Karnes, LaSalle, McMullen and Wilson counties in South Texas. KKR will have the right to participate for one-third of the company's working interest in wells drilled on its 28,000 net acres in exchange for paying $25,000 per acre through a drilling carry for the net acreage being acquired. KKR will earn one-third of Comstock's working interest in 80 acres for each well it participates in.

The agreement applies to wells spud on or after March 31, 2012 and applies to 100 wells to be picked by Comstock.

CEO Jay Allison told financial analysts during an earnings conference call that the JV allows KKR to participate with it in the Eagle Ford but does not obligate Comstock to drill wells in the future. "KKR earns one-third of our working interest in 80 acres for each well they participate in. In other words, they pay $667,000 for 26.7 net acres that we assign them and they pay one-third of the well costs," Allison said.

"Basically, we are guaranteed $67 million for the 2,167 net acres that the first 100 wells will earn, and they can continue to participate on the same terms until they have earned a one-third interest in all of our undeveloped acreage.

"This transaction will provide the capital necessary to accelerate drilling of this exciting oil play, while still allowing us to have the capital to develop our Wolfbone properties in West Texas," Allison said. The new joint venture agreement...will allow us to balance our operating cash flow and drilling expenditures and gives the company a strong financial partner to help us pursue other growth opportunities."

Analysts at Tudor, Pickering, Holt & Co. called the deal a "nice watermark on a relatively small package," and said they assume most of the interest will be around the positions in La Salle and McMullen counties.

"We started going through this JV process back in January, and we had several proposals from some quality partners," Allison said. "What we were really looking for was more of an oil and gas partner, not really a financial partner but more of an oil and gas-type partner. Your preference would be is that they've been in the area before. Because what they can do is they can stamp approval on the 28,000 net acres that we have and say, 'I've been in and out of this are before. I like it; I like your program.'

"We didn't want to be locked in by a big prepayment up front that would cause us to drill wells over the next three or four or five years if oil prices went south. So we wanted a win-win. We want total flexibility. Our goal this year was to transition into oil from dry gas and at the same time keep our 7 Tcfe of resource upside in the Haynesville-Bossier.

"So what KKR did is they came in...they looked at all of our acreage and we came up with a program that said we want to decide where the wells will be drilled...We want to decide where to drill, how to complete. You can have some input...The intent is for us to be the operator and you be a passive working interest owner, really."

The JV was the good news. The bad was last quarter during which realized natural gas prices were less than half what they were a year ago.

Comstock reported a second quarter net loss of $10.3 million (minus 22 cents/share) compared to net income of $3.9 million (8 cents/share) for the year-ago quarter. The most recent results included a $5.3 million ($3.4 million after tax, or 7 cents/share) impairment on natural gas properties as well as a gain of $20.3 million ($13.2 million after tax or 28 cents/share) from the sale of oil and gas properties. Results for the year-ago quarter included a gain on sale of marketable securities of $8.5 million ($5.5 million after tax or 12 cents/share).

Comstock shares plunged 9% ($1.60) to close at $16.18 in heavy trading last Tuesday following the release of earnings and news of the Eagle Ford JV. During the last 52 weeks the stock has traded between $11.05 and $33.63.

Production in the second quarter of 583,000 bbl of oil and 21.9 Bcf of natural gas, or 25.4 Bcfe, increased 6% over the 24 Bcfe produced in the second quarter of 2011. Oil production increased 267% over the year-ago quarter. Oil production in the second quarter, which averaged 6,400 b/d, grew 14% from the 5,600 b/d day produced in the first quarter of 2012.

Comstock's average realized natural gas price of $2.03/Mcf for the second quarter was 52% lower than the $4.19/Mcf during the year-ago quarter. The company's average realized oil price, including hedging gains, was $103.37/bbl, which was 2% higher than year-ago quarter price of $101.02.

Higher oil production in the second quarter only partially offset the effect of the "extraordinarily low natural gas prices" as oil and gas sales for the second quarter of 2012 decreased by 7% to $104.7 million as compared to 2011's second quarter sales of $112.5 million. Oil sales comprised 58% of total sales in the quarter as compared to only 14% in the second quarter of 2011.

CFO Roland Burns told analysts the company is forecasting 2012 oil production to be 2.4-2.6 million bbl, representing an increase over last year of 190-210%. Gas production is forecast to be 84-86 Bcf, a decrease of 5-7% from last year.

Burns said that with the KKR JV in place, cash flow is expected to exceed drilling expenditures during the second half of the year based on the current Nymex strip.

During the first half of this year, Comstock drilled 39 wells (31 net) and had five wells (3.6 net) drilling at the end of the quarter. The wells drilled in the second quarter included eight (7.2 net) oil wells in West Texas and eight (7 net) oil wells in the Eagle Ford. At the end of the second quarter, the company's six operated drilling rigs were all drilling oil wells in South Texas and West Texas as the company has suspended natural gas drilling until gas prices improve.

Since the beginning of 2012, Comstock has completed 31 oil wells, 15 in the vertical Wolfbone program in its West Texas region and 16 in the horizontal Eagle Ford program.

Since closing on the acquisition of acreage in Reeves County in West Texas, Comstock has drilled and completed 13 operated vertical Wolfbone wells. The wells have an average per well initial production rate of 374 boe/d (78% oil). "Comstock's vertical Wolfbone wells continue to be some of the best vertical oil wells in the play," the company said. Of eight new wells, three had initial production rates over 400 boe/d. Comstock is currently drilling its first horizontal well targeting the Wolfcamp shale formation.

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