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Forest Oil Trips On Faulting in Eagle Ford

Shares of Denver-based Forest Oil Corp. lost nearly 38% of their value Wednesday after the company said it was deferring drilling in the Eagle Ford Shale while it mulls 3D seismic data and evaluates recent well completion designs due to poor well performance. Capital is to be redirected from the South Texas play to liquids-rich opportunities in the Ark-La-Tex.

"This decision will result in lower oil growth for 2014; however, we believe this is a prudent capital allocation decision," said CEO Patrick R. McDonald.

Forest said it encountered greater-than-anticipated faulting in a portion of its southern Eagle Ford acreage that hindered the flow rate of three wells. The fault complexes are in an area where two of the company's seismic surveys overlap. Forest is merging and reprocessing its 3D seismic surveys to better identify and avoid fault complexes, it said.

For this year, about 64% of drilling and completion capital is now to be allocated to the Ark-La-Tex with 36% going to the Eagle Ford. Average net sales volumes are now estimated to be comprised of 35% oil and natural gas liquids, and 65% natural gas.

The news sent Forest shares reeling Wednesday in trading volume that was 18 times the norm. Shares closed down $1.22 at $2.01 Wednesday after touching a new 52-week low of $1.94.

BMO Capital Markets analyst Dan McSpirit wrote Wednesday that "it is uncertain how permanent the damage in South Texas is." He cut his target price on Forest to $1.00/share from $4.00 and wrote that leverage could increase to potentially "unmanageable levels" over the remainder of the year. Capital spending could be cut to preserve liquidity, McSpirit wrote.

Management said during an earnings conference call that it does expect to outspend cash flow this year; however, it is entering 2014 with about $65 million in cash. Asset sales are not being contemplated. The borrowing base would likely be adjusted downward, but more on that is to be known in March after meetings with lenders.

Wells Fargo Securities analyst David Tameron was also dour. "While we had only previously assumed roughly half the Eagle Ford acreage was prospective, this calls into question even that," he said in a note Wednesday. "While this area could eventually be proven economic, we believe the risk-reward has further deteriorated and now view current share price levels as more neutral."

Wells Fargo downgraded Forest to "market perform" from "outperform," now with a $3.00-5.00/share valuation, down from a previous $4.00-6.00.

McDonald told analysts the company's inventory of Eagle Ford drilling locations is "probably closer to the mid-500s now" as compared to the previously estimated mid-600s. "I think as we continue on through 2014 now and throughout the year we'll have a much better sense of how the development will take place," he said.

Forest's 2014 Eagle Ford drilling plan will now involve 48 gross (24 net) wells and entail capital spending for drilling and completion of $95 million. The company said reprocessed Eagle Ford data would be available and utilized to select drilling locations by the third quarter.

"Forest plans to focus its first half of 2014 drilling program in areas where it has a high degree of confidence in the geology, geophysical and reservoir data and believes the fault patterns are accurately imaged," the company said. The southern area is considered to be the more productive portion of the field and is to be the primary focus of the 2014 program.

Last year in the Eagle Ford, Forest was focused on lease expirations in advance of transitioning to the development phase of its program. It plans to hold through production 49,000 gross (24,500 net) acres within Gonzales County, TX. Eagle Ford drilling and completion (D&C) costs averaged $5.6 million per well in the fourth quarter, and the average well cost in 2013 was 15% lower than 2012, the company said.

Forest said it expects to see further improvement in well costs in 2014 through the continued optimization of D&C techniques, the use of existing pad locations, and as an associated oil and gas gathering system and centralized production facility becomes operational during the second half of 2014.

However, incorporating the impact of a slower pace of development in the Eagle Ford and lower-than-expected fourth quarter well results, first quarter net sales volumes are expected to average 105-110 MMcfe/d (67% natural gas and 33% liquids). Based on current projections of planned 2014 activity, the company expects fourth quarter 2014 net sales volumes to average 145-150 MMcfe/d (63% natural gas and 37% liquids).

"...[W]e maintain a balanced portfolio of projects that provides attractive risk-adjusted rate-of-return opportunities," McDonald said. "This [Eagle Ford slowdown] will enable us to reallocate capital to our liquids-rich opportunities in the Ark-La-Tex to maintain a consistent level of drilling activity in 2014."

Forest holds about 234,000 gross (162,000 net) acres in the greater Ark-La-Tex region, including East Texas, North Louisiana and the Arkoma Basin. The acreage is largely held by production and provides "repeatable and predictable drilling and recompletion opportunities in multiple natural gas, oil, and natural gas liquids horizons," the company said. Last year activity was focused on the liquids-rich Cotton Valley and other oil formations.

Based on an improving price environment, lower drilling and completion costs and "excellent" well results, Forest said it is increasing its East Texas activity and recently added a second operated rig to its program. A third operated rig is expected to begin drilling during the second quarter. Forest plans on drilling 20-25 wells in East Texas this year.

As part of an expanded Ark-La-Tex program, the company plans to continue development of a light sweet crude oil play in East Texas where it has completed three horizontal producers since the second half of 2012. Forest holds 19,000 gross (14,000 net) acres within this area. It is currently integrating 3D seismic data with geological and well data, and expects to begin additional drilling in the area during the second half of 2014.

Net earnings for the fourth quarter were $106 million (89 cents/share) compared to $2 million (2 cents) in the third quarter of 2013. Fourth quarter 2013 results included a $202 million net gain on asset dispositions; a $9 million loss on derivatives; rig stacking costs of $4 million; a $38 million decrease in the valuation allowance of deferred tax assets; a ceiling test writedown of $58 million; employee-related asset disposition costs of $6 million; and a net loss on early debt extinguishment of $24 million.

Adjusted net earnings for the fourth quarter were $2.7 million (2 cents/share) compared with $17 million (14 cents) for the year-ago quarter.

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