Editor's Note: A previous version of this article claimed Miller Energy Resources did not have a crude hedging program in place, but in fact, Miller Energy Resources has hedges in place through 2017. The Fool regrets the error.
A junior producer that has been capitalizing on the energy resources of Alaska is Miller Energy Resources (NYSE: MILL). Miller's core operations are in the Cook Inlet area, and the stock has doubled over the last six months, making any prudent investor wonder whether there is any upside left. To answer this, let's check out the company's strengths, weaknesses, opportunities, and threats.
Production Growth: The successful drilling program in Alaska, coupled with an acquisition, helped Miller grow production by 147% in the second quarter of this fiscal year over the same period of the prior fiscal year. Miller reached daily gross production of approximately 4,015 boepd at the end of November 2013.
Reserves Growth: Miller's success in Alaska boosted its reserves located in the Cook Inlet area. Including the North Fork acquisition, Miller's reserves (proved developed) in the Cook Inlet area have grown approximately 400% since April 2013.
Revenue Growth: Total revenue for the first half of fiscal 2014 rose 66% year over year, primarily due to additional production being brought online in Alaska. According to the CEO, Miller will more than double its fiscal 2013 revenue of $34.8 million during fiscal 2014.
Successful Development of Reworked Wells: Assessing the deficiencies that historically caused less-than-optimal production from its offshore Alaskan wells, Miller determined that sidetracking the existing well bore could remedy the issues met by the previous operators and improve flow rates. Thanks to this new well bore design, the company reworked, recompleted, and sidetracked wells on its Osprey offshore platform, increasing production from the wells it has brought back online since early 2013.
Alaska's Premium Pricing: Alaska's oil production will most likely continue to shrink over the coming years, because several major development projects have been shelved. In March 2013, Royal Dutch Shell (NYSE: RDS-A) put its drilling plans on hold in Chukchi and Beaufort Seas after it was forced to remove its two drilling rigs from the Alaskan Arctic. The rigs were sent to Asia for repairs after a series of ship groundings, harsh weather, equipment failures, and regulatory uncertainty.
ConocoPhillips (NYSE: COP) is Alaska's largest oil producer and one of the largest owners of exploration leases. The company's main producing assets in Alaska are the Kuparuk and Prudhoe Bay oil fields.
In April 2013, ConocoPhillips announced that it was suspending plans to drill in Alaskan waters in 2014, because of uncertainties over federal regulatory and permitting standards. The company wanted to reevaluate its exploration program, and needed time to further clarify the requirements for drilling offshore Alaska. ConocoPhillips is ramping up its production at Kuparuk by adding a drilling rig to Kuparuk's rig fleet on Alaska's North Slope.
This lack of significant new energy investments in Alaska helps oil and natural gas prices retain their premium pricing. Currently, commercial natural gas prices in Alaska are almost double the price paid in the rest of North America, and Alaskan crude has also been holding a decent premium against WTI.
Better Loan Terms: Miller recently entered into an amendment to its loan agreement, which reduces its borrowing costs and provides it with greater financial flexibility. The amendment increases the amounts available by $20 million and reduces the interest rate on new funds that are borrowed to an initial rate of 9% per annum.
Continuing Losses: Although production has grown since 2012, Miller is losing money quarter after quarter. It recorded a net loss of $8.3 million for the second quarter of fiscal 2014.
High Key Metrics: Miller's adjusted EBITDA rose to $5.9 million for the second quarter of fiscal 2014. With estimated adjusted EBITDA for the fiscal year 2014 at approximately $20 million, Miller's key metrics are much higher than other junior producers', as illustrated below.
Miller's peers have oil-weighted production, and significant production growth on a year-over-year basis.
Alaska's Favorable Tax Policy: The Alaska Clear and Equitable Share and the Cook Inlet Recovery Act programs are part of the existing favorable tax policy in Alaska, and allow producers to recover up to 40% of qualified expenditures on certain costs incurred in connection with their Alaska energy projects.
This favorable tax policy doesn't seem to be changing anytime soon, because the state recently dropped to the third position in the top 10 oil-producing states in the U.S. To reverse two decades of declining oil production, Alaska introduced in April 2013 a new oil tax bill and granted a tax break to oil companies.
Potential Acquisition Target: Several E&P companies operate close to Miller's properties in Alaska. For instance, Apache (NYSE: APA) is Alaska's largest leaseholder with about 850,000 acres under lease, and is engaged in a multi-year seismic program to acquire 3D data on a large area of the Cook Inlet basin, both onshore and offshore. Apache completed drilling at its first Cook Inlet exploration well in March 2013, and has high hopes for Cook Inlet, which produced more than 200,000 bbl/d in its heyday, but its production has dwindled to about 10,000 bbl/d today.
Appalachian Diversity: In Appalachia, Miller has been reworking existing stripper wells. In January 2013, Miller drilled its first horizontal Mississippian well with encouraging results. Miller has identified 25+ horizontal drilling targets in Tennessee with a relatively low cost and quick payouts.
Commodity Volatility: Miller is a junior producer that doesn't have the financial resources to weather any sustained downturn in oil prices. Moreover, the company only has a portion of its oil production hedging, thus a prolonged drop in oil prices will negatively affect Miller's top and bottom lines.
Alaska's Strict Environmental Laws: Miller operates in an ecologically sensitive environment with strict environmental regulations in light of the Exxon Valdez oil spill. Any environmental damage in Alaska caused by accidents and spillages could lead to costly litigation and regulatory fines.
I won't personally be buying Miller, because the stock is richly valued at current levels. Miller's peers have more compelling metrics, offering more upside potential to investors.
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