NON-OPERATED OIL & GAS INTERESTS: BUILDING & FINANCING A PORTFOLIO

JAY GOLDFARB, PH.D.WOODBRIDGE OIL & GAS ADVISORSMAY 22, 2012

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INTRO

DUCTIO

NAgenda & Presenter

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AGENDA:1. Introduction2. Capital Sources3. Illustrative Economics4. Summary/Conclusions5. Contact

Jay Goldfarb, Ph.D. is President of Woodbridge Oil & Gas Advisors 1, an investment banking firm specializing in the sale of upstream oil & gas properties.  Jay has assisted his clients with the execution of more than $1 billion of acquisition, divestiture and financing transactions throughout North America, including numerous Bakken projects.  Prior to joining Woodbridge, Jay was a Vice President at Mesirow Financial, a Chicago-based boutique investment banking firm.  He holds a Ph.D. in Chemical Engineering from the University of Massachusetts at Amherst. 

1 Securities offered through Woodbridge Financial Group, LLC.  Member FINRA, SiPC

PRESENTER:

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INTRO

DUCTIO

NSingle Well Economics – Participating vs. Selling Undeveloped Core Acreage

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Rates of return from drilling in core areas are too extraordinary to forego for lack of funding

Bakken development activity is challenging the non-operated working interest owner’s ability to finance participation

Selling undeveloped core acreage will capture only a fraction of the potential returns available from participating

The market for undeveloped acreage demands a seemingly high rate of return compared to risk 

NOTE:  The examples contained in this presentation are for illustrative purposes only .  You should consult with appropriate experts to evaluate specific investment opportunities. 

UNDEVELOPED CORE ACREAGE FOR ONE WELLWell spacing (acres) 320                    Market value ($/acre) 5,000                Market value ($) 1,600,000        After Tax $ (assume 35% tax rate) 1,040,000

SINGLE BAKKEN WELL ASSUMPTIONS AND ECONOMICSGross EUR (Mboe) 585.5                Realized oil price ($/bo) 75.0                  Realized gas price ($/mcf) 5.0                     NRI (%) 80.0%Completed well cost ($) 8,000,000        After Tax NPV-10 (assume 35% tax rate) ($) 7,228,666 ATAX IRR 46.5%

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INTRO

DUCTIO

NOpportunities and Challenges of Non-Op Oil & Gas Interests

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Non-operated interests are essentially financial assets. Managing these assets consists of choosing the structure and timing for a series of financing and divestiture transactions. Effective planning and decision analysis supported by financial modeling is essential for maximizing value.

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INTRO

DUCTIO

NElements of a Successful Plan

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The plan is the Roadmap for the transformation of a portfolio of undeveloped working interests to cash. It provides support for decision analysis related to potential financing and divestiture transactions.

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Capital structure, Risk and Pricing

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Understanding the capital markets is essential for managing these assets. The market provides a spectrum of products to suit the capital requirements and associated risk.

CAPITAL SOURCES

Risk Type

IRR Objective

CapitalParameters

Engineering Risk  Exploration Risk 

5%              10%             20%               35%               50%+ 

Proved Producing

Proved Non-Producing

Proved Undeveloped

Probable Producing

Proved Undeveloped

Proved Undeveloped

Wildcat

Mezzanine /Sub DebtDevelopment expected to cure loan to conforming bank debt within 12-18 months

Senior Bank Debt~60% of PDP Small % PDNP/PUD

EquityNo proven reserves, limited probable reserves

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ILLUSTRATIVE ECO

NOMICS

Economics of Mezzanine Financing for a Single Well

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Mezzanine Lenders seek 18%+IRR with typical two year minimum term. The cost of this capital should not be a barrier as the typical Bakken well pays out the loan by maturity.

SINGLE WELL INCOME STATEMENT FIRST TWO YEARS

($MM) Production (Mboe) 230                               Revenue 15.6                             Operating expenses (0.2)                              Production taxes (1.7)                              Depreciation and amortization  (5.1)                              Mezzanine loan interest and fees (3.0)                              Income before tax 5.5                                

Taxes @ 35% (1.9)                              Net Income 3.6

SINGLE WELL INCOME STATEMENT FIRST TWO YEARS

($MM) Production (Mboe) 230                               Revenue 15.6                             Operating expenses (0.2)                              Production taxes (1.7)                              Depreciation and amortization  (5.1)                              Mezzanine loan interest and fees (3.0)                              Income before tax 5.5                                

Taxes @ 35% (1.9)                              Net Income 3.6

Cash Flow StatementNet income 3.6                                Depreciation & amortization  5.1                                Cash from operations 8.7                                

CAPEX (8.0)                              Mezzanine loan advance 8.0                                Change in cash 8.7

Cash Flow StatementNet income 3.6                                Depreciation & amortization  5.1                                Cash from operations 8.7                                

CAPEX (8.0)                              Mezzanine loan advance 8.0                                Change in cash 8.7

Illustrated for the first two years production, a typical mezzanine maturity

SINGLE BAKKEN WELL ASSUMPTIONS AND ECONOMICSGross EUR (Mboe) 585.5                Realized oil price ($/bo) 75.0                  Realized gas price ($/mcf) 5.0                     NRI (%) 80.0%Completed well cost ($mm) 8.0                     

SINGLE BAKKEN WELL ASSUMPTIONS AND ECONOMICSGross EUR (Mboe) 585.5                Realized oil price ($/bo) 75.0                  Realized gas price ($/mcf) 5.0                     NRI (%) 80.0%Completed well cost ($mm) 8.0                     

NET ASSET VALUE AT END OF YEAR TWO ($ millions)PV-10  6.9                                Cash from operations 8.7                                Mezzanine debt (8.0)                              NAV 7.7                                

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Initial Development Funded with Mezzanine, Refinanced with Senior Debt

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Mezzanine lenders may finance 100% of development expenses with no starting production on the leases. Production generates borrowing base to refinance with less expensive senior debt.

• Mezzanine finances initial drill-out @ 18% ROR, minimum 2 yr. duration (1.4x return)• Refinanced with senior conforming loan, advance rate less than 60% of PDP PV-10, at end of year 2• Further drilling could be funded with senior debt and cash flow • Need for mezzanine is limited, cost of capital is a blend of mezzanine and senior rates

UN-LEVERED CASH FLOW ($ 000's) YR1 YR2 YR3 YR4 Total Net wells (EOY) 10                        20                      30                 30                       30                BTAX operating cash flow 40,159                95,168              119,722       96,558               351,606      TAX -                       (16,309)             (22,903)        (27,795)             (67,007)       CAPEX (80,000)               (80,000)             (80,000)        -                     (240,000)     

Unlevered cash flow (39,841)               (1,141)               16,819         68,763               44,600        

DRILLING FUNDED WITH MEZZANINE LOAN REFINANCED BY SENIOR DEBT AT END OF YR2BTAX operating cash flow 40,159                95,168              119,722       96,558               351,606      Interest (14,400)               (14,400)             (4,130)          (3,150)                (36,080)       Tax -                       (5,284)               (21,457)        (26,693)             (53,434)       CAPEX (80,000)               (80,000)             (80,000)        -                     (240,000)     Change in cash (54,241)               (4,516)               14,135         66,715               22,092        

Mezzanine debt draw (18% ROR) 80,000                -                     -                80,000        Mezzanine debt paydown -                       (80,000)             -                -                     (80,000)       Senior debt draw (6% ROR) -                       59,000              -                -                     59,000        Senior Debt paydown -                       -                     (14,000)        (45,000)             (59,000)       Net Debt 54,241                58,758              44,623        Cash  -                       -                     -                22,092              

UN-LEVERED CASH FLOW ($ 000's) YR1 YR2 YR3 YR4 Total Net wells (EOY) 10                        20                      30                 30                       30                BTAX operating cash flow 40,159                95,168              119,722       96,558               351,606      TAX -                       (16,309)             (22,903)        (27,795)             (67,007)       CAPEX (80,000)               (80,000)             (80,000)        -                     (240,000)     

Unlevered cash flow (39,841)               (1,141)               16,819         68,763               44,600        

DRILLING FUNDED WITH MEZZANINE LOAN REFINANCED BY SENIOR DEBT AT END OF YR2BTAX operating cash flow 40,159                95,168              119,722       96,558               351,606      Interest (14,400)               (14,400)             (4,130)          (3,150)                (36,080)       Tax -                       (5,284)               (21,457)        (26,693)             (53,434)       CAPEX (80,000)               (80,000)             (80,000)        -                     (240,000)     Change in cash (54,241)               (4,516)               14,135         66,715               22,092        

Mezzanine debt draw (18% ROR) 80,000                -                     -                80,000        Mezzanine debt paydown -                       (80,000)             -                -                     (80,000)       Senior debt draw (6% ROR) -                       59,000              -                -                     59,000        Senior Debt paydown -                       -                     (14,000)        (45,000)             (59,000)       Net Debt 54,241                58,758              44,623        Cash  -                       -                     -                22,092              

ILLUSTRATIVE ECO

NOMICS

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Summary Economics

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In this example, 100% of the external capital requirement is funded with debt, resulting in significant value creation relative to the cost of capital. Upside is retained.

CASH FLOWS ($000s) UN-DISCOUNTED PV-10

After tax cash flow 314,304              126,154               

Interest 36,080                30,246                  

Tax savings - interest deduction 12,628                10,586                  

After tax interest expense 23,452                19,660                  

CASH FLOWS ($000s) UN-DISCOUNTED PV-10

After tax cash flow 314,304              126,154               

Interest 36,080                30,246                  

Tax savings - interest deduction 12,628                10,586                  

After tax interest expense 23,452                19,660                  

NET ASSET VALUE ($000s) UNDEVELOPED DRILLED-OUT YR4

Undeveloped acreage @ $5000/acre 48,000                -                        

Cash -                       22,092                  

PV-10 production  -                       164,676               

NAV 48,000                186,768               

NET ASSET VALUE ($000s) UNDEVELOPED DRILLED-OUT YR4

Undeveloped acreage @ $5000/acre 48,000                -                        

Cash -                       22,092                  

PV-10 production  -                       164,676               

NAV 48,000                186,768               

POTENTIAL UPSIDE   Change in Reserves  Bo

Refracs and increased density 50% 7,500,000            

Deeper Three Forks Benches 100% 15,000,000          

POTENTIAL UPSIDE   Change in Reserves  Bo

Refracs and increased density 50% 7,500,000            

Deeper Three Forks Benches 100% 15,000,000          

ILLUSTRATIVE ECO

NOMICS

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SUMMARY/CO

NCLU

SIONS

Summary and Conclusions

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SummaryRates of return from drilling in core areas are too extraordinary to forego for lack of funding.

Mezzanine loans is an alternative to equity and may finance 100% of development costs is proven areas with attractive economics. 

Mezzanine loans can be refinanced with less expensive senior, reserves based lending.   Reserves based lending and cash flow will be available to finance subsequent development. 

Hold or Sell?The market for undeveloped acreage appears to demand equity returns inconsistent with risk, particularly when considering the potential upside. 

Notwithstanding the upside, buyers for production will accept lower returns, limiting the attractiveness of holding.   Further, the benefit of holding production is offset by the tax arbitrage between ordinary income and capital gains.

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CONTACT

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Upstream oil & gas asset acquisitions and divestitures

CONTACT:JAY GOLDFARB, PH.D.WOODBRIDGE OIL & GAS ADVISORS847.668.8472