ATP Oil and Gas – Almost 50% of Float is Short, Short Squeeze Starts in September

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Aug 25, 2010
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I just saw the most recent short interest on ATP Oil and Gas which now amounts to over 21 million shares. With just over 50 million shares outstanding and 13% of those tied up by management we are looking at an incredibly high short interest.

Now usually seeing such a high short interest would give me pause. But I have been following this company extraordinarily closely for over 3 years, and to be honest, if there is an information edge here it is on my side.

Prior to BP messing up their well in April ATP shares were touching $24. Now they are under $11 with a short interest that has doubled since then. Those shorts are going to be in for a tough decision as there is going to be a flood of good news coming that may set off a classic short squeeze. Here are the reasons that I think those short this stock are going to be wishing they weren’t in the coming weeks:

1) ATP is going to monetize the ATP Titan. They are going to do it in the very near term. And it is going to provide them with more liquidity than they need. The amount of cash that is going to be freed up from this monetization is $350 million. This single transaction alone should be enough bring in interest from investors who have been concerned about ATP’s liquidity.

2) A increase in cash flow of more than 40% is coming within the next few weeks when ATP brings on the second Telemark well. It is expected to be about 7,000 BOE per day vs the existing production of 22,000 per day. So this is a 30% plus increase in production, but an even larger increase in cash flow as this well is almost 100% oil vs production that is more evenly split between oil and gas.

3) So stop and think about that for a minute. Within the next month ATP is going to bring in enough cash to fund an entire year worth of capex AND add a well which will increase cash flow by 40%. That is a massive improvement to both liquidity and cash flow within the next few weeks.

4) The big spending is done. It is done. Over the past two years ATP has struggled to come up with the $900 million to complete the ATP Titan and the Telemark pipelines. That is what created the highly leveraged balance sheet. Now the spending goes into drilling wells that immediately add production and cash flow. Over the last two years there has been little spending on drilling, the spending was all on the infrastructure. To put it in perspective the first half capex was almost $500 million. The second half will be $140 million.

5) And ATP wells that are drilled make a big difference to production and cash flow quickly. Consider that in Q4 2009 ATP was producing 13,000 BOE per day. Current production as a result of being able to drill just a couple of wells is already up to 22,000 BOE per day. What is that a 40% increase already this year ? Next is the 7,000 BOE per day MC941 #3 well at Telemark which brings the company to almost 30,000 BOE per day. Then in Q4 the 5,000 BOE per day well at Gomez (already drilled just being connected by pipeline). So in just 2010 ATP is going to enter the year at 13,000 BOE per day and leave it at 35,000 BOE per day. But there is more coming because the infrastructure is now in place and the spending is going into drilling. In 2011 comes the third Telemark well at Mirage which will be another 7,000 BOE per day, and the fourth Telemark well at Morgus which will be yet another 7,000 BOE per day. And also in 2011 will be two additional development wells at Gomez which will both come in at around 5,000 BOE per day.

6) Just to get my point across in #5. The cash over the past two years was being spent on infrastructure that provided no immediate cash flow reward. That spending is done. Now the cash goes into drilling and cash flow increases immediately. This company is crossing the bridge from huge infrastructure spending to drilling spending.

7) This brings me to another point that I want to make. ATP is horribly overleveraged using the REARVIEW mirror. Their balance sheet is the result of all of that spending on infrastructure at Telemark. While their income statement and cash flows have yet to show any benefit from all of that spending as the production is just starting. Perhaps the multitude of short sellers are using some sort of REARVIEW mirror approach where leverage to cash flow ratios look horrible. When you look FORWARD and see what production is going to be after just two more wells you start to see very manageable leverage ratios. When you consider the next 3 Telemark wells and the next 3 Gomez wells which are coming on in the next year or so you should fully get the picture.

8) Now if you know ATP at all you should be asking “but what about all of the infrastructure spending at the next big project Cheviot” ? The answer there is that there just isn’t going to be much. The bulk of cost of Cheviot relates to the production unit called the Octabouy that is already 70% complete in China. Under an agreement with the Chinese company building the Octabouy the entire cost (topsides and hull) will be constructed on a payment deferred basis. When it is complete in early 2012 it will be financed under a similar SPV structure that the Titan will be going into in the upcoming weeks. In other words no cash required from ATP. And for the rest of Cheviot I believe that you will see ATP bring in a partner on the project. ATP has said as much several times and I believe they are already well into discussions.

9) Are you aware of the reserve increases coming to ATP in the next 18 months ? ATP has 212 million BOE of 2P reserves. This could will increase materially in the next 18 months. First will be the addition of Entrada which was picked up this year. The prior operator had over 30 million BOE booked. Second and even more exciting is MC710 which is right beside Gomez. ATP picked it up early this year and believes that it is a mirror image to MC711 which is Gomez and has 50 million BOE. Keep in mind that ATP already has all of the infrastructure in place at Gomez and if this turns out as they expect will result in a huge amount of cash flow with no additional infrastructure spending.

10) What about the government regulations coming ? The answer is that we have seen what Congress has proposed and it is manageable for companies like ATP. The Senate still has to pass something and it appears that their legislation will be even less harmful. The bottom line is that the Certificate of Financial Responsibility requirement WILL allow for pooling of interests by smaller operators and that works well for the GOM independents.

11) And the drilling moratorium ? Well, it is scheduled to end in November and it seems likely that it will end earlier. And the fact is that the ATP Titan is the premier production and drilling unit in the entire GOM with respect to safety redundancies and will be the first to get back to work. And even more importantly ATP already has drilling permits in hand for all 3 remaining Telemark wells.

12) And perhaps even most importantly any legislative changes will apply to FUTURE leases not existing leases. Existing leases were acquired under binding legal contracts that can’t be broken without breach of contract. All of ATP’s value comes from existing leases.

There was a pretty significant short interest back in April. These people got very lucky that BP made the mess they did or ATP would already have the MC941#3 well on production and have the Titan monetized. But what we have learned is that government legislation is going to have minimal impact on ATP and other independent operators. And at this point with 50% of the float sold short I think there is going to be a scramble to cover ahead. ATP has ample liquidity, access to more liquidity, and no debt covenants to worry about. All that is ahead is a series of six large DEVELOPMENT wells to drill and complete (2 of which are already drilled, 2 are partially drilled and 2 to be drilled completely). As a short how long can you sit around and watch as ATP adds well after well each of which add at least 5,000 BOE of production (to put that in perspective 5,000 BOE per day x 365 days x $60 oil = $100mil of revenue per year per well). Get your eyes off the rearview mirror and actually do some math on the size of the cash flow increase that is coming.

Here is a pain for shorts checklist of what I think is coming:

- Monetize the ATP Titan $350million of cash (could be any day)

- MC941#3 well 7,000 BOE per day of oil production (before the end of September)

- Formal announcement on deferral of Octabouy topsides construction cost (any day)

- Moratorium is lifted

- MC754 (Gomez) well 5,000 BOE per day (in fourth quarter)

- Formal announcement on a partner on Cheviot

- Add reserves from Entrada on year end reserve report (this opens $300mil of additional funding on first lien loan)

- Third Telemark well at Mirage Q1 2011 7,000 BOE per day

- Fourth Telemark well at Morgus Q2 2011 7,000 BOE per day

- Two Gomez wells in 2011 5,000 BOE per day each

- Result from drilling MC710 at Gomez which could result in a large increase to reserves with no additional infrastructure cost

With these “Big Six” wells coming on over the next while ATP is going to be a company with annual EBITAX in the $800mil to $1bil range. I’ve seen various valuations suggesting that the company would be worth $50 to $70 with this sort of production. If you are short here you are looking at a potential loss of 5x to 7x from here. And what are you really hoping will drive the stock down much further ? ATP has plenty of liquidity, a huge step change in cash flow coming in a couple of weeks, and more increases coming every quarter almost indefinitely and no financial covenants.

I’m obviously long ATP. I don’t love the company, but a love the increase in production from 13,000 BOE per day to 22,000 BOE per day that has already happened and the increase of another 30,000 BOE per day that is in the drilling pipeline with no further infrastructure spending required.

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