Unocal Scrambles to Turn Dry Holes Into Discoveries

Analysts are not pleased with Unocal's exploration results, and want the company's sizable investments to translate into oil finds.
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Unocal

(UCL)

likes to tout its souped-up drilling technology, which pierces the earth 47% faster than comparable wells. There's just one problem: The wells it's drilled with this fancy technology in the Gulf of Mexico's deep waters have been duds.

Now, Unocal is on the hot seat to produce results in its exploratory efforts after spending two years gearing up for its entree into the deep-water gulf arena.

"So far we have heard a lot of talk, but where's the beef?" asks Fadel Gheit, who follows Unocal at

Fahnestock

in New York. After shares of El Segundo, Calif.-based Unocal ran up 45% this year, he slapped a sell rating on the stock; Fahnestock hasn't done underwriting for Unocal.

Unocal's stock has run up this year more than even well-regarded

BP Amoco

(BPA)

, which on Thursday announced a potential billion-barrel find in the gulf. And at about 43 a share, Unocal is trading at an implied reserve valuation of $7.30 per-barrel-of-oil-equivalent, Gheit says. Most large-cap and medium-sized independent exploration companies trade at an implied reserve valuation of $5.50 per-barrel-of-oil-equivalent. That 30% premium comes thanks to expectations that Unocal will come up with huge discoveries, or expectations that a larger oil company will take it over.

But Unocal's poor showing so far in the gulf's deep water will intensify the focus on results from additional exploratory wells Unocal will drill this summer, as well as on the results from appraisal wells on the earlier discoveries that are expected to be drilled in the fourth quarter. Expectations for at least one of those fields, the BP Amoco-operated Mad Dog prospect, are high. Unocal estimates that its 25% stake could net it 100 million to 200 million barrels over the life of the field.

The dry holes in Unocal-generated prospects represent a troubling kick-off for its domestic exploration unit,

Spirit Energy 76

, and its deep-water Gulf of Mexico exploration program. Its investment to date has been substantial: In last summer's western-gulf lease sale alone, Unocal won bids on 77 blocks, paying $185 million. In just two years it has amassed 216 deep-water blocks in the gulf. So it needs to show results soon.

"I think it's somewhat disappointing that they haven't had better results," says Charlie Ober, manager of the

(PRTAX) - Get Report

T. Rowe Price New Era fund and a Unocal shareholder. "It concerns me that they spent a lot of money in one of the lease sales in acreage that's pretty far out in the field from where current discoveries have been made."

Unocal says it's impossible to find oil without drilling dry holes. "That's what happens when you go out exploring," says spokesman Barry Lane. "Dry holes are a fact in the oil industry. The fact that we mention our dry holes is what draws your attention to it."

Unocal's time and money-saving drilling techniques still are good for the company's shareholders, he says, noting that even the recent dry hole costs were nearly halved by the company's technology.

And Unocal participated in two discoveries this spring with BP Amoco and

Vastar

(VRI)

as operators.

Moreover, says Gene Nowak, who follows Unocal at

ABN Amro

, the prospects which came up dry weren't the "big prospects" on Unocal's list. Any one of 14 prospects Unocal will drill over the next several years could give it the giant find that would crown its gulf efforts, he says, and would go a long way for the company. (Nowak rates the stock a hold; his firm hasn't done any Unocal underwriting.)

It would go a long way for disillusioned shareholders as well. "This company has a really good track record of coming out and disappointing like this," says one buy-side analyst whose fund is in the process of shedding Unocal shares.

Unocal's goal is to add 400 million barrels of oil to its deep-water reserve base by 2002, an ambitious target that's more than all of the crude reserves currently held by the Spirit division. Much of those reserves are expected to come from the deep and ultra-deep waters of the gulf, as well as from Unocal's holding in the Far East. Meanwhile, Unocal's net worldwide proved reserves totaled 532 million barrels of crude and just over 6 trillion cubic feet of natural gas at Dec. 31.

So investors are quite eager to see Unocal find new reserves. The next few wells Unocal drills "are critical" says Ober at T. Rowe Price. Unocal's management has "a lot of things working for them, they just need to get back-to-back successes."

As Gheit at Fahnestock says, the expectations "have to be earned." And all that Unocal is earning right now is a rep as the company that is drilling the fastest dry holes in the Gulf of Mexico.

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