Goodrich Petroleum Part 2

In general, I try not to return to ideas that I have written about before. It strikes me as a bit lazy; I mean I have already done the research that prompted the initial call and you, dear reader, are probably looking for new ideas, not old ones. Sometimes, though, a situation changes, or appears to, and a previously talked about stock becomes an opportunity all over again.

Such is the case with Goodrich Petroleum (GDP). I first talked about Goodrich in a piece you received in the April 4th edition of Oil & Energy Insider. At that time I identified the stock as one of the best plays on the continuing shale oil boom. GDP closed that day at $17.11 and then went on a tear, peaking at $29.60 in June.
 

If you took my advice then, I am sure you were quite pleased with a 67 percent profit in 2 months, but if you did and are still holding on I am equally sure that recent news and subsequent price action has you worried…don't be. In fact, now may be a good time to add to that position and for those that missed the chance to get in on the action.

The news that caused the recent drop was Goodrich's announcements that their last two completed wells, Nunnery 12-1H-1 and Beech Grove showed "disappointing" first day production of 815 and 740 Barrels of Oil Equivalent per day (BOE/d). For comparison, the two wells completed before that, Blades 33 H-1 and Lewis 30-19H-1 yielded around 1200 and 1450 BOE/d. I understand that these lower initial yields caused the stock to drop, but a 30 percent fall looks to be a serious overreaction.

The basic case for investing in the Tuscaloosa Marine Shale (TMS) play that GDP is involved in and for buying that stock in particular is still in place. The TMS has, until recently, been a problematic field. Drilling problems have led to delays in production and even some failures, but recent technological advances and simply learning from past problems have made recent wells less problematic. This process is continuing and days to completion and therefore the cost of de-risking known reserves continues to fall. Goodrich wells currently cost around $13 million to complete and the company has a goal of reducing that to $10 million. Five consecutive wells drilled without major problems suggest that that goal is achievable. Obviously, at that point, margins would increase significantly and that is the key to GDP's future profitability.

At the time of the initial article, I also pointed out that significant short interest of around 10 days to cover could exaggerate any upward move in the stock, and that could well have been the case, as shorts were down to around 7 days to cover by the end of June. It is likely that the recent drop has attracted more shorts and we could well see a repeat of the squeeze that took place in April and May.

Of course, there are risks. The relatively high cost of production means that companies committed to the TMS would face significant problems if the price of oil were to collapse, but given the resilience of WTI as U.S. production has boomed that looks unlikely except in the event of a more general economic meltdown.

The more general market trend away from growth potential could also cause further losses in the stock, but  the contrarian in me says that is about to change. Janet Yellen's recent comments in particular seem to me reminiscent of Greenspan's "irrational exuberance" remark in 1996 after which the NASDAQ composite continued on up over 300 percent. When central bankers try to talk away a problem that they have created rather than making policy changes it rarely has the desired effect. Speculative investing in growth potential is likely to continue.

The risks, then, look manageable, but the overall, long term picture remains unchanged. Goodrich Petroleum owns significant drilling rights in a proven field that has seen, and is likely to continue to see, falling production costs. The fact that initial production in the last two wells is lower than in the two before that should come as no surprise and certainly doesn't justify a 30 percent drop in the stock. That move just means that I have to repeat myself; GDP once again looks like a good play on a continuing shale oil boom in the U.S.