By Steven Ralston, CFA
Dejour Energy (NYSE MKT:DEJ) reported financial results for the second quarter ending June 30, 2012. Like the first quarter, this quarter was impacted by lower natural gas prices, which fell 44.8% year-over-year and 12.6% sequentially. Again this quarter, management did not attempt to maximize gas production, and as a result, gas production declined 9.8% sequentially. On the other hand, oil production increased 5.4% sequentially as a result of the waterflood; however, the rate of improvement was less than expectations. Total revenues declined 4.9% sequentially to $1,488,586. G&A expenses decreased 7.7% sequentially and 13.6% year-over-year as management continues to implement cost savings. Also, operating & transportation expenses decreased 11.7% sequentially; therefore, operating netback only declined 1.0% to $640,000 from $646,000. For the second quarter of 2012, Dejour reported a loss of $402,628 or $0.004 per diluted share, in-line with expectations despite lower-than-expected oil & gas production.
Production levels at Woodrush in northeastern British Columbia are improving sequentially, albeit modestly, due to the increased effectiveness of the waterflood and the reworking of the third well which was drilled late last year. With the water injection rate having been increased to a higher level during the first half of 2012, management expects a full production response to occur during the second half.
However, due to weak NGL prices, management decided to reduce the number of wells in the initial development of the Kokopelli field from four wells to one well, which will require the minimum required investment to maintain the lease on the 2,200 gross acres. Also, additional drilling is being deferred until early 2013, and the number of wells will be dependent on NGL prices.
In addition, lower NGL prices are delaying the construction of the Williams natural gas pipeline into the area. Originally, construction was to have begun in 2012; however, Bargath LLC, a wholly-owned subsidiary of Williams Midstream, has now indicated that construction will not begin until at least 2013. Known as Kokopelli Phase II, the proposed 16-inch natural gas pipeline is expected extend 22.3 miles and terminate in section 4 of Township 7S-92W, within six miles of Dejour’s well pad in section 21 of Township 6S-91W.
Management’s decision to adjust the initial development of the liquid-rich gas Kokopelli field from four wells to one well is disappointing. Though the company is modifying the pace of development in reaction to weak NGL prices, it is necessary that the single well not only be successfully completed by year-end, but also attain the minimum paying quantity of gas in order to preserve the lease on the entire 2,200 gross acres (by changing its status to a held-by-production lease). Also, the economies of scale of developing multiple wells from a single drilling pad at the same time are being forgone. A rig is expected to be mobilized in the next few weeks.
Lower gas prices have also influenced management to defer development of the North Rangely and Roan Creek projects to at least 2013. Management prefers that the company’s cash flow support a greater percentage of the costs of developing its leases in Colorado.
The stock reacted negatively to the lower than expected oil & gas production, the adjusted drilling program at Kokopelli and the deferred development of North Rangely and Roan Creek projects, by declining 18% from $0.23 to $0.19 on the day of the earnings release.
Nevertheless, our rating on Dejour’s stock remains Outperform based upon the expectations of increased production from the company’s Woodrush property in the second half, along with the stock’s continued attractive valuation level of the stock relative to its reserve valuation.
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