Contango's Kenneth Peak on Low Costs, Value Creation, and Shareholder Wealth Per Share

As a follow up to yesterday's post on Contango Oil and Gas (MCF), here's a presentation that contains a summary of the company's core beliefs. Kenneth Peak, the founder, CEO, and chairman of Contango, says that these core beliefs have been in place since the company's inception in the late 1990s.

Contango's Core Beliefs
- The only competitive advantage in the natural gas and oil business is to be among the LOWEST COST producers
- Virtually all the exploration and production industry's VALUE CREATION occurs through the drilling of successful exploration wells
- The whole point of a business is only and always to increase SHAREHOLDER WEALTH – PER SHARE…with conditions

Beliefs are optional, Results are mandatory and the only result that matters is long term – 3-5-10 year returns to shareholders

It's also worth noting Contango employs no hedges, has no debt, keeps plenty of cash on hand, and that 23 investors own 75 percent of the stock (Mr. Peak owns more than 15 percent).

"Investing is only and always about return on capital invested." - Kenneth Peak

In this Bloomberg interview, in addition to noting the importance of being low cost, Mr. Peak explains why you cannot lever up an exploration and production company saying that Houston is littered with the graveyards of enterprises that thought they could.

Contango generally drills in less than 200 ft of water in the Gulf of Mexico. Mr. Peak says that, in shale exploration, you may "never drill a dry hole", but that doesn't mean what you'll find will be economically sound (I guess he's saying that what's discovered too often produces a low return on capital). In contrast, he says that the types of wells you do find in the Gulf of Mexico tend to be economically sound.* In other words, when you find a productive well it's very profitable even though, in between, there may be some dry ones. Overall, he essentially argues that, if you know what you are doing, the cost of the dry wells are more than compensated for by the ones that end up not being productive.

In the Bloomberg interview, Peak says the payback on the investment is often 1 to 1.5 years for the kinds of wells he typically goes after.

Contango has few employees (ten or less) and just twelve wells offshore. So operationally it is a relatively uncomplicated and smaller company. According to this presentation back in 2010 (page 7), Contango's full cycle costs sit at roughly half the industry average which, if the case, sure seems rather impressive. 

While Contango may not exactly be my favorite kind of business, I think it's worthwhile noting when the person running the show seems such a competent capital allocator and, more generally, capable operator. It wouldn't hurt to have more CEOs that think along these lines.

In any case, listening to what Mr. Peak has to say probably isn't a bad way to learn more about what's critical to business success in the energy industry.

Adam

No position in MCF

* At least in the shallower depths that he seems to favor. Here is a letter that Ken Peak wrote after the Deepwater Horizon oil spill in 2010.  In the letter, he differentiates the kind of shallow water drilling Contango engages in from the deep water variety. He explains that shallow water drilling does not pose the same kind of operating challenges as deep water. For example, divers can be sent to the mud line of the well bore. Not so for deep water drilling.

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Contango's Kenneth Peak on Low Costs, Value Creation, and Shareholder Wealth Per Share

Reviewed by jembe
Published : 2012-07-06T07:13:00-07:00
Rating : 4.5