Royale Energy, Inc. (ROYL)
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Royale Energy is turning higher pricing
and production into profit and higher value for shareholders
CEOCFOinterviews: Mr. Hosmer, please give us an overview of Royale.
Mr. Hosmer: Royale Energy is primarily a natural gas exploration and production company. Most of our production is based in California. We are exploring producing fields utilizing 3-D seismic. We go into producing areas and look for bypassed reserves of natural gas. That would be either in the form of an undrilled fault block or up-dip natural gas or what they call attic gas looking for the nooks and crannies utilizing 3-D seismic and being able to image those sub-surface structures and reserves.
CEOCFOinterviews: Is it the availability of the seismic technology, which leads you to want to do this?
Mr. Hosmer: 3-D has allowed us to better visualize these sub-surface structures, and look for natural gas that couldnt be discovered through conventional 2-D seismic or just wild-catting. It gives a better picture of what we are exploring for and optimizes the drilling locations. It allows us to get more reserves per well drilled.
CEOCFOinterviews: Why is California a good area for you, and have you always been in California?
Mr. Hosmer: We are primarily a California company. We do some joint ventures down in the gulf coast and in west Texas. Our primary core area is California and there are two reasons; we like the natural gas basin of the Sacramento Basin and the shallow gas basin down in Bakersfield. The producing areas are very good for 3-D seismic, and then we get a bright spot AVO response out here with natural gas. It works in other areas as well, but California works very well. Those bright spots are the sound transmission of a 3-D seismic survey that travels through the various formations. Natural gas is a very absorbent hydrocarbon, so when the sound traces transmit through a gaseous formation, that gas absorbs the sound trace and creates an anomaly or a bright spot. We can not only identify the structures and the traps for the natural gas, but we can also identify whether or not they are gas-filled because of the bright spot anomalies. It doesnt eliminate the risk, you still have risks of tight sand and water formations, but it greatly reduces our risk for finding natural gas reserves. We like California because of the exploration potential, but also because of the market. California is at the end of a pipeline grid, and as the natural gas flows from the producing regions on El Paso pipeline out here to California, a lot of that natural gas is now being absorbed by the growing economies in Nevada, New Mexico and Arizona, where they are building a lot of new homes and gas and electric generating plants. That is being absorbed before it gets out here to California. The natural gas flowing from Canada is being absorbed by the growing economies in the Northwest, Washington and Oregon. Consequently, California imports 84% of its natural gas, so we are very tight out here in the supply-and-demand balance. We consume a great deal; most of the homes being built are equipped to burn natural gas. Most of the new power plants being built are equipped to burn natural gas, so there is a lot of consumption and at the same time we are having a diminishing supply to the state, both from an exploration standpoint and a market standpoint to sell the gas, its a very good place to be a California producer.
CEOCFOinterviews: How involved are you in exploration, and how much production?
Mr. Hosmer: The more we explore, the more we produce. We shoot our seismic and then determine which wells we are going to drill, and then depending upon our success, that is how much we are going to end up with in production. In exploring for natural gas here in California, last year we had 100% success. Every well we drilled in California was a commercially productive well.
CEOCFOinterviews: Is that unusual?
Mr. Hosmer: It is very unusual. In Texas we drilled three dry holes, so we didnt have 100% success rate overall. Using the 3-D technology, typically there is about a 70-80% success rate.
CEOCFOinterviews: Is all the work you do in California, 100% yours?
Mr. Hosmer: We operate 99% of what we do here in California. We have done a few joint ventures, but only on a few wells. Everything else is company operated and we operate about 70 wells here in California.
CEOCFOinterviews: What is involved in the operation and production, as are there new technologies at work in that area?
Mr. Hosmer: Absolutely! In production we have telemetering at our well site, so that we can see what the production flows are on a real time basis. We know exactly what the wells are producing right here from the office, based upon our meter flows, so technology has really advanced both in the area of exploration, 3-D seismic technology and in production, being able to flow and meter the wells.
CEOCFOinterviews: How do you work around the ebbs and flows in natural gas pricing?
Mr. Hosmer: You dont, you just live with it. We have had cycles; we went all the way down to a $1.06 per MCF IN 1993. In 1994 and 1995, we were in the $2.00 to $2.20 range, and went all the way up to fifteen dollars per MCF in 2001. The main thing in production and our pricing, is our total operating and lifting cost, which is about 70-80 cents an MCF; we can still make a small margin of profit all the way down to $1.06. You dont make as much money when you are producing and delivering gas at those price levels. Recently the fundamentals have been stronger for natural gas.
CEOCFOinterviews: Do you see that trend continuing?
Mr. Hosmer: I cant forecast what prices are going to do but all the analysts think that the fundamentals are good. In fact this morning, the Federal Reserves Chairman Greenspan, in his speech said natural gas is an extremely serious problem, supplies of storage are at extremely low levels and the normal seasonal rebuilding of these inventories seem to be behind the typical schedule he also said that Canada a major source of domestic gas imports, has little room to expand shipments to the United States, and limited capacity in the United States to import liquified natural gas, and effectively restricts our access to abundant supplies of natural gas. Tight supplies affect increases and demand, and demand will be tight going forward.
CEOCFOinterviews: How do you decide what properties to explore?
Mr. Hosmer: Our geologists identify areas that have been drilled based upon 2-D seismic or no seismic data at all. Those are prime areas to go and purchase the production and lease the properties. We then go in and conduct our 3-D survey and then not only image some areas where the existing well didnt produce all of the reserves, but find new areas within those fields that have not been drained at all. It is low-risk drilling because you are in areas, which have known production. You are trying to image the fault traps that have not been fully drained.
CEOCFOinterviews: Is there much competition in this area of the business?
Mr. Hosmer: There is competition; Royale being a publicly traded company on NASDAQ national market, allows us a greater visibility and confidence from the lease-holders, so it helps; us in certain areas to compete for good properties and acreage.
CEOCFOinterviews: Will you tell us about your most recent quarter?
Mr. Hosmer: We came in first quarter with twelve cents a share, primarily based on increased production by drilling those successful wells last year that I mentioned. In addition to that, there was a very nice price increase; our average price was over $4.00 per MCF, and in the third month of the quarter we averaged $6.00 per MCF. That contributed to a much higher earnings growth. Here in the second quarter we are averaging an even higher price; we have been averaging over $5.00 per MCF, and our production has grown even more than our first quarter. I see a very strong growth curve for Royale going forward.
CEOCFOinterviews: Do you sell the gas as you produce it, or hedge on the pricing?
Mr. Hosmer: We dont hedge any of our gas, we sell it on a gas daily index. As the price has been going up, we have been enjoying that increased price; at some point we may decide to lock in a certain price for some period of time but at this point, we are just going on a gas-daily index and selling it on a daily basis.
CEOCFOinterviews: Where do you see the company five years from now?
Mr. Hosmer: We are going to continue building our inventory of prospects, and we are doing that by acquiring new properties here in California; we just acquired two more 3-D surveys in the first quarter of 2003. We will be generating new prospects to drill from there. We are expanding our joint ventures in Texas; we just shot a fifteen square mile 3-D survey on the gulf coast of Texas, with another company. We are also exploring based upon some 3-D data out in west Texas, going for a twelve thousand ft. FUSSLEMAN oil play. We expect to keep expanding. We did a joint venture in Louisiana with a 3-D survey.
CEOCFOinterviews: Is it a deliberate plan to do a certain amount outside of California, or do you wait for something to come your way?
Mr. Hosmer: We move when something looks good, which helps us to expand our inventory but only if it meets a certain criteria of quality prospect, and that would be using 3-D seismic with good well control in producing areas.
CEOCFOinterviews: When you look at property, how much is science and how much is the human factor?
Mr. Hosmer: You have to have good people; our chief geologist was with AMOCO as their exploration manager for twenty years down in Houston, and he looks at all the projects that we enter into and he has the knowledge for what areas are good and what areas are not. He has a good scientific background to be able to process and analyze the geophysical data. People are very important. The land people that are the ones that go out and get the acreage and the people that negotiate for the production are just as important as the geologists in determining whether it is a good area or not. In order to be able to produce it optimally, there has to be a knowledgeable and experienced engineer. We also need marketing people to fund the program. Fund raising is important for the company to raise capital.
CEOCFOinterviews: What is the financial condition of the company?
Mr. Hosmer: The financial position is excellent! We have a good line of credit with a bank down in the producing region and good access to the capital market in order to fund our growing programs. Our debt is relatively low compared to our equity and our market cap. I think we only have about two or three million in debt. We are able to continue funding through internal cash flow and accessing some of the capital markets.
CEOCFOinterviews: Tell us a little about the oil aspect.
Mr. Hosmer: We were a 100% natural gas producer just two years ago and then we did these joint ventures down in west Texas and the gulf coast. We found a well that is making over 300 barrels per day. We have a couple of wells producing over 100 barrels a day as well. We just drilled another one here in Bakersfield, which is an 11,000 ft. test well, and we will be testing that next week to see if and how much oil we have there. We are starting to utilize 3-D for oil, and we are starting to add oil to the mix.
CEOCFOinterviews: Why did you make the decision to go that direction?
Mr. Hosmer: The volatility of oil has been taken out along with and the low price collapse scenario. We felt the economics started to look attractive, and the projects looked attractive. We felt that we could find some relatively low-risk oil reserves to add to our production mix.
CEOCFOinterviews: What sets you apart from your competition and what should investors know about Royale?
Mr. Hosmer: I would say the thing that sets Royale Energy apart is the ability to take the higher prices and margins resulting from those prices, and put them to the bottom line of earnings. We have done that. Two years ago when the price was spiked, we earned over seventy cents a share. Every time the price increases, and we have been adding production consistently; we put that right to the bottom line of earnings, so our earnings per share is what sets us apart from other oil and gas companies that may be looked at on the basis of their cash flow and not their earnings. We are able to increase our equity. Oil and Gas Journal, in their September 2002 issue, listed Royale for the fifth time as one of the twenty fastest growing publicly traded oil and gas companies. We were listed and ranked number-nine on return on equity of over 30%. That is among all publicly traded companies, form Exxon to Shell and so on. I would say it is our ability to capitalize on higher prices and production and turn that into profit and higher value for the shareholders.
CEOCFOinterviews: What are your biggest challenges going forward?
Mr. Hosmer: The challenge would be to continue finding good quality prospects to drill. They are out there; just finding them, and finding them at the right prices and being able to continue adding those to our inventory will be the main challenge.
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