?“With the commodity price pull-back, private-equity providers are motivated, because previously prices were a little lofty, and there tended to be a large discrepancy in valuation with potential industry partners,” says Adam Connors, associate director of corporate finance for C.K. Cooper & Co.

?Life is good for this year’s class of oil and gas microcaps as energy-focused private-equity providers turn to them for good returns. In fact, a few microcap E&Ps are forming special-purpose vehicles (SPVs) to partner with private-equity providers and monetize carve-outs of high-value assets.


“There is an abundance of private equity available, not only for traditional private companies, but also for public companies,” says Adam Connors, associate director of the corporate finance group for Irvine, California-based C. K. Cooper & Co. “By carving out assets and partnering with private-equity investors, this is proving to be a very viable option.”


Since the last few months of commodity price fall-off, microcaps are reluctant to issue equity or tap turbulent debt markets due to the pro-rata valuation decline. Private-equity fund managers are stepping in to fill the gap. Via the partnerships, microcaps can accrete their properties and equity-fund managers can get in, realize gains, and get out.


Carved-out assets that might be slightly higher risk, or cost an E&P more to develop than its other holdings, are suitable for SPV financial structures, says Connors. For microcaps with temporary capital-constraints due to the currently depressed value of their equity, it makes sense to integrate private-equity partners that will contribute up to 100% of development costs in exchange for returns based on the risk-versus-reward aspect of the project.


It’s also common for the private-equity partner to option back the assets to the E&P, through a put feature, after a certain level of gain is met. Gains are usually measured via internal rates of return thresholds.


C.K. Cooper is assisting several of its clients to form SPVs. In one case, the investment will total $30 million. In another case, it could reach $250 million.


“With the commodity price pull-back, private-equity providers are motivated because previously prices were a little lofty and there tended to be a large discrepancy in valuation with potential industry partners. Now is a good time for them to get capital working as asset values are being reassessed and returned to more realistic values,” says Connors.


Meanwhile, the following five up-and-coming microcap independents are busily adding value the old-fashioned way—by growing reserves and production in today’s hot plays.


Crimson Exploration Inc. Houston-based Crimson Exploration (OTCBB: CXPO), a $69-million market cap E&P, owns and operates more than 280 wells, primarily in the Gulf Coast region of Texas, Louisiana and Mississippi. As of December 31, 2007, it had proven reserves of 130 billion cubic feet of gas equivalent (Bcfe), 75% proved developed producing, 70% gas and 84% operated, and it held interests in more than 173,500 gross acres.


In June, Crimson reported its #6 Catherine Henderson gas well was completed and producing at a rate of about 7.3 million cubic feet and 550 barrels of condensate per day in the Willis Marsh Field in Liberty County, Texas. The well was drilled to a total depth of 13,111 feet and logged 80 feet of net pay in the Cook Mountain formation.


The well will yield an estimated 75 barrels of gas liquids per million cubic feet produced and processed. Crimson has a 67% working interest and a 50.6% net revenue interest in the well.


This is Crimson’s first well in Willis Marsh Field but is the seventh successful out of eight wells drilled in Liberty County since it acquired the property last year, says president and chief executive Allan Keel.


“Crimson has also been successful in nine out of 10 wells drilled in the Felicia area over the past 12 months,” he says. “The drilling success we have experienced in Liberty County supports our belief that this area still contains a significant amount of upside potential for the company. We will continue to be active in Liberty County for the remainder of this year and in 2009, with an estimated two to four more exploitation wells and one development well anticipated for the remainder of the year.”


Crimson reported production of an estimated 4.8 Bcfe, about 53.2 million cubic feet per day, for the second quarter of 2008, an increase of some 52% from second-quarter 2007.


The dramatic increase in production was due to its own drilling program and production from the South Texas and Gulf Coast producing assets Crimson acquired from Exco Resources Inc. in May 2007 as well as producing properties it acquired from a private company this year.


Crimson’s major properties are the Felicia fields in Liberty County, SW Speaks Field in Lavaca County, Cage Ranch Field in Brooks County, all in Texas, and the Iowa Field area in southwest Louisiana. Crimson also has emerging plays in 14,000 gross acres of potential in Colorado’s Denver-Julesburg Basin. The company is evaluating the benefits of listing on a major exchange.


Before Crimson, Keel was vice president and general manager of Westport Resources’ Houston office until its ultimate sale to Kerr-McGee. He also was vice president of Enron Energy Finance, president and chief operating officer of Mariner Energy Co., and interim president to Woodside Energy Inc. (USA).


Other management includes Thomas Atkins, senior vice president of exploration; E. Joseph Grady, senior vice president and chief financial officer; Jay S. Mengle, senior vice president of operations and engineering; and Tracey Price, senior vice president of land and business development.


Southern Star Energy Inc. Houston-based Southern Star (OTCBB: SSEY), a $53-million market cap E&P, owns a 40% working interest in some 5,300 acres in Sentell Field, in the heart of the Cotton Valley trend north of Shreveport, Louisiana. Formed in November 2006, Southern Star has quickly built up its Sentell Field position in North Louisiana.


“In a relatively short period of time, we have been able to assemble a very high-quality asset position in North Louisiana,” says Dave Gibbs, president and chief executive. “We got in early and underneath the radar screen. It took a lot of work, but our all-in land costs are less than $400 an acre.”


Notably, Southern Star owns all rights to all depths throughout most of its Sentell acreage, including prospective Haynesville shale potential. Management intends to evaluate the potential for drilling and producing gas from the Haynesville with a vertical delineation well later this year.


In May, Southern Star completed its fourth consecutive successful Cotton Valley well. This #7-2 Rendall, in Sentell Field, is the best well in the company’s development program in Bossier Parish to date. The well was fracture-stimulated in multiple Cotton Valley Davis sand intervals within an 800-foot gas-bearing section at depths between 8,449 and 9,252 feet, and it is currently flowing at a rate of 1.4 million cubic feet of gas per day.


“Although our Sentell Field has the potential for about 50 Haynesville wells positioned on 160-acre spacing, there are no probable or possible reserve estimates for the Haynesville shale potential in Southern Star’s year-end May 31, 2008, reserve report,” says Gibbs. “Our delineation program will clarify the viability of our Haynesville potential later this year.”


Southern Star began a 10-well development program in the third quarter of this year, drilling for the Cotton Valley and Haynesville. The first well was spudded August 13.


As of year-end May 31, 2008, Southern Star’s estimated total proved reserves from Sentell Field were more than 3.5 Bcfe, including 810 million proved developed producing, 317 million proved developed non-producing, and 2.4 billion proved undeveloped.
The company plans to grow production through the drillbit and is currently evaluating the benefits of listing on a major exchange sometime early next year.


Gibbs joined Southern Star after working as president of private operator TDC Energy for several years. Previously, he worked with Union Texas Petroleum, Superior Oil Co. and ExxonMobil Corp.


Other management includes Eric Boehnke, chairman and director; Bruce L. Ganer, vice president of exploration and development; and Douglas M. Harwell, operations manager.


Pegasi Energy Resources Corp. Tyler, Texas-based Pegasi Energy (OTCBB: PGSI), founded in 2002, is a $70-million market cap E&P active in East Texas, with offices in Houston and Jefferson, Texas.


“Our focus area is East Texas in Marion and Cass counties,” says senior vice president and chief financial officer Richard A. Lindermanis. “We are focusing on the Cotton Valley, Bossier and other multiple zones very close to the Haynesville shale.” Pegasi also operates a 40-mile gas pipeline, a gathering system and owns and operates a saltwater disposal facility.


The company holds more than 20,000 gross (14,000 net) acres in the Cornerstone Project area of the East Cotton Valley trend.


In July, Pegasi reported its #2 Harris and #2 Childers in Marion County, Texas, had been completed. Both wells were fracture treated in the first of several stages in the Cotton Valley group and are producing oil and gas into temporary production facilities while awaiting permanent equipment. Gas production will go to market through a new high-pressure, 8-inch pipeline recently built by Pegasi.


To date, Pegasi has drilled five producing wells to establish a proved reserve base in the Rodessa Field region with a substantial increase in reserves, based on its February 2008 updated reserve report. The increase is due to the previously mentioned two wells drilled. The company’s net reserves are about 30 Bcfe proved, 22.7 Bcf probable and 212 Bcf possible, based on a 70% working interest. This compares to its 2007 reserve report of 15 Bcf proved, 21.8 Bcf probable and 217 Bcf possible. Production is about 1.33 million cubic feet equivalent per day.


Pegasi has identified 109 drilling locations within its present acreage position and plans to drill an initial 10 wells using horizontal drilling techniques. These wells will target the Bossier oil formation and are expected to yield significantly higher flow rates than its existing lower-risk vertical wells.


Speaking of his management team, Lindermanis says, “We’ve been in this all our lives, but we have just recently gone the public route. We recently undertook a reverse merger through a PIPE (private investment in public equity) transaction.” The company went effective in late August and Pegasi plans to list on the American Stock Exchange (Amex) in the near future.


Prior to co-founding Pegasi, Lindermanis was with Amerada Corp., Louisiana Land & Exploration Co., Patrick Petroleum Corp. and Sandefer Oil and Gas in Houston. Since then, he has founded several other companies. Other Pegasi co-founders are Michael H. Neufeld, president and chief executive, and William L. Sudderth, executive vice president of land.


Rock Energy Resources Inc. Houston-based Rock Energy Resources (OTCBB: RCKE) is a $193-million market cap oil and gas E&P. It was formed as a master limited partnership in 2004 and continued to be privately held until a reverse merger in January. The company produces gas in Texas and heavy oil in California.


Rock Energy has a 100% operated working interest in the Wilcox gas trend in Garwood Field, including a leasehold position of some 1,650 net acres in Colorado County, Texas. Its proved, probable and possible reserves there are estimated to be about 40 Bcf.
The company also has a 100% working interest in a gas prospect in the Bob West field area, with a 1,110-acre leasehold in Starr County, Texas. Its Wilcox discovery potential there is pegged at 250 Bcf.


“We have another seven development locations to drill in Garwood,” says Mark Harrington, vice chairman. “In Bob West, given the potential of 21 separate pay zones, we could have seven to 20 wells there. We will be spudding that in the fourth quarter.”


In August, the company recompleted its #1 Pintail well in Upper Wilcox in Garwood Field. The well had an initial flow rate of 300,000 cubic feet per day. Another recompletion, #1 Pintail Flats, was targeted for September with a potential in excess of 3 million cubic feet per day.


In California, Rock Energy has a 20% earning interest in 214 barrels of oil per day from the Orcutt Monterrey formation in Santa Barbara County’s Santa Maria Basin, and three resource projects in the Opal A Diatomite formation in the same area. According to company reports, there may be as much as 2.5 billion barrels of oil in place in those formations, and recovery rates could top 20%.


To fund working capital for its development activities, Rock Energy closed a $40-million equity financing agreement with Perm Energy Advisors Inc. earlier this year, with the first tranche of that funding coming in the fourth quarter.


“In California, we have a potential of more than 1,200 locations to be drilled on our Orcutt property and about 2,000 on Northwest Casmalia,” Harrington says. “We successfully pilot-steamed Orcutt and are going to pilot-steam Northwest Casmalia in the fourth quarter.” Rock Energy also has a nearby third property on which it will conduct pilot-steaming in 2009.


“Our objective is to find opportunities that fit our pistol of low finding and development costs,” says Harrington. “And our pistol is to find projects in which we can find a first-mover advantage such as has happened in California.”


Rock Energy expects to have a presence on the Amex in the fourth quarter of this year.


Prior to joining Rock Energy, Harrington helped incubate an oil service company, Best Energy Services, which went public earlier this year. He also formed a private E&P called Quinduno Energy, which was sold in 2005, but he is best known for Energy Vulture Funds, which he formed in 1986.


Other management includes Rocky V. Emery, founder, principal, chairman and chief executive officer; and Tom S. Elliott, president and chief operating officer.


ReoStar Energy Corp. ReoStar Energy Corp. (OTCBB: REOS), based in Fort Worth, is a $25-million market cap E&P focused on oil and gas properties in the Barnett shale of Cooke County, Texas, and the Corsicana enhanced oil project in east-central Texas. As of March 31, 2008, the company had about 20,000 gross acres of leasehold, including 16,000 acres of exploratory and developmental prospects and 4,000 acres of enhanced oil recovery prospects.

As of March 31, ResoStar’s production had increased to 92,192 barrels of oil equivalent (BOE), a 36% increase from the previous year. Its revenues also increased by 71% to $4.9 million. Its total proved developed reserves are 1.4 million BOE, and proved undeveloped reserves are 1.6 million BOE, allowing plenty of running room.


“We have realized excellent progress, operationally, in both our Barnett shale and Corsicana development projects,” says chief executive Mark Zouvas. “We remain focused on continuing these results.”


ReoStar owns an average 40% interest in 62 wells in the Barnett shale. During first-quarter 2009, it will complete and begin production in seven wells and drill another six that should be completed in second-quarter 2009. The company also repurchased working interests in another 30 wells for about $1.8 million.


In February, it moved up-hole from the Barnett and re-completed a well into the Forestburg limestone formation. The well showed initial production of 40 barrels of oil and 50,000 cubic feet of gas per day.


ReoStar also has 114 producing wells in Corsicana Field, most of which have been enhanced and put back online. Since injecting surfactant polymer in mid-June of 2007, average production has increased about 50%. It has drilled two of its planned four deep exploration wells and expects to drill the rest in second-quarter 2009.


Zouvas says the oil reserves in Corsicana are shallow, found at depths of less than 1,000 feet. While the field has been producing for more than 100 years, several engineering studies have estimated that more than 80% of the original reserves, some 100 million barrels, remain in place. Its total proved developed reserves there are 430,000 BOE and proved undeveloped reserves total 10.3 million barrels. Reo­Star plans to list on Amex at some point.


Before joining ReoStar, Zouvas was a principal in a commodities-trading operation in Chicago and a former chief financial officer or board member of several publicly traded companies. Other management includes M.O. Rife III, chairman; Scott Allen, chief financial officer; Vern Wilson, vice president of operations; and Brett Bennett, vice president of administration.

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