Decision to Sell GEOI and Buy ARD Shares on July 29, 2005 is Analyzed
One Year Later ARD Shares Rise 163%; GEOI Shares Decline 47%

Concerns about GEOI production declines raised concerns about the company's future prospects. As production was declining costs were also increasing on a per BOE basis. There were other concerns as well. However, after a call to GEOI headquarters even more red flags became evident. A conference call with both Treasurer and comptroller Ms. Connie R. Hval and Secretary Business Office Manager Ms. Cathy Kruse was unimpressive. Neither woman seemed very knowledgeable about GEOI operations. Many questions went unanswered. The speaking ability of these women left me feeling as though I had been talking to a couple of hillbillies with North Dakota accents. The way these women spoke and conducted themselves in the telephone conference call led me to believe that both were former waitresses at a greasy spoon truck stop with minimal education. GEOI was certainly not a quality oil company to be invested in due to a whole host of issues.

I made some comments on the Yahoo Message board regarding my decision to sell GEOI shares in favor of ARD shares on July 29, 2005. My first post on this day details my thought process on selling GEOI in favor of ARD. My second post is a continuation of additional thoughts. My third post on July 29, 2005 summarized my decision. All three posts lay out the case for selling GEOI and buying ARD.

In the end it was an easy decision. Fast forward one year and it also turned out to be an extremely profitable decision as well. The market is often irrational in the way it prices securities and is therefore often times not efficient as many have postulated. Longterm Mr. Market eventually seems to get things right. On July 29, 2005 I sold my GEOI shares to Mr. Market for $14.85. On that same day I purchased ARD shares for $13.50. One year later GEOI shares closed at $7.80. ARD shares closed at $35.60.

__July 29, 2005_________________July 28, 2006_
SOLD: GEOI...$14.85______________GEOI...$7.80
BUY: ARD...$13.50_______________ARD....$35.60

GEOI share price declined 47%.
ARD share price appreciated 163%.

In the end it was an easy decision to sell GEOI in favor or ARD. Fast forward one year and it also turned out to be an extremely profitable decision as well. The market is often irrational in the way it prices securities short-term and is therefore often times not efficient as many have postulated. Long-term Mr. Market eventually seems to get things right.

Boone Pickens Interviewed on CNBC

"If I went to sleep this afternoon and woke up January 1st and you called me and said, 'Boone did you see that oil is $100 a barrel,' I would not be surprised."

~Boone Pickens, July 25, 2006

Q2 2006 Operational Update Commentary

It seems finding oil bearing acquisitions in TX or NM that meet all the criteria has been difficult for ARD. The company is nibbling on additional acreage in KS with little or no fanfare.

The best part about ARD today is that they are not "boxed in." By this I mean they are NOT pressed to buy unless the deal favors ARD. The reason ARD is not hard pressed to acquire TODAY or in the next 2-3 years is because they have over 540 drilling locations. 300 of the 540 are on the Fuhrman-Mascho Property. This figure for 300 drilling locations on F-M assumes 20 acre spacing. Keep in mind that ARD's neighbor Range Resources (RRC) have already been approved and are drilling on 10 acre spacing. With this being the case ARD has over 600 possible drilling locations at F-M alone if you figure 10 acre spacing down the road at ARD.

130 drilling locations in 2006
260 drilling locations in 2007
450 drilling locations in 2008
...............................
840 drilling locations between now and year-end 2008
(even with an aggressive drilling program.)

Today Capex was increased by 17%. Wells to be drilled in FY 2006 were increased from 120 to 130. Re-fracs for FY 2006 were boosted from 36 to 60. This is no doubt good news and will certainly reap big rewards for ARD shareholders. If oil prices continue to drift higher I wouldn't be surprised to see CAPEX increased again in 2006. This would especially be true if ARD is given the opportunity to acquire and own a second drilling rig. Tim Rochford stated that he would be open to this possibility if the economics favor such an acquisition (acquiring a second rig) in the Q4'05 and FY2005 C.C. on March 17, 2006.

You gotta love ARD.Keep your eyes on net margin. I'm targeting 42% net margin on 15.225mm shares fully diluted for an EPS of $0.40. If ARD can come in with a higher net margin and/or a smaller fully diluted share count then we could easily see some FABULOUS numbers. I just hope there are no big "other expenses" in the income statement.

Also I'd like to say that I"m a bit suspicious of the production figures of 240,000 BOE and $14.5 million in revenue. If ARD really did produce 240,000 BOE then I would have expected something higher than $14.5 given my projection of about 87% production in oil. Unless the Yates Gas formation on the F-M was adding significant amounts of increased incremental BOE then I would have expected the revenue number to be higher. Wouldn't it be a treat if we read the Q2 Earnings to find that revenues were actually closer to $15 million???

Expect More Analyst Upgrades on ARD Shares in Near Future
Fantastic Q2 Results & Increased Drilling Program Seen as Driver for Upgrades

Don't be surprised to see more analysts upgrade ARD shares and raise projected EPS and ultimately the target price on the shares. ARD production as a percentage is growing faster than any domestic oil producer. With over 87% of production in crude oil, ARD is better positioned to profit from Peak Oil than any other company.

ARD Analyst Consensus Estimates Increased
Current Estimates Will Easily be Topped; Expect Further Upward Revisions in EPS Estimates


Q2 2006 EPS Estimate increased from:
$0.36 to $0.37.......UP $0.01

Q3 2006 EPS estimate increased from:
$0.42 to $0.44.......UP $0.02

FY2006 EPS estimate increased from:
$1.54 to $1.61.......UP $0.07

FY2007 EPS estimate unchanged:
$2.61.

Yahoo Downgrades Message Board System; Investor Village Becomes De Facto Message Board for Investors
Link Added to Sidebar for Easy Access

At first I was disappointed that Yahoo changed their message board system for the worst. However, as a result of Yahoo's changes investors looked for a free alternative message board system. Investor Village was found to offer not only a very similar board to that of the old Yahoo message board, but also has enhanced features that make it significantly better. Instead of describing these enhancements I hope you will go to Investor Village and try it out for yourself. I'm confident you'll be extremely pleased.

Amendment: Analysis of ARD FY2007 Earnings Estimates
Share Count Revised Higher

In the latest S-3/A filing with the SEC it was noted on page 3 that the common stock to be outstanding after the offering (including option and warrants) is 16,247,484 shares. Previously I calculated 16 million even. For purposes of EPS calculations I"ll use an even more conservative share count that will not only take into account the slightly higher share count of 16.24 million shares (original calculation was 16 million shares) but also factor in an extra 191,070 shares to be even more conservative in my projections for 2007.

It is evident that even after the latest upward revisions in ARD FY2007 EPS estimates the current estimate of $2.61 is still dirt cheap.

Why?

Lets work the math...

Assume the following:
1. 17.438 million shares fully diluted. (Let's assume that ARD offer another 1.191 million to acquire new reserves or for Capex.)

2. Net profit margin of 45% (48.9% average net profit margin in 2007 is my actual projection based on current information.)

3. $68 Average Realized Price ($80 average realized price in 2007 is my actual projection based on current information.)

4. 1.5 million BOE produced. (This projected growth of 50% is conservative in light of historical growth of 93%, 74% and 127% growth in 2003, 2004 and 2005 respectively. 85% production growth is my actual target.)

In essence I"m offering two figures. The first is a conservative estimate and the second is my actual projection.
1. Shares Outstanding:
____17.43 million (Conservative)
____17.43 million (Realistic)
2. 2007 Net Profit Margin:
____45% (Conservative)
____48.9% (Realistic)
3. Average Realized Price per BOE
____$68 (Conservative)
____$80 (Realistic)
4. Production Estimate for 2007
____1.5mm BOE (Conservative)
____1.85mmBOE (Realistic)

Lets do the math first from the conservative viewpoint.

Revenue:
1.5mm (BOE) X $68 (Ave Realized price)= $102 million

Net income:
$102 mm (revenue) X .45 (net profit margin) = $45.9 mm

EPS:
$45.9 mm (net income)/ 17.43 million shares = $2.63 EPS.

Now lets figure the more realistic earnings potential of ARD in 2007.

Revenue:
1.85mm (BOE) X $80 (ave realized price)= $148 million

Net income:
$148mm (revenue) X .489 (net profit margin)=$72.37mm

EPS:
$72.37 mm(net income) /17.42 million shares = $4.15 EPS.

By conservative estimates we should expect ARD to come in at a worst case scenario of $2.63 EPS. A more realistic expectation for ARD shareholders would be for 2007 EPS of $4.15. If $2.63 is the low end, $4.15 is the middle ground then the high end is something north of $4.15. At this point it doesn't make any sense to even try to determine the high end.

Lets now use both of these figures and use a conservative PE multiple of 30, a more realistic multiple of 35, and a high end multiple of 38 (current PE today.)Share Price Projections based on EPS of $2.70

$2.63 X 30 = $78.9
$2.63 X 35 = $92.05
$2.63 X 38 = $99.94

Share Price Projections based on EPS of $4.25
$4.15 X 30 = $124.5
$4.15 X 35 = $145.25
$4.15 X 38 = $157.7

Even with a slightly higher share count assumption, the current 2007 estimate of $2.61 is low and proof that Wallstreet has yet to realize the true value in E&P companies and especially ARD.

CNBC Interview: Analysts Debate $80 Oil
Maria Bartiromo Moderates Debate

The Effects of $80 Oil and Beyond on ARD Share Price

You have no doubt heard in the media many times about $100 oil. In the U.S. government Shockwave Study it was determined that a 4% decline in worldwide oil production will lead to crude oil prices rising to over $161 per barrel. (Currently Iran controls 4% of worldwide production.) Steven Leeb has talked about $200 oil. Matthew Simmons has even mentioned oil prices far beyond $200 a barrel.

Triple digit oil prices aside, $80 oil would generate MASSIVE earnings for ARD. Consequently the share price would soar. Keep in mind that $80 oil is a drop in the bucket compared to projections of $161 to $200 oil or even higher. $80 a barrel is cheap. I'm afraid that even $80 oil will not be enough to sufficiently kill demand even in an economic slowdown. Factor in the crisis in the Middle East and God only knows how high the prices go. Clearly ARD has is well positioned to earn $4.25 per share in 2007 with $80 oil. $80 oil could ultimately end up being a low projection for the year. In any case, sleep well at night knowing how valuable your ARD shares really are. The last couple days we have seen the Dow and Nasdaq sell off significantly. When oil continues to rise and other sectors continue to sell off due to declining earnings and expectations investors (both Wallstreet and individual investors) will be looking to recover their losses by investing in oil stocks with superior fundamentals and growth such as ARD. When the herd finally realizes the value, earnings power and growth of ARD they will push valuations to levels you never dreamed possible. Many of you may remember the valuations on internet stocks in the late 1990s. Many internet and tech stocks had triple digit PE multiples. There were also many internet stocks that were losing money. These stocks were valued based on price to sales ratios (P/S.) Some of those P/S ratios were also triple digit.As long as humans are investing in stocks you will continue to see panic buying and selling. At some point we will see investors panic buy quality stocks like ARD. Don't be surprised if you see ARD valued like the internet and tech stocks of the late 1990s. The only difference is that ARD has MASSIVE earnings power(unlike a large number of internet stocks that were losing money with triple digit p/s ratios.) Put a MASSIVE earnings multiple on MASSIVE earnings and you have MASSIVE share price. The money to be made in oil stocks such as ARD will eclipse even that of the highest flyers during the internet boom of the late 1990s.

The Effects of Average Realized Price per BOE Produced on ARD Net Margin
Analysis Confirms Initial FY2007 Projections

By taking a look at the effects of historical average realized prices per BOE produced on ARD net margin we can take a look into the future and make a realistic projection of future net profit margin.


Analysis of Average Realized Prices per BOE Produced

We can determine average realized oil prices for 2003, 2004 and 2005 by dividing total revenues by total production. Revenues were as follows:
2003: $3,665,477
2004: $8,482,130
2005: $25,843,077

Production (BOE) was as follows:
2003: 128,867
2004: 223,334
2005: 508,430

Average Realized price per BOE was as follows:
2003: $28.44
2004: $37.97
2005: $50.82

The percentage increases in yearly average realized prices were as follows (year over year):
2004: 33.5%
2005: 33.8%


Analysis of Net Profit Margins

Below are the total net income figures:
2003: 670,143
2004: 2,451,652
2005: 9,460,683

Below is Net Profit Margin:
2003: 18.2%
2004: 28.9%
2005: 36.6%

The percentage year over year growth in net profit margin is as follows:
2004: 58%
2005: 26.6%

Since 2003 our average realized oil price increased 33.6% while our net profit margin increased at an average of 42.3% per year. Put another way, for every 1% increase in average realized price per BOE we received a 1.25% increase in net profit margin. Over time I expect the yearly average realized price to continue to climb. However I believe that the corresponding grow rate of the net profit margin will no longer exceed that of the growth in average realized price. In 2006 I"m expecting growth in average realized price of 37.7% (going from $50.82 in 2005 to $70 in 2006.) Assuming $80 oil in 2007 the growth rate in average realized price comes out to a conservative 14.2% (going from $70 in 2006 to $80 in 2007.)

You see that even $80 oil is very conservative in 2007 EPS computations in a previous post. Clearly, price has a direct and dramatic impact on net profit margin at ARD. If net profit margin grows only TWO/THIRDS as fast as the projected average realized price (37.7% in 2006 and 14.2% in 2007) then we will see net profit margins of:
2006: 45.9%
2007: 49.9%

(You can see that my realistic FY2007 net profit margin estimate of 48.9% in previous post is in fact conservative.)

In conclusion, the case has been made that $80 realized price and 48.9% net profit margin projections in 2007 are in fact conservative. Also given the fact that an additional million shares has been factored in for 2007 along with a modest production increase of 85% we see that 2007 EPS of $4.25 is a realistic number that could easily be topped. We also see that the Wall Street consensus of $2.61 is quite low. In fact it is obvious that the analysts are not going out on a limb. Their reputations are at stake and the consensus is that oil prices can't possibly go higher. Wallstreet is figuring $40 to $60 oil. The analysts will continue to nibble at their estimates by increasing them little by little over time. There is certainly nothing bold in their predictions. Don't wait for Wallstreet to up their consensus again and again. Instead, buy ARD shares before they become progressively more expensive.

Analysis of ARD FY2007 Earnings Estimates
Expect Wallstreet to Increase ARD Projected Earnings

Yesterday Wallstreet increased ARD FY2007 consensus EPS estimate from:
$2.46 to $2.61.......UP $0.15

The previous day ARD FY2007 consensus EPS estimate was increased from $2.30 to $2.46. So in the last two days we have seen FY2007 estimates increased $0.31 or 13.4%. The increases the last 2 days were a result of the fantastic results of the Q2 Operational Update. There were two key elements of the Operational Update. The first was the estimated revenue of $14.5 million. The second was the estimated production of 240,000 BOE. Another item that was buried in the release was the announcement of a partnership between ARD and another Tulsa based company.

The partnership was revealed in the Q2 Operational Update when it was stated, "Syracuse Prospect, Hamilton County, Kansas -- Two exploratory wells were drilled on this 18,000-acre lease and are currently being completed and readied for production. The two wells were drilled as part of a joint venture the company has entered into with another Tulsa-based energy company. The partnership will evaluate the results and then determine a future development program."

It is evident that even after the latest upward revisions in ARD FY2007 EPS estimates the current estimate of $2.61 is still dirt cheap.

Why?

Lets work the math...

Assume the following:
1. 17 million shares fully diluted. (Let's assume that ARD offer another 1 million to acquire new reserves or for Capex.)

2. Net profit margin of 45% (48.9% average net profit margin in 2007 is my actual projection based on current information.)

3. $68 Average Realized Price ($80 average realized price in 2007 is my actual projection based on current information.)

4. 1.5 million BOE produced. (This projected growth of 50% is conservative in light of historical growth of 93%, 74% and 127% growth in 2003, 2004 and 2005 respectively. 85% production growth is my actual target.)

In essence I"m offering two figures. The first is a conservative estimate and the second is my actual projection.
1. Shares Outstanding:
____17 million (Conservative)
____17 million (Realistic)
2. 2007 Net Profit Margin:
____45% (Conservative)
____48.9% (Realistic)
3. Average Realized Price per BOE
____$68 (Conservative)
____$80 (Realistic)
4. Production Estimate for 2007
____1.5mm BOE (Conservative)
____1.85mmBOE (Realistic)

Lets do the math first from the conservative viewpoint.

Revenue:
1.5mm (BOE) X $68 (Ave Realized price)= $102 million

Net income:
$102 mm (revenue) X .45 (net profit margin) = $45.9 mm

EPS:
$45.9 mm (net income)/ 17 million shares = $2.70 EPS.

Now lets figure the more realistic earnings potential of ARD in 2007.

Revenue:
1.85mm (BOE) X $80 (ave realized price)= $148 million

Net income:
$148mm (revenue) X .489 (net profit margin)=$72.37mm

EPS:
$72.37 mm (net income) / 17 million shares = $4.25 EPS.

By conservative estimates we should expect ARD to come in at a worst case scenario of $2.70 EPS. A more realistic expectation for ARD shareholders would be for 2007 EPS of $4.25. If $2.70 is the low end, $4.25 is the middle ground then the high end is something north of $4.25. At this point it doesn't make any sense to even try to determine the high end.

Lets now use both of these figures and use a conservative PE multiple of 30, a more realistic multiple of 35, and a high end multiple of 38 (current PE today.)Share Price Projections based on EPS of $2.70

$2.70 X 30 = $81
$2.70 X 35 = $94.5
$2.70 X 38 = $102.6

Share Price Projections based on EPS of $4.25
$4.25 X 30 = $127.5
$4.25 X 35 = $148.75
$4.25 X 38 = $161.5

The purpose of today's exercise in math is to show that the current 2007 estimate of $2.61 is low and proof that Wallstreet has yet to realize the true value in E&P companies and especially ARD.

The Possible Effects of Middle East Tension on ARD Shares

Expect volatility in ARD shares due to events transpiring in the Middle East with Israel and bordering Lebanon. Tensions could quickly escalate causing Syria and Iran to be brought into the war-zone. While this would certainly cause oil prices to rise it could also cause the markets to PANIC and cause UNCERTAINTY. In other words, even with rising oil prices Mr. Market could declare, "The Sky is Falling." This would set off program and hedge fund selling causing even E&P companies like ARD to sell off potentially. If history is any guide we know for a fact that Mr. Market is not always rational. He certainly isn't efficient either (Just look back to when Mr.Market valued GEOI and GMXR more than ARD. Or look at how high the valuations are on the airline sector: LCC, UAUA, AMR, etc.)

Anyway, the point is that if the market is often times irrational and inefficient then we shouldn't bet the farm that a surge in oil prices would guarantee higher share price of a superior E&P like ARD.

In conclusion, don't over extend yourself on margin to buy ARD shares. They are golden. However you don't want the hedge funds to box you in and cause a margin call that would force you to sell your shares in the cheap. Just remember:
1. Expect Volatility
2. ARD shares are GOLDEN.
3. Don't over extend yourself on margin.

ARD Q2 Results a Home Run
Total Production Estimated at 240,000 BOE on Estimated Revenue of $14.5 Million

The Q2 Operational Update was released this morning promptly at market open. ARD results for Q2 were nothing short of not only a "home run" but one that was 'hit out of the park.'

Let me begin by saying that I expected ARD to have sequential quarter over quarter production growth of between 15% and 19% for oil and an increase 14% to 16% for gas. My most optimistic case for total oil and gas production was for a quarter over quarter production increase of 35,539 BOE for a total output during the second quarter of 226,000 BOE.

ARD not only topped my most optimistic projection but they went off my projection scale by large margin. My best case quarter over quarter projection of 35,539 BOE for combined oil and gas production represented an increase of 18.6%. ARD came in at a 25.7% quarter over quarter production increase. This topped even my most optimistic projection by 7.1 percentage points or 38%.

THIS IS INCREDIBLE!!!!

Is it any wonder that SunTrust upgraded ARD shares from neutral to buy?!

Revenues were very strong as well! ARD did $14.5mm.

Oil Production Estimates
Lets do the math: My best case scenario for oil production was a quarter over quarter increase of 18% or 31,752 Bbl. If we add this amount to Q1 oil production of 167,117 we come up with a best case total oil production of 198,869.

I previously determined average realized oil price for Q2 was $63.26. Total Oil production considering my best case scenario would have been:
198,869 X $63.26 = $12,580,452

Gas Production Estimates
Quarter over quarter gas production best case scenario called for an increase of 16% or 3787 BOE. The previous quarter had gas production of 23,672. Therefore the best case scenario would have reflected total gas production for Q2 of 27,459 BOE. Based on $5 NG per Mcf($30 per BOE)we would have had total Q2 gas revenues of:
27,459 X $30 = $823,770

Total Oil and Gas Production Estimates
Adding both best case oil and gas revenues:
$12,580,452 + $823,770 = $13,404,222

Previous Q1 revenues were $10.38 million. My most best case scenario was calling for a revenue increase of 29%.

ARD Tops Production and Revenue Estimates
ARD came in at about $14.5 million or a sequential increase of 39.6%. This topped my best case scenario by 10.6 percentage points or 36.5%.

I believe total oil production was between 88% of total production or 211,000 Bbl. Gas production was near 29,000 BOE for Q2 up from previous quarter of 23,672 BOE.

EXCELLENT QUARTER!

Thankyou Tim and Stan! Keep up the good work.

ARD shares are EXTREMELY UNDERVALUED in light of most recent Q2 RESULTS. If you factor in a very conservative 42% net profit margin and 15.225 million fully diluted shares we arrive at $0.40 EPS. Consensus was for $0.35. The consequences of these results are for ARD shares to continue the march towards my 2006 target price of $60 per share.

The Case Against Ethanol
E85 May Actually Cost You More per Gallon at the Pump

Here is some analysis on why Ethanol is a bad deal.

Just remember: E85 has about 83,260 Btu/Gal.
Gasoline has about 114,000 Btu/Gal.

Therefore E85 has only 73% of the energy of a gallon of gasoline.

Hypothetically if your car could get 100 miles per gallon of gasoline it would only get 73 miles per gallon with E85.

Therefore, if E85 is $2.75 and gasoline is $3.00 per gallon which is the better deal?
Many think buying E85 is the better deal because it costs less per gallon. However if we do the math it is a TERRIBLE proposition to fill up with E85 under this situation.

We must divide $2.75 by .73 to arrive at the true price for the equivalent amount of energy found in a gallon of gasoline.

$2.75/ .73 = $3.76

So if you fill up with E85 you are really paying an equivalent of $3.76 per gallon of gasoline. Not such a good deal is it?

You'll end up paying an extra 25% if you fill up with the E85. This further erodes your buying power as an individual and sucks the energy (no pun intended) right out of the economy. When you figure the tax dollars that go into subsidizing the ethanol in each gallon of E85 the costs are even higher.

ARD Executive Comments on Oil Rig Purchase

Stan McCabe was interviewed recently and explained the reasons for the previous rig purchase of December 2005.

ARD Q2 Average Realize Oil Price Estimated at $63.26
Projection is 13.2% Increase over Q1 Average of $55.85

Boone Pickens Projecting $80 Oil Before Year End in CNBC Interview

"When you look at OPEC and they're producing 750,000 barrels a day less today than they were a year ago well you know you've got a tight supply situation."

ARD Valuation Based on WGR
Analysis of Anadarko's Acquisition of WGR Indicates ARD Significantly Undervalued

Valuing WGR E&P Segment

On June 23, 2006 Anadarko acquired Western Gas Resources (WGR) for $61 per share in cash. The press release issued by WGR stated, "The per share consideration payable in the merger represents a premium of approximately 49 percent over Western's closing stock price on June 22, 2006. The transaction is valued at approximately $5.3 billion, including approximately $560 million in indebtedness." By digesting this acquisition we are not only able to measure the value of the various business segments of WGR but to also confirm the intrinsic value of ARD shares.

Let us begin by first looking at the value of proved reserves per share. Our calculations are based on $65 oil and $7 gas. The results below are depicted in figure 1.


Figure 1. (Click on Image to Enlarge)

It should be noted that ARD Value Proved Reserves per Share (VPRPS) has increased in every year since 2002. WGR had a 2 for 1 stock split in 2004 thereby reducing its VPRPS by 50%. In any case, ARD has significantly more VPRPS than WGR in 2005:
ARD....$139
WGR.....$86

Now lets take a look at the historical trends in proved reserves growth. Figure 2 below illustrates the percent growth year over year in proved reserves.


Figure 2. (Click on Image to Enlarge)

It should be noted that ARD has been growing proved reserves significantly faster than WGR since 2002. Figure 3 below indicates that ARD also has superior production growth when compared to WGR.


Figure 3. (Click on Image to Enlarge)

It really is amazing how ARD production has been more than doubling every year for the last three years. The same can not be said about WGR production.

It should also be noted that ARD has 82% oil proved reserves to less than 3% for that of WGR. Given the fact that:
1. Oil spare capacity is razor thin and
2. Natural gas does not exhibit the same tight supplies as oil and
3. 70% of oil is used for transportation purposes in the production of gasoline in which there is no substitute and
4. Natural gas can be substituted with coal and nuclear power and
5. The world's thirst for oil is increasing at a time when maintaining current levels of production let alone increasing it is becoming more difficult with every passing day

Be it resolved that future oil prices are going higher while natural gas is headed flat to lower. Gas has less intrinsic value than oil. Therefore, the intrinsic value of companies with a higher percentage natural gas are less than those companies that have a higher percentage of proved reserves oil all other things being equal.

The target price on ARD is $60. This represents 43% of VPRPS.
$60 (Target Price)/$139 (VPRPS*) = 43%
*VPRPS = Value Proved Reserves per Share; See Figure 1.

If we also take 43% of WGR VPRPS of $86 we come up with a target price of $36.98 (rounded to $37) based on the company's E&P segment. Since ARD is not only growing proved reserves and production faster than WGR but also has a higher percentage of oil we must discount the intrinsic value or target price of WGR based on VPRPS. Since we valued ARD at 43% of VPRPS we should value WGR at something less than this amount. A 10% discount would be very conservative and favorable to WGR shareholders.

Fair value of ARD is 43% of VPRPS.
WGR E&P operations should be valued at a 10% discount to ARD's fair value ratio of 43% of VPRPS. Therefore, WGR fair value ratio is 38.7% of VPRPS. The math is as follows:
43% X .10 = 4.3%
43% - 4.3% = 38.7%

WGR VPRPS is $86. If we multiply this amount by 38.7% we have arrived at a per share valuation of the E&P segment of WGR. This amount comes out to be $33.28.

$86 X .387 = $33.28

With 76.01 million shares outstanding the value of this segment is $2.529 billion.


Valuing WGR Natural Gas Gathering, Processing & Treating Facilities Segments

These segments of WGR are comparable to those of Holly Corp (HOC.) Holly Corp has a market cap of $2.75 billion. Lets make some comparisons between HOC and WGR in order to determine a valuation of these segments of the WGR business.

Revenue ttm:
WGR...$3.54 B
HOC....$3.38B

Profit Margin ttm:
WGR...3.9%
HOC....5.94%

Operating Margin ttm:
WGR...7.7%
HOC....8.32%

Net Income ttm:
WGR...$141 million
HOC....$183 million

Shares:
WGR...76.01 million
HOC....57.45 million

EPS:
WGR...$1.85
HOC....$3.18

Debt:
WGR...$560 million
HOC....No debt

Since the revenues are of the same magnitude lets assume for a moment that both companies deserve the same market cap. HOC has a market cap of $2.75 billion with no debt. WGR has debt of about $560 million. To keep our comparison of these two companies comparable we must reduce the value of the WGR assumed market cap of $2.75B by $560 million. If we subtract $2.75B by $560 million we arrive at $2.19 billion.

Since HOC has superior fundamentals to WGR it would be prudent to discount WGR. Let us discount these segments of the WGR business by an amount that is both conservative and favorable to WGR shareholders. This amount shall be 3.7% ($82 million to be exact.)

$2.19B - $82 million = $2.108 billion

With 76.01 million shares outstanding the value of these business segments per share is $27.73


Valuing All Segments of WGR

Previously we determined that the value of the E&P segment was worth $2.529B or $33.28 per share based on 76.01 million shares. We also determined that the natural gas gathering, processing and treating facilities segments were worth $2.108B or $27.73 per share based on 76.01 million shares. If we add these amounts we come up with $4.637 billion or $61.01 per share. There were also approximately 1.69 million shares of restricted stock and stock options that were automatically converted and paid out at $61 per share. This effectively raised the value of the transaction another $103 million from $4.637 billion to $4.74 billion. If we add the debt of $560 million to the sum of $4.74 billion we arrive at a total transaction purchase price of $5.3 billion.


What We Have Learned from Analyzing the Value of the Various WGR Segments

By using Holly Corp as a benchmark of valuation for the WGR natural gas gathering, processing and treating facilities segments and ARD as a benchmark of valuation for the WGR E&P segment we were able to get a better understanding of what Anadarko really paid in order to acquire WGR. Not only did Anadarko pay full price for the right to acquire WGR assets but they also paid a fair price.

In conclusion, analysis of the Anadarko acquisition of WGR has allowed us to not only measure the value of the various business segments of WGR but to also confirm the intrinsic value of ARD shares. This is done by a process of "Reverse benchmarking." In other words, after logically assigning a value to each business segment by breaking down the total value of the transaction we have determined that the superior fundamentals and proved reserves of ARD are indeed worth at least $60 per share. With oil rising to $75.19 and gas continuing to fall to $5.76 the Crude oil/ NG ratio has risen to 13.05X. As this ratio continues to expand, expect those fundamentally superior companies with the majority of their proved reserves in oil to become increasingly popular with investors. There is every reason to believe that 2006 will be an extremely rewarding year for ARD investors as the shares advance towards $60 before year end.

God Bless America!!!!!
Happy 4th of July

Larry Kudlow Confident Oil Prices Headed Lower
CNBC Host Fails to Understand the "Rest of the Story."

Yesterday Larry Kudlow of CNBC and the National Review Online stated his case for lower oil prices. Unfortunately he is part of the problem as to why oil prices will go higher: his rhetoric silences the alarm bells and camouflages the red flags that should be evident to the public and our political leaders. Kudlows remarks are an example of groupthink in that he is going with consensus even though the consensus is wrong. He is ignoring the facts. His editorial is an example of how freedom of the press can actually harm our country. Whether Kudlow realizes it or not, he is giving a false sense of security to his readership and blurring reality by not telling the whole truth.

Below Kudlow and myself debate the energy issues.

Kudlow: "The Energy Department just announced that crude oil supplies rose 1.4 million barrels to 347.1 million for the week ended June 16. Analysts had been expecting a drawdown, so this news caught them by surprise. More, crude oil supplies in the U.S. are now at their highest levels since May 1998, when oil was trading around $15 a barrel. Add in the fact that Canadian oil inventories are fully stocked, and the more imminent reality is of a sizable oil-price decrease not a huge increase."

Dok: Petroleum inventories are at or near record highs due to expectations of higher prices in the future and nervousness about future supply disruptions. During the 1970s the oil industry also maintained oil inventories at higher than normal levels. Another reason why the oil industry inventories are so high is the razor thin spare capacity of oil production. Current oil production is operating at about 97% of capacity. There is no business in the world that can operate at sustained periods of capacity. Businesses must allow downtime for routine maintenance and other variables that would limit continuous production. So too the oil production industry must allow for such variables that would limit production such as hurricanes, terrorism, geopolitics, government policies, etc. Kudlow needs to understand that inventories are high because spare capacity is razor thin and we are near a breaking point that could send oil prices spiraling higher with the possibility of shortages and supply disruptions. This is why the oil industry maintains higher than normal inventories.

Kudlow: "Recently I interviewed four oil-tanker executives who control a combined 85 percent of the oil coming into the United States. They confirmed market rumors that the amount of oil being stored on large carriers on the high seas is abnormally high."

Dok: Spare Capacity is razor thin. The oil industry would prefer to store more petroleum than their storage facilities would allow. Therefore they are paying big bucks to store this petroleum on ships at sea. This is actually very bullish for rising oil prices.

Kudlow: "One of the CEOs even predicted the possibility of $40 to $50 oil in the next 6 to 12 months."

Dok: Notice the use of the word possibility.' Anything is possible. The odds of $40 to $50 oil in the next 6 to 12 months is probably about as likely as $1000 oil. It ain't gonna happen. My point is anybody can make a prediction or have an opinion. Notice the CEO wasn't named and didn't give a reason on his prediction.

Kudlow: "Chevron CEO David OReilly suggested that gasoline and energy demands have flattened in the U.S., and may be showing signs of decline."

Dok: I see gasoline demand flattening in the USA too year over year. Keep in mind that prices have been running 20% to 36% above last years gasoline prices. There has been no demand destruction. While it is true there are weeks where gasoline demand might be down a fraction of a percent, there are other weeks where demand is actually higher than year ago periods even in light of significantly higher prices. Gasoline demand is very inelastic.

Kudlow: "Prince Turki can threaten $200 oil all he wants, but we may instead be looking at a downward correction that will have oil prices dropping more than anyone imagines possible. Supplies are at their highest levels in eight years, while demand appears to be falling, or at least leveling off."

Dok: Hey Larry Kudlow does it bother you at all that spare capacity is razor thin? You keep going back to your argument about inventories being at historic highs. Do you not understand the meaning of 'spare capacity?' Demand is not falling off. U.S. demand for gasoline has flattened from last year no doubt. What is demand for gasoline in China and the rest of the world doing? No doubt it is growing.

Kudlow: "Should a significant price correction be in the offing, stock markets and the economy will cheer. The economic principles at work here are very simple: Markets work. Supply and demand works. Higher prices are gradually slowing consumption. "

Dok: Higher prices may be slowing consumption. However it should be underscored that higher prices are not causing demand destruction in the USA. This is incredible given the fact that gasoline prices are up 20-36% since last year. All signs indicate that demand for gasoline will be exploding in China and the rest of the developing world.

Kudlow: "There's even good news from Washington on the energy front. The House Resources Committee, chaired by California Republican Richard Pombo, has just delivered the Deep Ocean Energy Resources Act, which will give coastal states the authority to drill 100 miles or more offshore. This will allow for exploration and production in the deep seas and on the Outer Continental Shelf (OCS), where kajillions in oil-and-gas reserves are waiting to be siphoned. It also will provide the coastal states with significant oil and gas royalties. Democratic House Minority Leader Nancy Pelosi opposes this, but the bill has strong bipartisan support."

Dok: "This production will take time to develop. Deep ocean oil production will be more expensive. This underscores the fact that the cheap oil has already been produced or is being produced. Continued production is going to progressively get more difficult. Like the early whalers who eventually had to sail to the ends of the earth to harvest supplies of whale oil due to years of heavy consumption so is it also true today with our search for oil. It is becoming more difficult."

Kudlow: "Finally, the Nuclear Regulatory Commission has issued its first license for a major commercial nuclear facility in thirty years. Construction of the $1.5 billion National Enrichment Facility in New Mexico could begin in August, and according to Louisiana Energy Services CEO Jim Ferland, it could be ready to sell enriched uranium (for electricity) by early 2009. Senate Energy chair Pete Domenici calls this a  renaissance of nuclear energy in this country.""

Dok: "Increasing nuclear energy will have virtually no affect on reducing our demand for petroleum. This is because during the oil shocks of the 1970s we shifted our energy mix to replace oil fired power plants with coal and nuclear power. Today less than 3% of electricity is generated by oil. Reducing use of electricity in the 1970s certainly helped conserve oil. However this is not the case today. Unfortunately our automobiles are not nuclear powered."

Kudlow: "A combination of market forces and government deregulation could be setting us up for a big crack in energy prices, including gas at the pump. And it may happen sooner rather than later. Many years ago, during the 1970s oil crisis, Milton Friedman argued that free markets are more powerful than OPEC, and Ronald Reagan proved the point when prices plunged after he deregulated energy in the early 1980s. "

Dok: "Prices plunged in the 1980s because the shortages of the 1970s were caused by geopolitics. Spare capacity was significant during the mid 1980s and was testament to the fact that oil supplies were excessive. Demand for oil was also reduced as the USA adjusted the energy mix in favor of coal and nuclear power for electricity generation. Gasoline consumption was also reduced by lowering the speed limit to 55mph. Both Supply and demand forces no doubt caused prices to decline. Unfortunately the conditions fo the 1980s are completely different from the conditions today. Today spare capacity is razor thin. This can not be emphasized enough."

Kudlow: "Conventional forecasters understate the economic power of free markets, low marginal tax rates, and energy deregulation. As a supply-side contrarian, I'll take the other side of that trade. Indeed, as future events unfold, we may be headed for a much different energy and economic scenario."

Dok: "Unfortunately, low marginal tax rates and a strong economy contribute to high demand for petroleum. We need to kill demand because there is not enough supplies to go around. The only way to kill demand is for oil prices to rise. There is an amazing relationship between oil consumption and real GDP."

End Debate...

In conclusion, a growing economy will put additional pressure on already razor thin spare capacity as demand for oil increases. As oil demand increases prices will have to rise in order to kill the demand and to avert oil shortages worldwide. As prices rise so will inflation. The USA would certainly be at risk of going into recession as consumers have less disposable income to spend as a result of higher energy prices. An economic recession would reduce demand for oil short-term in the USA. The direction of prices would be determined by the consumption patterns of the rest of the world most notable China. As OPEC is losing control of oil prices by their limited ability to increase supplies, so too is the United States losing control of oil prices by limiting demand by virtue of our diminishing percentage of new incremental worldwide oil consumption. On page 111 of Peter Tertzakian's book, "A Thousand Barrels a Second," Figure 4.6 illustrates the sources of incremental world oil demand percent by region on a total 1.7 MMB/d 2005 over 2004. The United States consumed 11% of new demand. China consumed 23%. Certainly oil prices are headed higher and the USA will have very little control over the rising prices.

Bibliography:
Tertzakian, Peter. A Thousand Barrels a Second: The Comingoill Break Point andtheh Challenges Facing an Energy Dependent World. New York: McGraw-Hill, 2006.

Arena Resources #12 on IBD 100 List
Report in July 3rd Edition; Coverage Begins on Page 1B