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Company gambled on going deep into the Gulf of Mexico

Callon’s deep-water drilling program paying handsome dividends

NATCHEZ — Mississippi’s only publicly-traded oil and gas company, Callon Petroleum Company, took a big gamble when it expanded from its traditional shallow-water offshore drilling program to participate in deep-water drilling. But the bet paid off handsomely when Callon’s first two prospects in the deep waters of the Gulf of Mexico turned out to be the largest discoveries in the company’s history.

“Our analyst has a buy recommendation on the company,” said Gary Williams, an investment broker with Morgan Keegan & Company in Jackson. “We think the real potential for the company is the deep-water drilling program they’ve got going. They have some tremendous prospects in the deep water areas in the Gulf of Mexico that are in addition to their traditional shallow water drilling.”

In recent years Callon Petroleum, which will celebrate its 50th anniversary next year, has teamed up with major oil companies like Shell Oil and Murphy Exploration & Production Company to drill in the deep waters of the Gulf of Mexico. In February of this year the company announced its second deep-water discovery at the Habanero prospect located in 2,000 feet of water. The same month Callon announced two other Gulf of Mexico shelf wells were online producing at a combined rate of 21.5 million cubic feet of natural gas equivalent per day.

Williams said the deep water wells are high risk, but also have much greater potential.

“With the firming up of natural gas and oil prices, it just makes those prospects that much more attractive,” Williams said. “We don’t think the price of the stock reflects the current net assets of their proved reserves. So the stock has some catching up to do. If we continue to see a firming up of commodity prices, we feel like we will continue to see the price of the stock move up. It is a well-managed company. They have a lot of experience plus education. We believe this next generation managing the company really has them moving in the right direction.”

Callon Petroleum is one of only 11 companies headquartered in Mississippi listed on the New York Stock Exchange. Callon’s common and preferred stocks are traded on the New York Stock Exchange under the symbols “CPE” and “CPE.PrA,” respectively. In July 1999, the company completed a $40-million sale of 10.25% Senior Subordinated Notes due 2004. The notes also will be traded on the New York Stock Exchange under the symbol “CPE 04.”

Fred L. Callon, president and CEO of Callon Petroleum Company, said sale of the notes allowed the company to pay off all of its bank debt, freeing up a credit line to have financing available over the next year for additional drilling.

Callon is one of the smaller independent oil and gas companies involved in deep water drilling.

“We balance our drilling program from shallow state waters of eight to 10 feet, out into the outer continental shelf in depths up to 400 to 500 feet, to off the shelf in waters 1,000 feet and deeper,” Callon said. “These deeper areas were relatively unexplored until the past five or 10 years when the technology became available to drill and produce in deeper waters. Exploration in deeper waters has been led by major oil companies and by improvements in technology. The costs have come down, and have allowed significant increases in the deep water drilling led primarily by major oil companies. But a number of independent oil and gas companies are also getting involved in the deep water drilling.”

Callon teams up with major oil companies on deep water drilling prospects, taking a 10% to 35% interest in the projects.

“We have typically partnered with the major companies that have the technology and experience to operate in deep water,” Callon said. “It requires a large staff and cutting-edge technology to work in the deep-water area. Certainly it is much more expensive, but the rewards are much larger because reserves are much greater in deep water. There are some large fields to be found in the deep water. And this is relatively undrilled territory compared to areas like the shelf where the industry has been drilling for many years.”

In business since 1950, Callon Petroleum operated privately before going public in late 1994.

“Taking the company public simplified and streamlined our business, gave some critical mass to the company, and put us into a position to take much larger interests in the things that we were doing,” Callon said.

Callon said the company’s objective is to enhance stockholder value through sustained growth in its reserve base, production levels and resulting cash flows from operations. Over the past several years, the company has shifted its emphasis from the acquisition of producing properties to the acquisition of acreage with development and exploratory drilling opportunities.

Callon performs extensive geological and geophysical studies using computer-aided exploration techniques (CAEX), including, where appropriate, the acquisition of 3-D seismic or high-resolution 2-D seismic data to facilitate these efforts.

As of June 1, 1999, the company had estimated net proved reserves of 183.3 billion cubic feet of natural gas equivalent which had a discounted present value of $173.9 million. Reserves comprising 72% of this discounted present value were classified as proved developed.

Average daily net production during the first six months of 1999 was 43.6 million cubic feet of natural gas equivalent.

A.G. Edwards currently has a buy recommendation on Callon Petroleum.

“Through a balanced strategy of acquisitions, development and accelerating exploration, the company has built a solid portfolio of producing properties and an outstanding inventory of exploration prospects,” stated an A.G. Edwards research report dated Aug. 17, 1999. “Callon’s shares trade at roughly a 10% discount to our peer group based on price-to-net asset value, price-to-cash flow and enterprise value-to-debt-adjusted cash flow. Given Callon’s very significant deep-water exposure, we believe this discount should disappear before year end. Our 12-month price objective is 18.”

Contact MBJ staff writer Becky Gillette at mullein@datasync.com.

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