AN INTERVIEW WITH CANO’S JEFF JOHNSON - Cano’s low-risk strategy: redevelop legacy oil fields using latest EOR technology

JEFF JOHNSON: By nature I am a contrarian. When oil prices bottomed in 1998-99, I viewed that as an opportunity. I committed to focusing my efforts on accumulating oil assets that were appropriate for secondary and tertiary recovery methods that were located on shore in the Lower 48.

OGFJ: What percentage of Cano’s production is oil, and how did you happen to focus on domestic oil rather than gas?

JOHNSON: Approximately 60% of our production is oil while over 80% of our reserves are oil.

I believed that Cano could be more competitive in the oil arena than in natural gas. The natural gas market was and is very competitive when you consider the price one has to pay to acquire assets. We have been able to assemble almost 70 million boe of proved reserves at a cost of less than $2 per barrel or about 30 cents per mcfe. I don’t believe we could have done this had we been acquiring natural gas assets - particularly as a start-up.

OGFJ: Where is your production?

JOHNSON: Texas, Oklahoma, and the Permian Basin in Eastern New Mexico.

OGFJ: How much of your growth has been through the drillbit and how much by acquisition? Are you looking for acquisition candidates?

JOHNSON: Almost 100% of our growth to date has been through acquisitions. Now that we have our asset base built, Cano has enough inventory for double-digit growth through the drillbit for the next five years.

As far as acquisitions, Sam Smith (our senior vice president and CFO) reminds me that we have to “eat what we’ve killed.” While I concur with him, if a good-looking gazelle is walking by, we will certainly take a close look.

OGFJ: How have advances in recovery technology impacted your business?

JOHNSON: Tremendously. I am a big believer in technology and our industry has been outstanding in this area - from 3-D seismic to CO2 floods to chemical floods and of course drilling and completion techniques. These advances along with many others are allowing Cano and other oil companies to produce large amounts of oil from our domestic fields.

OGFJ: Cano’s business model would appear to be fairly low-risk because you’re not doing a lot of exploration. However there are other risk factors that could affect the company’s performance, including price risk and weather. Can you elaborate on some of these factors?

JOHNSON: Sure. Some of the other challenges that we manage daily are no different than our competitors. In my view, people are the number one asset in any company, so retaining our people and hiring qualified persons would be at the top of my list. Next is patience. Although we can control many things, many things we cannot.

For Cano, I would place response time for our waterfloods as second. We have just started water injection in our Panhandle field. Although we are looking to see a response by the end of 2007, it may come later or possibly sooner. But the way to mitigate that risk is on the front end when you buy an asset. If you do your homework and buy good fields with good rock, you should get good results.

OGFJ: Can you tell us a little about your senior management team and how you assembled it?

JOHNSON: Absolutely. I feel the Cano shareholders have been very blessed to have these people.

First, Sam Smith is our CFO. Sam has an extraordinary track record. Sam’s prior experiences include being CFO of Union Pacific Resources, leading the IPO of Encore Acquisition Company as CFO, and interim CFO at Stroud. Sam actually chaired our audit committee for a year prior to coming on board full time in June of 2006.

Next is Patrick McKinney. Sam and Pat actually worked together at Union Pacific Resources where Pat began his engineering career about 25 years ago. He cut his teeth so to speak in the Wilmington field - one of the largest and oldest waterflood fields onshore in the US. Pat was at Pioneer as manager of their worldwide assets when he joined our team as senior vice president of operations and engineering in June of 2006.

Each and every employee is meaningful at Cano, but Sam and Pat are the key people managing our day-to-day business.

OGFJ: Is most of Cano’s expertise in enhanced recovery techniques in-house or do you have consulting partners?

JOHNSON: We do utilize consultants as well as the University of Texas for lab work to help us find the right surfactant/polymer “recipes” for our tertiary projects.

However, at the end of the day, the buck stops with us. So Pat’s team manages the process and execution on all of our enhanced oil recovery projects.

OGFJ: Can you explain how you go about acquiring properties that you think would be good candidates for enhanced recovery? How do you assess these assets and how long does the process take typically?

JOHNSON: We look for legacy assets that were discovered and developed by major oil companies. There are many advantages associated when acquiring these fields. We get a lot of information including production history, existing infrastructure, production, cores, logs, etc. But most importantly we have an identified oil field in which we know the size, how much oil has been taken out, and approximately how much oil was left behind. I view this information as a tremendous competitive advantage.

We assess these fields with homework and old-fashioned engineering. Because we acquire legacy assets, there are usually analogues either in the same field or close by. Once we get comfortable with the field’s history, Pat’s team will conduct extensive engineering and capital modeling. If we are comfortable with the capital costs to develop the field, we will look to acquire it. If capital costs are too high, we won’t. Time varies, but we can usually complete this whole process in about 30 days.

OGFJ: How do you determine which type(s) of enhanced recovery works best in a particular field? Do the chemistry and characteristics of the rock dictate which method is preferable?

JOHNSON: Absolutely. This is very important to scrub down on the front end, before we acquire an asset. The rock has to lend itself to waterflooding or surfactant/polymer flooding. Once we own the asset, we drill cores and send them to the lab where extensive core flooding will occur. It is only after we have success in the lab that we will implement a surfactant/polymer pilot in the field. In my view, this cuts down on both financial and engineering risks.

OGFJ: Are some fields not good candidates for secondary or tertiary recovery? Can you explain?

JOHNSON: Yes, for a variety of reasons. From Cano’s perspective, the primary reason we would stay away from a potential waterflood candidate would be that there has been no prior success in the same rock as an analogue. Second, if the field is simply too small.

OGFJ: Given today’s high commodity prices, it is economical to pursue enhanced recovery in most fields?

JOHNSON: It is. As long as we can maintain a $40 oil price, we should be able to execute and see good returns.

OGFJ: What are the recovery efficiencies of the chemical floods? That is, how much additional oil (percentage-wise) can you get out of a typical mature field, and is it possible to estimate this in advance?

JOHNSON: Each asset is like a child, different. But, generally speaking, we should be able to recover from 12% to 25% of the original oil in place.

OGFJ: Who is doing most of the enhanced oil recovery in the US at this time - small- to mid-sized independents like Cano?

JOHNSON: Most of this work has been done by companies with market caps in excess of $1 billion - OXY Permian, Denbury, Whiting, Continental, and Encore to name a few.

OGFJ: Do you expect the oil majors - who sold off many of their legacy assets in the late 1990s and early 2000s - to become active players in EOR?

JOHNSON: I do. And actually many of them are now just mostly not in the US.

OGFJ: Is there a lot of recoverable crude yet to be produced in the US?

JOHNSON: There is. For every barrel of oil that has been produced in America, there are still about two barrels left in the ground.

OGFJ: Would you say that EOR is a highly individualized process specific to a particular field or reservoir’s characteristics - in other words, not a “cookie cutter” approach?

JOHNSON: Very good question and I would say that yes it is an individualized process, but, we have tremendous technology and a lot of data to pull from as we “fine tune” the development for each field.

OGFJ: Do you see Cano one day applying these EOR techniques outside the US? Why or why not?

JOHNSON: I will never say never. However, I am a big proponent of developing our reserves here at home. For every barrel we can produce in the US, that is one less barrel we have to depend on foreign sources for. Additionally, I do not believe that a company of our size has the resources necessary to take on international projects.

OGFJ: Do you see any new EOR technologies on the horizon that will benefit your company?

JOHNSON: I’m sure that there are many EOR technologies that lie ahead. But I see the short-term horizon as fine tuning and improving the technologies we currently have - i.e., surfactant/polymer flooding. There is a lot of excellent work being done by the service companies and many of the engineering schools that continue to improve our ability to get more and more oil out of our existing fields.

OGFJ: Last year, Cano announced a new gas field discovery in Eastland County, Texas, on the western edge of the Barnett Shale. How far along are you in this field, and do you expect it will have an impact on the company’s business strategy?

JOHNSON: We have drilled 15 vertical and 4 horizontal wells to date. Our strategy was to prove up our 11,000 acres with the vertical wells and try to accelerate production with horizontal development. As of today, we are planning to continue to develop this field with horizontal wells.

As far as our business strategy, it really won’t change. Although we are an EOR company, Cano will always be opportunistic. So when we inherit an opportunity like this, we have to take advantage of it.

OGFJ: Cano recently released its third quarter financial results for the three months ending March 31, 2007. Production is up, but you commented that weather and refinery outages hurt the company’s financial performance in the quarter. Are you satisfied with Cano’s progress to date and how will you continue to grow the company?

JOHNSON: I am proud of the progress we have made since we opened our doors in June of 2004. However, satisfaction will come when we ring the victory bell with our Panhandle waterflood.

OGFJ: What will Cano look like in the next five years?

JOHNSON: I hate to make predictions, so all I can say is that my hope is that we will be a leader in domestic oil production via waterflood and EOR techniques. But more importantly, I want to be able to say our team did things right - that we didn’t take shortcuts and that we earned the respect of our peers.

OGFJ: Is there anything you would like to add that we haven’t covered?

JOHNSON: Just that I am proud to be in this wonderful industry. Unfortunately the only press we seem to get is negative. We all know that this industry, for the most part, is made up of good, hard-working people who create energy for the masses at a very reasonable cost.

And thanks to you guys at Oil and Gas Financial Journal for giving us this opportunity to tell our story.

OGFJ: Thank you for taking the time to talk with us.