Gary C. Evans, chairman and chief executive of Magnum Hunter Resources Corp., shares his thoughts on the company, its future and the future of energy.

At the beginning of 2012, new shale plays are still emerging throughout the country, but which are the best and brightest? As a relatively new company, but blessed with super-experienced leadership, Magnum Hunter Resources Corp. seems to have a talent for finding itself in the right play at the right time with the right assets.

Today, the savvy independent holds nearly 82,000 acres in the Williston Basin, 59,000 acres in the Marcellus shale, 16,000 acres in the Utica, 280,000 acres in southern Appalachia, and 25,000 acres in the Eagle Ford play, and produces some 9,500 barrels per day from about 37 million barrels of oil equivalent of reserves, 52% of which are liquids.

Last year, to ensure adequate water-handling capacity, one of the major challenges to hydrocarbon development in the all of the emerging shale plays, management of the Houston-based independent restructured GreenHunter Energy, Inc which formed a water subsidiary that provides water management processes and systems, such as handling, recycling, monitoring, hauling and disposing of produced water and frac flowback. One of GreenHunter’s primary customers is Magnum Hunter, but it also does business with third-party operators active in the Marcellus, Eagle Ford and Bakken shale plays.

Prior to that, in early 2010, Magnum Hunter acquired control of the 180-mile Eureka gas pipeline and pipeline right-of-ways when it acquired Reno, Ohio-based Triad Energy Corp., out of bankruptcy, including the pipeline and some 88,417 net mineral acres in Ohio, West Virginia and Kentucky, for about $81 million in cash, stock and debt assumption. Eureka Hunter has expanded the transportation and processing business to third parties in this region.

The company began as Petro Resources Corp., but changed its name to Magnum Hunter Resources Corp. on July 14, 2009. The corporate name changed immediately following the appointment of Gary C. Evans as Magnum Hunter’s chairman and chief executive on May 23, 2009.

By Jeannie Stell

MIDSTREAM Focusing on your assets in the northeast first, what would you say are today’s main challenges to Marcellus shale development?

EVANS Water issues are always important, but the hidden constraints right now are the roads, sight location difficulties due to terrain, infrastructure and new regulations. The West Virginia terrain is very difficult with mountains and winding roads, especially with the harsh weather we have had during the past two winters. Another challenge is permitting. The rules have begun to change in West Virginia, so it takes about 75 days to get fully engineered. The permits also need third-party signatures, which takes another 90 days. The new permitting process can add 180 days to the lead time for these projects. Water is not an issue for us presently, because we have developed a new company to address those needs, GreenHunter Water, to specifically handle that necessary business segment.

MIDSTREAM What is the relationship between Magnum Hunter and this new company, GreenHunter Water LLC?

EVANS It is an affiliate of Magnum Hunter. Jonathan Hoopes is the president and chief operating officer of GreenHunter. It was previously a renewable energy company that we converted to a water-management company earlier this year. It is basically a sister company of Magnum Hunter in these unconventional resource plays. We realized, with all of our activities in shale resource plays, that water was becoming a big issue, whether it has to be disposed, hauled, cleaned, or tracked. That is what GreenHunter’s business is all about today. Although the business has many customers, Magnum Hunter and its subsidiaries are the most significant customers presently.

MIDSTREAM Looking westward from the Marcellus, is the industry overly optimistic about the potential development of the Utica shale?

EVANS I don’t think so but it is still really too early to say at this juncture. We’ve seen some technical data that is very encouraging. There is no doubt in my mind that we are going to see some great Utica wells, but we don’t know the limits of the trend and where the sweet spots are going to be yet. The play is going to require drilling and more drilling. Just a year ago, we didn’t know that the Marcellus areas where we are currently drilling were going to be this good until we began to drill wells and put them on production and see the resulting performance. Indeed, the shale is fully charged and works. We are encouraged enough that we are leasing and looking at joint venture possibilities, but we are not betting the farm on it just yet.

MIDSTREAM Do you have some good data in that area?

EVANS We were one of the first companies to drill a horizontal Marcellus well in Ohio. That data showed the horizon to be very wet with hydrocarbon liquids. It was almost a pure condensate well. We used our own data along with publically available information to extrapolate where the Utica might be. That was in northern Monroe County, Ohio, about two-thirds of the way up the Ohio River, where it interfaces with Monroe.

MIDSTREAM In the northeast, how did you solve the natural gas liquids infrastructure takeaway issue?

EVANS About a month and a half ago, we announced that we had predominately solved our natural gas liquids issue with our Eureka Hunter pipeline through the announcement of a joint venture with MarkWest Hydrocarbons. That will be an unregulated, high-pressure, wet-gas system, and as of now, it is the only wet gas system in the immediate 1,000 square mile area. It is beneficial because all the producers want to get their wet gas to processing facilities where they can get the pricing uplift. So we will be pigging the lines and doing what is necessary to move that wet gas to the processing facilites. Magnum Hunter will also get a nice uplift of about $1.25 per thousand cubic feet of gas, by June 2012, from processing this wet gas.

MIDSTREAM Why partner with MarkWest, specifically?

EVANS We chose to joint venture with MarkWest because not only do they have the ability to solve the liquids handling issue on acceptable economics, but they also have the downstream pipeline infrastructure behind the plant with the capability of moving the finished product. That includes ethane. And, as we all know, the Marcellus shale gas stream produces a certain amount of ethane, so you have to do something with that product. The companies in Pennsylvania and West Virginia are profiting on the midstream side due to the spread between ethane in the Northeast versus Mont Belvieu, but that gap will continue to contract over time. On the other side of the fence, some of the chemical guys are complaining about the high price because ethane is a prevalent feedstock for them.

MIDSTREAM When do you think this will all even out?

EVANS As with any new play, the Marcellus is going through growing pains. There are going to be basis differentials between certain commodities which will eventually get resolved because the markets will certainly become more efficient. But to get that done requires infrastructure, fractionation and the capital to build those necessary facilities. The industry is not going to see those investments until the upstream spends the initial drilling capital, finds the wells and proves up the reserves. Then the necessary capital for both the midstream and downstream businesses will come. This could be a play that could take five to 10 years to develop. What we believe today to be true could be totally different a year or two from now. But that’s the beauty of a shale play that garners so much interest and activity.

MIDSTREAM Yet, Magnum Hunter has reduced its own initial planned capital expenditures for 2012.

EVANS That reduction relates specifically to the Eureka Hunter pipeline. We reduced the capital budget there. We also wanted to stay much closer within our cash flow expectations and existing liquidity. In other words, we plan to use our cash flow and our ability to draw down our credit lines, which will allow us to fund 100% of our $150 million upstream and our $50 million midstream budget for 2012, which is funded by a combination of cash and existing credit facilities, and not requiring to access the equity markets next year. Having said that, if we complete some of the transactions we are considering during the next three months, that number could materially change. If we do a high-yield offering early next year, that could also change our capital budget. For today, we want to be able to show the market we can grow production some 25% from yearend 2011 levels to yearend 2012 by just spending that $150 million in upstream, which is 400% production growth from the beginning of 2011. We think that is sufficient, but we will obviously be monitoring our capital expenditure program as next year progresses.

MIDSTREAM Will you form a master limited partnership to hold your midstream assets?

EVANS We’ve got this Eureka Hunter Pipeline that we basically paid nothing for, and we have already put about $60 million of capital into it so far building new 20-inch pipe. In fact, we are in discussions with several private-equity firms that want to give us new capital for a minority ownership interest, somewhere between a $300- and $400-million enterprise value. If we spin that asset out and get the multiples that MLPs traditionally receive, which is typically 10 to 12 times EBITDA, that is much better than the four to six times EBITDA today. So by putting those assets in a separate vehicle that trades mostly with retail investors, it can stand on its own and realize a higher value to our shareholders. I get asked all the time why we don’t just sell it to another MLP to capitalize on it now. Here’s why: Our midstream assets are what have allowed us to go drill new wells in West Virginia and Ohio and have immediate take-away capacity. We can’t allow someone else to control that piece of our business. We have to be in control. We’ve set up our own separate management team, we have our own financing in place and we are geared up to either spin that out in an initial public offering or dividend it out to our shareholders. Next year we should have about $25 to $30 million in EBITDA. So this is a prudent way to maximize shareholder value, by taking an asset that, today, Wall Street doesn’t give much value to, and put it in a vehicle that will be valued separately from Magnum Hunter.

MIDSTREAM Did Magnum Hunter’s 2011 stock values enter into that decision?

EVANS We hit an all-time high in our share price of $8.50 per share earlier this year, but then got dinged later in 2011 because the market felt that we had a funding gap. So we are proving we have no funding gap. Our ability to attract and place capital is far greater than the capital we have on hand at this point.

MIDSTREAM What is your exit strategy for Hunter Magnum?

EVANS Well, this group has only been together for about two and a half years, so we are still in the early stages of developing the company. Being up 2,000% in two and a half years with our share price is not bad though. However, we continue to believe our company is significantly undervalued at present. As we continue to prudently develop our properties and increase our production, the stock will perform better. We are in volatile times today with the European credit issues, so the stock has moved 10% either way, up or down, on a daily basis as the market reacts to these issues.

MIDSTREAM What is your solution to that?

EVANS What some people do not realize is, we are almost 60% crude oil. For now, oil is about $103 per barrel. But in the Eagle Ford, we are getting a $10 premium, so our oil is worth $113 per barrel. The stock price has to catch up with the uplift in commodity prices. Obviously, for the company to be sold, a willing buyer and a willing seller have to have a meeting of the minds. But the beauty of the way we structured this company is that we are very asset-rich, and we have a number of ways to develop the assets by having different forms of capital available to us. I would not be surprised to see us participate in a joint venture like others in certain areas, which could include foreign companies or private-equity firms. These people realize that we have significant high quality assets and a limited amount of capital. I think there will be much better times for the oil and gas industry during the next few years. If someone hits the right number, they can take it, and we can all go do it again.

MIDSTREAM What is your outlook for the near future of the U.S. oil and gas industry?

EVANS It’s exciting, in this part of the world especially, because of these new resource plays that are emerging. None of us know the future, but it looks very bright from the standpoint of today’s developments. We have never seen major oil companies come back to the U.S. like they have done over the last several years. During my 30 years in the business, I have been buying from majors, but I have never competed with a major. Now, major oil companies like Shell Oil, ExxonMobil and Chevron are my competitors. That changes the dynamics of the business. We all have to be cognizant of that fact, because they are thinking five and ten years out. We tend to think one or two years out. You might want to know what I am doing next month, next week, or in six months. The majors are thinking that they don’t care if gas is $2 per thousand cubic feet or $8 because they are in it for the long haul, and they plan to drill 100 wells this year no matter what. It’s a different mentality than a small cap independent.

MIDSTREAM What immediate effect will that have?

EVANS It brings up a concern about future natural gas prices. The majors have made big investments in the Marcellus, Fayetteville and Eagle Ford shales and they are plowing full speed ahead with their development efforts. We know from our GreenHunter Water business that the water that they need and will require for their drilling efforts is going to be huge. That is what is so different this time in this industry cycle that we haven’t previously seen in the past. These are really big, deep-pocketed companies that are going to be spending significant amounts of capital and change the dynamics of this business in a manner we have never seen before. This is one reason the oil and gas industry is such an exciting and dynamic business. Stay on your toes and stay tuned!