Quicksilver Resources (NYSE:KWK) has endured one of the most severe stock price corrections in the exploration and production sector, due in large part to its leverage situation and investor concern over whether or not the company will violate its loan covenants. Investors who are bullish on natural gas prices may want to consider Quicksilver a high risk, but with potential for high reward.

Quicksilver Resources is an oil and gas exploration and production company with operations concentrated primarily in Canada and Texas. The company had 2.2 Tcfe (trillion cubic feet equivalent) of reserves at the end of 2008, split 74% to natural gas, 25% to natural gas liquids and 1% to oil. Last summer, the company's stock peaked at $45, but has sold for as little as $3.74; its current trading price hovers around $6.95.

Financials
Quicksilver has three debt issues outstanding, with none maturing before 2012. They are:

8.250% senior notes due August 1, 2015 - $475 million
7.125% senior notes due April 1, 2016 - $350 million
1.875% senior notes due November 1, 2024 - $150 million
Source: Capital One Southcoast Inc.

In addition, Quicksilver has a bank credit facility that matures on February 9, 2012. As of December 31, 2008, the company had drawn $831 million, leaving $369 million available. Therefore, Quicksilver currently operates within compliance of its covenants.

The covenant on the credit facility has raised concern about the value of the company's reserves, which must be remeasured at the end of the second quarter of 2009. The value of Quicksilver's reserves, measured on a PV-10 basis (a measure of the present value of estimated future net revenues), must equal at least 1.5 times its debt. Also, Quicksilver owns a stake in BreitBurn Energy Partners (Nasdaq:BBEP), which means 50% of BBEP's fair market value is added to the numerator when calculating the 1.5 times debt level.

The risk here is that, if the price of natural gas collapses in the second quarter, the company will be forced to use a lower price to assess the present value of its properties. Should Quicksilver break its covenants, however, bankruptcy is not the guaranteed result, as the lender has the power to renegotiate the agreement with a smaller facility.

CAPEX Cuts
Quicksilver joined other companies in cutting back capital expenditures due to the fall in natural gas prices. In October 2008, it cut its 2008 capital plan back by $100 million and established a 2009 spending plan of $850 million. In November 2008,
Quicksilver prudently reduced its spending plan further - to $600 million.

Operations
Aside from the sticky financial situation, Quicksilver has some attractive properties.

The company's two main areas of production are the Barnett Shale in Texas and the Horseshoe Canyon in Canada. Quicksilver has 230,000 net acres under lease in the Barnett Shale, with 173,000 of those acres being in the "core" area of the play. Given that fewer than 40% of this acreage is developed, the Barnett Shale provides the company with a 10-year inventory. (Quicksilver defines the "core" area as acreage where the producing shale has a minimum thickness of 150 feet.)

The Barnett Shale is one of the more attractive and developed shale basins in the U.S. Large player Devon Energy (NYSE:DVN) holds 716,000 acres under lease in this basin, while EOG Resources (NYSE:EOG) had 1.4 Tcfe of proved natural gas reserves at the end of 2008.

Bottom Line
Quicksilver is a high risk energy play, but with potentially high return. Currently, it is developing a coal bed methane play in Canada, where 15% of its reserves already are located. In addition, the company plans to drill 92 new wells in 2009. If you can stomach Quicksilver's financial situation - as well as the market reaction, should it break its lending covenants - this could be the right risk at the right price. (Before jumping into this sector, learn how energy companies make their money at Oil and Gas Industry Primer and The Industry Handbook: The Oil Services Industry.)

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