1Q 2020 – It seems you can’t find any commentary on energy markets in the last several weeks which does not touch on two very significant events that have had drastic impacts on both the supply (OPEC+ price war) and demand (COVID-19) side of oil markets. Even as recently as 04/20/20, pricing for the May-20 WTI contract went negative to around -$38/bbl. Combine that with the fact that we saw the first chapter 11 filing of an independent US producer as a result of these events (Whiting Petroleum (NYSE: WLL) announced on 04/01/20), and energy markets are in one of the most unpredictable times in recent history. And while the overall market dynamics for crude come with a lot of uncertainty for the short term, the reality is that long term crude oil demand is not going away in the foreseeable future. However, on the operator level, it is highly unlikely WLL will be the only bankruptcy that we see for US producers. So the question becomes which operators are going to be best positioned to survive through a period of significant price declines, the likes of which have not been seen before for US shale producers? Screening ongoing economics, near term debt maturities, and hedging provides a list of companies both in trouble and better suited to weather the current downturn.
Breakeven estimates give a sense of potential profitability through the commodity cycle, but also a sense of how ongoing operations are likely to fare through the current downturn. The chart below shows annual average of half cycle breakeven estimates for wells brought to sale during 2019 for a group of oil-focused public independents. These estimates are compiled using methodology consistent with the differential breakeven estimates found in the BTU View.
Breakeven estimates at the well level are a good starting point, but companies have overhead and financing costs that must be included when trying to understand the ongoing cash needs of producers. The shale industry has required significant capital to grow over the past decade, and a healthy portion of that capital came from debt financing. Interest payments as well as SG&A costs should be considered when trying to understand how individual companies might weather the current storm of low pricing. Adding company specific SG&A and interest expenses to company half cycle breakeven estimates gives an approximation of a corporate level breakeven. Since we are using differential economics, this can then be compared to WTI pricing to approximate corporate level breakeven margins. Note that no adjustments are made for producer production or assets outside of the major US shale basins. The chart below shows a breakdown of this margin for these operators, based on wells brought to sale in US shale plays in 4Q19.
The margins provide insight into operator performance and general corporate costs as well as expected profitability at different potential price levels. The margins also shine a light on which companies may be best positioned to endure lower pricing levels for a longer period of time, all else equal. However, all else is not equal, and company liquidity is also a major concern in this environment. For that, a review of near term maturities and utilization of revolving loan facilities is useful.
The charts above highlight the liquidity risks some companies face as near term maturities will either have to be refinanced in a difficult environment of paid down, as well as the risk some companies who have drawn on credit facilities may face as those credit facilities are redetermined. On the other hand, a few companies have no upcoming debt maturities, some cash, and peer leading margins. While even peer leading margins cannot withstand the significant recent drop in crude pricing, hedges provide price protection and are another key differentiator in this environment. A breakdown of the hedges for the selected operators follows.
A significant number of operators have large hedge positions, and typically at prices that don’t represent a material swing from where pricing was before the two historic events mentioned in the opening paragraph.
Bringing the pieces today, BTU Analytics has put together a summary score card for the oil-focused independents, based on this handful of financial and economic metrics.
Once everything is put together, there is some clear stratification. Concho Resources (NYSE: CXO), Devon (NYSE: DVN), Parsley Energy (NYSE: PE), and Pioneer Natural Resources (NYSE: PXD) rank among the top when considering margins, liquidity, and hedging positions. To be clear, $10, $20, and even $30/bbl crude is unsustainable for extended periods of time for any US shale operator. In addition, each company faces different circumstances based on factors that are too complex to summarize across the entire group. However, some producers have differentiated advantages in margins, liquidity and hedging protection that make them better positioned to make it through the current environment.