QR Energy LLP (NYSE:QRE)
Citi North American Credit Conference
November 14, 2012 10:50 AM ET
Cedric Burgher – CFO
Analysts, it’s my pleasure to introduce Cedric.
Well, thank you Marisa and thanks to Citibank for hosting this. We are really excited to be here. This is our first high yield conference. We issued in our goal high yield bond this past summer, so we now have an issue outstanding and we are delighted to be here. We think QR Energy is a great credit story and we will walk through a few slides and certainly have plenty of time we hope for questions. But really the story is pretty simple. We think its credit story because it’s all about cash flow stability and growth. As an upstream MLP we are really designed to be that way. We are built on a foundation of mature, long live, low decline assets and we couple that with robust commodity hedging so that we can produce the stable cash flows at an MLP demands.
On the equity side, but it’s also I guess a great credit story as well. We went public about two years ago in December of 2010 and since that time we have executed well on our assets and we are going to talk a bit about how we grown since the IPO. But we are confident we have all the tools in place to be a successful upstream MLP for years to come.
Forward-looking language, all the disclaimers. So starting on slide three, this is s a snapshot of our asset base and key statistics. These statistics do not include the recent acquisition we announced on November 1. Our reserves are 88 million barrels equivalent. We are heavily developed at 72%. Our third quarter production which we announced last week with our earnings is just over 14,600 boe today. Our reserve life is about 50 years and we operate in four key areas, the Permian Basin, Ark-La-Tex, the Mid-Continent in the Gulf Coast. We have a small position in Michigan which came with an acquisition we made in April and about 85% of our reserves and production are in the Permian and Ark-La-Tex areas.
Our technical team is very experienced in all of these areas. By definition we won’t go to a new area unless it’s strategic for us because we build our technical teams with deep and rich talent and experienced in the areas that we operate.
Looking at our commodity mix, we have limited NGL exposure as you can see here there is two ways to look at our commodity mix in terms of run rate basis. As you can see on the left, on a production basis, we are about 58% liquids mostly oil. But on the right on a revenue basis not a hedge revenue basis we are 77% liquids. So we have a significant liquids component in our current portfolio and our NGLs represent about 6% to 15% of our run rate depending on how you look at it.
In terms of our business model and this is one of our competitive advantages that we are somewhat unique in our space. We have talked many times about the multiple avenues we have to grow the business in addition to third party acquisitions we have the ability to execute dropdowns from our sponsor. In terms of drive downs from our sponsor, we did a $579 million dropdown about a year ago in October of ‘11 that basically doubled the size of the company since the IPO. And as we have recently announced, we are working on second dropdown from our sponsor, our sponsor has about 5,000 boe a day of production today and we have said we are going to drop about half of that the Jay field and the panhandle Florida where QR Energy already has an 8% overwrite. So when drop the rest of that sometime early next year possibly sooner.
On the right, third party acquisitions, we think there has been an uptick in that market. Lot more activity you seen probably from our peers as well as ourselves. We are – we announced a second third party acquisition this year, $215 million East Texas primarily oil acquisition that we expect to close in December. So that plus the April acquisition $230 million acquisition comprise, so almost $450 million of acquisitions this year through the third party market.
Our preference is not to go to big auctions and we have so far successfully avoided those. The Prize acquisition in April was a source deal. And that we had an exclusive and we are able to pull it down without going to an auction process. And in this latest acquisition was a small auction process but we were very fortunate to win that at a Prize that we think is good and the accretion in our model is excellent.
So the combination of these two the dropdown that’s coming and the acquisition that’s about to close we have said we think is going to give us robust is very accretive – both of them are very accretive but were robust coverage ratio for years to come. In both cases, they have much slower declines than our current asset base. And so with a lower decline we are able to have even more accretion in the odd years than the initial year by buy assets like that. And the Prize acquisition was a similar story.
In terms of our capital structure, it’s a balance capital structure. We have about $1.8 billion enterprise value. We have obviously equity in bank debt. We have senior notes that we issued this summer as I mentioned our first high yield bond. We also have convertible preferred units which the sponsor took back when we did the dropdown last year because in August of ‘11, the equity markets were not in good shape.
Let’s talk about hedging for a minute. This is a core component of our business strategy. It’s again we make some MLP, a viable MLP as well as a great credit story. You can see here our gas and oil hedges, we have hedged over 50% through 2017, a very high percentage in the next few years basically 85% of our oil and gas is hedged through the end of ‘14 and our overall majority through ‘17 at good prices. Mid 90s to $100 oil for the next few years and $5 to $6 gas for the next several years. So we think this is a great attribute that makes protects our cash flows. I will also mention that we have intentionally diversified our counter party risk with just under a dozen counterparties at this time and growing and all investment grade A rated type counterparties that we are diversifying our risk through.
So we think we have a great hedge portfolio and if you compare that to our peers in the handouts we gave you, it’s not a peer but you can see a comparison to our peer average is for MLP, we believe we are if not the most one of the top two or three in terms of total hedging as a percent of our cash flows particularly in the outer years ‘16 or ‘17 you will find most of our peers have not hedged much and we have hedged over 50% as I mentioned.
So in summary, we believe we have a solid strategy for cash flow stability. It all starts with a foundation of our long live assets. And so we have a great asset base build from MLP and secondly we plan to finance our growth conservatively with a balance of debt and equity and then thirdly most importantly perhaps we put on robust hedges when we do an acquisition. So when we announced the acquisition on November 1, within two days we had our full hedge portfolio put on for that acquisition through 2017.
So we are very pleased with where we come in the two years that we have been around since the IPO. We think we have a good growth story. We think we have a great growing story in terms of our coverage ratio and our long-term viability through buying and growing our long-term live lived assets.
I will stop here and that’s really yet for the slide. There is a few more in your handouts which we can talk about or you may have some other questions. So we will open it up for questions.
Okay. I will go ahead and kick of the Q&A. Thank you. My first question for you is about the fiscal cliff and your thoughts about any tax changes potential implications to the MLP model?
Yeah. Good question. There is a number of tax changes – well, there is a lot of tax uncertainty today. If you read the journal today, there is a news that came out I guess last night where some of the revenue ambitions to raise the tax revenues. It’s a cloud that’s going to cover the whole market. We don’t know any more than anyone else about what might come. Oil and gas has certain deductions which are really ordinary business deductions that could be at risk. And we are watching that. We would like to think that we are not any more – our industry wouldn’t be any more targeted than the other industry in terms of revenue raise.
The partnership structure of an MLP we believe it’s less likely – less that risk. We think there is a number of reasons for that. if you look at the MLPs, they are virtually all U.S. energy produce – they have done capital investments all in the U.S., the job they created is U.S., so very U.S. centric. And also the investments are heavily weighted towards retirees. So for those and then maybe the biggest reason if you were to really jack or change that completely for taxes, it’s really only a symbol in the ocean in terms of the revenue that would be raised. So there is a number of reasons why we don’t think the partnership status is at risk. But there is certainly everything is on the table when you are trying to raise the amount of revenue has been talked about these days.
Okay. Switching gears and talking your value acquisition size, you talked about that the dropdown in Jay field. Can you tell us a little bit about the 20,500 barrels a day that you are not acquiring right now through the sponsor, whether located, what’s the mix then any thoughts on timing of dropping that down potentially?
Sure, sure. Yeah, so there is obviously half of the product that we are not dropping immediately. It is less developed which is why it’s not ready at the moment. We are dropping down it will be – it’s been developed, capital has been deployed on the private side of the higher percentage than we would be comfortable with as an MLP. So while that’s happening, we think that will happen over the next 12 to 24 months and it’s in our core areas predominantly in the mid-continent. It’s mostly oil and it’s long lived MLP ready assets once this initial development redevelopment stage as happened.
Okay. One of the thing that investors focused on your G&A expenses and what they would look like in 2013. I know you talked about that on your earnings call. Can you just talk a little bit more about it today and explain it to us?
Sure. That was a little bit of a cloud that hung over us for sometime because as those who know us what all we had a two year arrangement with the IPO which was basically 3.5% of EBITDA quarterly we would pay. So as we can afford it, we pay but if you do the math, that’s a very subsidized G&A rate from our sponsor. But after two years the plan was to go to a normalized G&A rate with our sponsor and that’s what happened. On the last week earnings call, we announced that go forward plan it’s in place and it’s a combination of allocation. So we will be paying our direct expenses 100% as they will for the sponsor, the private side. There are two businesses here.
We will allocate compensation primarily through time sheets. So what are people working on and so that’s how that will be allocated which is by the way is very common with many of our peers that have a sponsor they allocated in the similar way. We hired a third party consultant to help us and we are really not doing thing that’s unusual. And then on the other indirect expenses we will allocate based on our metrics, things like production and reserves and so on. So we think we have a very center of the faraway formula, it’s very like other sponsor backed MLPs. And then we gave guidance specifically on the call as well for the next year. And so we expect our G&A burden to be $29 million to $32 million next year. And if you look at that that’s a pretty good number. It’s certainly for most of the self side that has model that. I think it’s below everybody I saw not a huge number below the others but certainly below consensus for our expectation of what that will look like. So we think we remove that uncertainty. We think we got a good program on board.
And the other thing to say is that this is a real synergy between for us because we have the benefit unlike an MLP without a sponsor. We have the benefit of sharing approval G&A, so we get a better team if you will for less months than those that don’t have sponsors. So we think it’s a great benefit, obviously the dropdown benefit, having a sponsor is also something gives us a competitive nature.
Okay. You pretty well hedged as you shared on the one slide but can you give us some thoughts on what you think prices will look like for in like the next 12 months for gas and oil and NGL?
That’s a good question price forecast. We are certainly not – we don’t have a core competency there. We hedge a lot, we are – most of it’s in the business for long time. If you do that you tend to have some use. I would say oil is a global GDP call and I leave it to the experts here Citibank to do a better job estimating that. We’ve got concerns. So we are glad we are fully hedged there for five years.
Gas, we are actually a little more bullish on and that part explains our hedging strategy in the outer years. 50% of our 2016-17 hedges are plus. So that gives – that we did that it’s a little more expense to do with that way. But we did that because we have a view that longer term we think there is some upside with natural gas.
Okay. You relatively new to both the equity market and as you mentioned to the high yield market. What’s your growth strategy, what do you think you will look like in five years?
We are big on the fundamentals. We talk about blocking and tackling, we are an engineering centric organization. I am the finance guy but to tell you I am surrounded numbered by a lot of engineers on our executive team. Over half of this are engineers, our CEO and COO petroleum engineers. So we will block and tackle and build and grow the way we been doing which is to get assets that are make sense for an MLP, long lived, low decline assets in our core areas. And we intend to stay within those guard rails and not get out there with assets that really don’t belong in MLP.
We will continue to execute our hedging programs. When we find an asset that we can acquire, add an accretive price. We will immediately put on long-term hedges mostly five years or so and we intend to continue to go that way. So we will grow as the market allows us to grow, so that’s why we don’t for example give you hey, we are going to grow the distribution x percent every year. we don’t know what the market will give us but we will go where the market allows us to go and we think our hands as good as anybody or better because of our team has build for that kind of growth.
But I will tell you also that the activities picked up lately and we think that this mature asset market is a $15 billion to $20 billion year market. That’s a lot of supply for the MLP universe that doesn’t have its bit out there. And so we think we got really great opportunities to grow for many years. And in terms of financing our growth, we will continue to do the same fundamental thing. I think fancy we will combine our debt and equity. We will certainly look forward to coming back to the high yield market and we will use our bank revolver. We go over $400 million today with the availability in our bank revolver. We will get more availability with the two acquisitions once they closed because they are very leveragable or they had a borrowing base with them.
So we can finance both of those deals and have a good amount of surplus with our borrowing base. But overtime we are going to balance that like we have done so far which is a combination of bank debt high yield and equity.
Have you said conversations that the bank cares about redeterminations on your borrowing base?
Yes, we have. Yes.
When is your next redetermination or is there a potential for the closing of the recent acquisitions to see an upside in that?
No, no. The question, we had our redetermination – we had that twice a year. We just had it about a week ago and it’s increased to $730 million which is the level of what’s before the high yield took it down. So we got all of that back to $730 which gave us an uplift in our liquidity. And then with the latest acquisition the third party deal and the dropdown, we are going to take both of those and we are in discussing with the banks right now taking both of those to get an increase to our borrowing base. And we will – once that completable certainly announce that.
Okay. (Inaudible) if there is any questions in the room.
What’s the – is this sponsor still in mall then your oil and gas besides the production the highlight the dropdown. Is there an ongoing role that they will continue to play in terms of sourcing other properties or developing other properties?
Great. Great question. So our sponsor Quantum Resources Fund, it’s a private equity fund for long life assets that had higher development component than we would allow. So it’s a $1.2 billion fund. It was started in 2006 and it is largely committed and capital has been deployed. So it doesn’t have much growth potential for more assets than it currently has that could be dropped. But they are in the process they belongs to a fund too fundraise which we would expect to be around the same size fund. And we would expect that to happen sometime next year to have a close perhaps even early in the year for a first close.
And so as that happens that has the double benefit I mentioned we have the potential for dropdown assets. There is no guarantee, there is independent parties on both side and so one of the cautionary there is to say we think our hands are better than the rest of the market. But it will be a competitive process and then also the G&A sharing will improve. So we expect as that fund gets up and running it will take its share of the G&A and we can even have some improvement in our G&A run rate.
And by the way that fund to – this is a young and hungry team. The plan is you just keep doing that fund two and three and four and so on. And our affiliate which is confusing there is a Quantum Energy Partners which is pure energy equity, they are on their fifth fund and so that’s where the business model as we continue to raise funds on the private side that have a little higher cost of capital little higher, CapEx spend and then you have the MLP that will continue to acquire and be the kind of final stock the properties that with it.
Can you talk little bit more of your selection process for acquisition and kind of what sort of opportunities you are seeking out there? So for every 10 or so that you are bidding on, you are looking at – maybe you are bidding on two or three and then other that you bidding on. How competitive is the market out there that you are actually getting into (inaudible) those kinds of offers?
Good question. That is our growth pipeline. The Permian is red hot and there is deals coming to market constantly in the Permian. The continuity just went to legacy is a good example. That’s a big deal and that’s a good asset for MLP. So we are seeing the Permian activity as we will get that. And as you seen from out story, East Texas, there is good assets in the East Texas, Ark-La-Tex area has been good as well.
Jay is all kind of by itself. There is not lot of assets in that area. But we are going to say primarily in our four key areas that’s our kind of – our hunting ground if you will looking for long lived assets. And like I said, it’s a $15 billion to $20 billion year market recently. We think it will continue to be that way and mid-continent as well. We could see that’s go into other core area it would be strategic, so we need to be a recently sizable entry point. And there aren’t that many that we would consider. But the Rockies oil would be a play, we had a good amount of experience on our team, lot of assets there that’s bid our profile, we looked at some, just haven’t found the right one.
We have yet to find a deal that’s really not competitive even the (inaudible) deal we had in the spring which was a 101. There was a competitive attention because the seller was is very experienced in this business as we are. So we both know what a competitive price would be. So if we didn’t deliver a competitive price, we wouldn’t have that deal. So on the other hand, I mean, MLPs have a significant competitive advantage over the rest of the market for these kind of assets. We should have below cost of capital, we should have a much low risk profile which brings a lot of cost of capital.
So it’s not just tax. It’s the hedging; it’s the whole risk profile that brings that that allows us to be a final stop for long lived conventional kind of the older oil and gas party. So the new Shale place you probably won’t find any MLPs there unless its old shale asset not many knows. But once that steep decline has kind of leveled out that’s when it fits an MLP and we look at those. I mean, lot of our assets were discovered in 30s, 40s, and 50s, really old oil field that are just (inaudible) long a nice slow predictable production rate. But it will always be competitive and it’s hard to predict exactly what’s going to be there for us.
Do you have preference for oil versus gas assets?
You know that’s a great question we get ask a lot and we actually don’t. We had some views like I mentioned earlier. But we are agnostic on that. We want quality assets which are they actually start to describe long lived low decline. We want to have good margin. So should the price has radically from where they are today, we will – that might affect that but as they are today, you don’t find many gas assets come in the market most like our sellers are really willing to accept the current price. And you don’t get – and they won’t get paid much for their undeveloped inventory.
And so but if we looked at gas assets with the hedges and it meets our return criteria, we will go after it and very happy to. And in fact, we might enjoy that more because the upside could be greater. But today, sellers they seem to be more oil assets coming to market because seller seem to be willing to take that price on this going price on oil versus gas today. So I think also as you look at the margin, that’s a big deal in making sure that we can’t – we have enough margin to run the asset because if gas prices were to go to $2, I think you find a lot of assets really challenged to just to even keep them or below that. I mean, our gas assets that are producing work well below $2. But there are some of these shale and other things you just couldn’t do at that level.
With respect to margins, we obviously talked about your G&A. But when we think about your LOE cost, where do you think you could get efficiencies from that?
Well, when we look at it, that’s a big deal. The LOE production CapEx, I mean, those are – that’s kind of what an EMP company ought to be talking about every day. And so that LOE is we kind of guided, it was below $15 this last quarter which was good. But we are kind of thinking around $15 all things combined. Gas assets on a BOE basis have a much lower LOE than oil. Oil assets are typically in the low 20s for a good one. We worked at this – that’s why we want to stay in our core markets because this East Texas acquisition we are making is right on top of some existing acreage.
In fact, there is – I didn’t cover the slide but it’s in your handouts. You can see a map of our existing acreage and then a map of its East Texas acquisition which is a great fit for field synergy and the opportunity to keep LOE low or even lower further. So those are the kind of things you look forward to reduce cost.
With the Jay field, it’s actually a great story for the abilities of our operating team. When we bought that field from Exxon, it had a very high LOE at $55 kind of lifting cost. We shut that field in – the private part shut the field same team riding both sides. So the private side shut it down in late 2008 when oil prices were below $40, completely redesigned that. That was a field of one billion barrel field producing 100,000 barrels a day in its peak. So that whole infrastructure there and it is not only a field you will get. It’s deep, it’s hot, it’s sour, it’s very difficult.
So the infrastructure cost and (inaudible) cost is very high. We (inaudible) completely redesigned it. It’s producing like I mentioned 2,500 a day. Today, so much lower level and now our lifting cost is mid-30s. So it’s a great turnaround story. But still mid-30s is high for an LOE, typical LOE for. But the margins at mid-30s and today’s price hedged are still very good.
Given your unique structure with the sponsor, can you talk a little bit about your management fantasies?
That’s a frequently asked question. It’s a point of confusion. Let me just – yes, I will and thank you for the question. I think the genesis of the fee is important to understand. Our Quantum – this is really the third upstream MLP that Quantum is been part of it. Most people know Linn Energy was a portfolio company, a Quantum Energy partner is when they took it public, great success story there. Legacy was close for (inaudible) affiliate. Quantum Energy founders and they helped to get public, (inaudible) was a Quantum before he went to Legacy to help take that public.
So QR Energy is really the third and as we looked at it, the sponsor was taking assets and putting in it. The general partner expect to get paid if you had a GP, I understand that some don’t. But if you do, they are going to require payment. So we look at the idea structure and decide not to do an IER and do management (inaudible) instead. And if you look the private fund this fee is identical construct. It’s an identical fee that the management team or the GP is already getting on the private side.
It’s basically on assets under management fees. So it’s 1% of assets under management, lot of these portfolio managers may be able to relate to that kind of a structure. But that’s really what it is. It’s 1% on asset under management and then the rest of your compensation would come under basically success based. We did put the – the fee was put at risk, have the increased distribution and maintain it 15% above the IPO level (inaudible). So as long as that’s happening then the fees paid and it’s 1% a year taken.
So that’s really the genesis of it. We think it’s a better structure than the IDR structure. It was lot of thought given to that. It’s I understand that we are unique and having and so it’s a point of confusion because it’s not a garden variety fee structure. But as one gets to know as we think it’s a better way to do it.
Okay. When you incorporate the Jay field in the recently announced acquisition, where should we think about maintenance CapEx for 2013?
Well, our current run rate $53 million, I am sorry $52 million. The additional maintenance CapEx for this East Texas acquisition is $3 million, so that’s $55 million run rate. We have not said what the Jay would look like. We will and when we get that deal signed up, we will bring all that information out. But as it is now our run rate looking forward to be around $55 million.
Okay. Any other questions out there.
Falling upon the topic of acquisitions and relationship with your sponsor and management overall, I think another point that’s helpful understanding when you are looking at a dropdown, how do you guys independently evaluate that the interest of QR Energy versus the interest of Quantum Energy?
Yeah, thank you. That’s good question. On the dropdown assets, when we do a dropdown there are independent parties on both sides. So that it is the arms linked, boxes and checked. And so if you look at the QR Energy board this is another – again this is the third Quantum upstream MLP, a lot of thought was given to that issue too. If you look at our independent board of directors at QR Energy, we are very proud of it. The conflicts committee which is the committee that evaluates any transaction like a dropdown and whether there is a conflict is headed up by Don Powell. He was former head of the FDIC. He is on the Board of Bank of America, very seasoned energy finance veteran banker, energy banker. We have Steve Thorington who is our CFO for an upstream, career upstream as well as a banker part of that. and then we had Ricky Baron who is COO of Burlington.
Really our leadership, our COO and (inaudible) used to work for Ricky Baron. So we – and there is a lot of ex-Burlington mafia out there running upstream companies. There is probably six or seven upstream public auction companies today including Linn and others that are run by ex-Burlington folks. And we like to drag and say, yeah, but we got the top guy out of that equation on our conflicts committee and on our board.
And so it’s a really robust process with that kind of leadership on the committee side, making sure that QR Energy gets a good deal when we make dropdown. And there is a similar equation on the private side where they have some other largest investors in the fund representing an advisory board that will also apply. We get third party valuations in legal help and things like that. So it’s a robust process.
When we did our first one last year, we kind of joked and said this is tougher than any third party deal we ever do. But it’s a healthy exercise to make that we have a mission on both sides are able to sign off on the deal.
Can you talk a little bit about your expectations for decline rates?
Decline rates are also a big deal in our house. These are very questions. We – it’s around a 10% or 11% decline rate today. That is something an upstream company always fights particularly in MLP. We used to try to produce long term stable cash flows. So that is a natural force we are trying offset so 10% to 11% today. These acquisitions, when I say they’re accretive, they’re accretive for distributable cash flow, they are accretive for our coverage ratio but they are also accretive for our decline rate. In every one of these acquisitions we’ve done the two third party deals and the dropdown that’s coming, they have a lower decline rate.
The prize acquisition that we did in April is 3% to 5% decline rate, very accretive. And so what that means is if it’s accretive next year, it’s really accretive five years out because of the lower decline versus our current asset base. Similar story for the East Texas deal and which is probably a 7% to 8% decline and then the dropdown is coming, I don’t think we’ve given numbers on that so I won’t but it’s a little decline that we current.
Okay. And can you remind us what’s your percentage of operated versus non operated?
We’re about 90% operated.
And who are your partners on the 10% that’s non operating?
Well, the biggest piece is the joint venture we have with AXON it’s in the Permian. And they are great operative, so that’s an important thing for an upstream company. We think that’s a full competency for us, we’ve built a team that is very good at operating in the basins we’re in. And so, especially if you’re an MLP and you don’t want to be in an non-op with a partner that’s not an MLP and maybe looking to maximize MPV, and accelerate spending you can really get your cash flow down the whack, if that were to happen. So, we intentionally have a very high percentage operated. And if it’s an asset, we are operating – we’re going to make sure it’s a good Operator
running, and like I said, the AXON is doing a great job with that joint venture.
With Sandler’s announcing last week their potential desire to divest their Permian assets, is that something that you guys maybe interested in, do you know if they are willing to split it up into different pieces?
Well, we would never talk about an asset that is in play or maybe coming, we just – it’s just two close to the edge. But that’s the type of asset, it’s obviously in our basin. You can look at the profile of that asset and I’m sure lots of MLPs will be looking at that closely.
Great. Any other questions? No. Okay. Thank you.
Thanks for coming.
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