Pioneer Southwest Energy's Perfect Timing of the Oil Market

Nearly every oil company in America is struggling to deal with lower commodity prices. The majority of these companies have chosen to respond to declining commodity prices with severe drilling cutbacks and asset sales. However, Pioneer Southwest Energy Partners (PSE) is likely to stand out as an aggressive grower within the energy sector as it has the resources to continue its drilling programs and to purchase assets at below market prices.

It is clear from recent statements by Pioneer that it is using its strong balance sheet to take advantage of the recent drop in oil prices and the corresponding drop in asset values across the sector. On Pioneer’s last conference call, management said they were negotiating a $200 million acquisition from the company’s parent, Pioneer Natural Resources (PXD); these assets will probably be centered in the Spraberry field.

Pioneer’s timing could not have been better. Pioneer was formed in early 2008 through a public offering of units and a simultaneous purchase of about $220 million of developed oil producing assets in the Spraberry field from its parent Pioneer Natural Resources. Pioneer promptly hedged the majority of its oil production in 2008-2011 at prices over $100. Even more astutely, Pioneer negotiated a $300 million credit facility at favorable rates before the credit crisis developed into its present form.

Because of Pioneer’s strong hedges, management has said they can maintain their current distribution rate of $0.50 per quarter through 2011 regardless of the spot price in the oil market. This distribution offers investors a high degree of safety as they wait for the company to leverage its strong balance sheet to acquire depressed properties.

In 2012, once the company’s current hedges expire, management has said that they need $80 oil to maintain their distribution with their current properties. While the current price of oil is significantly below that figure, I would not bet against oil rising to $80 yet again over the next several years. Fortunately, Pioneer is so heavily hedged that it is currently generating about $0.63 per quarter in distributable cashflow from which Pioneer will be able to build up quite a cash hoard that can be used to expand the company’s production portfolio.

With Pioneer now set to purchase another $200 million of oil producing properties in the Sprayberry from Pioneer Natural Resources at depressed prices it should be clear that the management team of Pioneer realizes the position they currently have as one of the more financially sound small cap limited partnerships. It should be noted that the purchase price between these two related companies is being set at metrics similar to other recent oil property transactions in the industry. Management has said that it is their intention to leave the majority of the assets acquired from Pioneer Natural Resources unhedged so that unitholders can benefit from the rise in oil prices in the coming years. From this action, it can be concluded that Pioneer will follow a similar strategy following the acquisition of additional assets in the months ahead.

After Pioneer's transaction with Pioneer Natural Resources, the company will still have almost $150 million of capacity available on its credit line for further acquisitions and drilling. In addition, unitholders can expect a substantial distribution increase following the transaction as the company’s leverage begins to grow.

There are only a few oil companies that have managed the downturn in oil prices as well as Pioneer. Linn Energy (LINE) and Exxon Mobile (XOM) are additional examples of companies that have done a good job of hedging their production and the timing of their capital expenditures. However, I know of no other company of similar size to Pioneer that is in such an excellent position to purchase assets in the oil sector at rock bottom prices.

Disclosure: Long PSE