QR Energy, LP (NYSE:QRE)
Wells Fargo MLP, Pipeline & Energy Conference
December 10, 2013 15:55 ET
Cedric Burgher - Chief Financial Officer
Michael Blum - Wells Fargo
I’m going to get started. Our next presenter is QR Energy LP and we are very pleased to have Chief Financial Officer, Cedric Burgher to present.
Well, thank you Michael and thanks to everyone for being here and its great to be here in Wells Fargo conference. This is a bellwether conference in the sector. One of the early pioneers for these energy MLP conferences and I guess this is the 12th straight year or so, congrats on hosting a great conference.
It’s also great to be in New York this time of the year. You know, its snowing today. And that’s kind of fun coming from Texas and those of us in the energy business particularly like the cold weather, it can help with commodity prices and in fact, I think yesterday was a six month tie on the natural gas prompt amount of price. So that’s always good news. But, thank you for having us here.
This Slide 2, really just says that we are going to do our best to give you good guidance but there are risks in the business particularly in oil and gas. And in fact, there are issues with cold weather and I’m going to talk a little bit more about that but cold weather can bring operational issues in our business as it has recently.
So let me just start with a quick introduction to QR Energy, we are an upstream master limited partnership headquartered in Houston. We went public, did our IPO rather three years ago in December of 2010 for $345 million, which is still the largest upstream MLP IPO to-date.
We currently have about 11.8% yield, the market cap of $1.1 billion and an enterprise value of $2.3 billion. Since our IPO, we have more than tripled the size of our company. We have increased our distributions by about 18%. And we have accomplished this growth by completing $1.3 billion of acquisitions, two, dropdowns from our sponsor and three, third-party deals.
Also last week, we announced that we are going to move to a monthly distribution policy, I think this makes us fourth in our sector to do that. We think it provides a steadier stream of cash flows for investors seems to be popular with a number of our investors. And we also think it could reduce (x state) volatility which can be more exaggerated when you have a higher yield which the upstream sector certainly does.
Our asset profile is 16 reserve life or liquids dominated, we have a high percentage of proved developed reserves and I’m going to talk a lot more about the assets in a minute, so I will move on for now.
So if you think about just from a high level what QRE – the QRE story is, I would point you to this slide, since inception, we have been very focused on owning the right kind of assets, assets that an MLP should own. We think that is a very big deal and investor should pay attention to that and we worked hard to do that to bring in the right kind of assets, we have long life low decline highly developed assets. And we are focused on that since the beginning and we plan to continue to do that as we grow through additional acquisitions in the future.
We are very bullish on the A&D markets, we think the thesis is still sound for C-Corps selling off assets to fund their growth projects whether they be in the shales or other high return place in the Permian, for example. We think this will continue for years to come. We also think the shales at some point will make sense to come into MLPs once the risk profile comes down and the decline curves come down.
This has been a soft year, I’m going to talk about that also a little more but we are bullish, we think deal flows picking up now and in the long run we think that almost every oil and gas asset will end up at one point in an MLP. The kind of assets that these C-Corps are selling are right in the wheel house for us, production MLPs are the old assets that really have been neglected for a number of years. They don’t meet their return criteria with a higher risk, higher return profile and we think it’s a $20 billion to $25 billion a year market.
Next thing to think about with an upstream MLP is hedging, we are big hedgers. Our goal is to create predictable cash flow streams and set a distribution that we can be confident and so really getting your production profile right and predictable along with commodity hedging is what it gives you or the two of that need to do that. And we will talk more about that.
So those are really the headlines to our story, the key components, we have been able to grow our distribution as I mentioned 18% since our IPO over the last three years that does put us in the top quartile of our peer group.
So let’s look at our assets, here is a snapshot, it does not include the East Texas oil acquisition, we closed in August. But, at year-end our proved reserve were just under our $100 million Boe equivalent heavily developed, its 75%. Our third quarter production was just over 18,000 Boe’s a day and our reserve life was over 15 years.
The recent East Texas acquisition, I’m going to give you more detail in a minute, but we added 6 million barrels of proved reserves approximately 900 million – 900 barrels a day of oil equivalent and really increased our footprint there in the East Texas field. So here we show you five areas, we would probably tell you that our – we operate in four key areas. That’s the Permian, the Ark-La-Tex, the Mid Continent and the Florida Gulf Coast. The Permian and the Ark-La-Tex are by far our largest areas making up 84% of our reserves and 70% of our production.
This is intentional and strategic for us. Our technical team is very experienced in these areas. We know these areas very well. So when we go to acquire an asset, the diligence process which is intent is much better for us and areas that we know well. There are other areas that we would look to go into that we have experience for example Rockies oil, even some areas of Appalachia or Michigan, where we do have a small piece today and there are some other areas that are onshore U.S. that were just a profile for us, but for today, this is our footprint and there is a lots of room to grow in these core areas.
In the Permian, you may have heard some news recently from some of our peers in the E&P business MLP and otherwise, but similar to other operators in West Texas, we’ve experienced some freezing temperatures with rain, which has resulted in severe icing in many of our fields and this is resulted in numerous electrical power disruptions at the field level. While, we currently view the impact to be in-material and do not anticipate changing our guidance range for the quarter at this point; the weather will have about 100 to a 150 barrel a day impact to our production in the fourth quarter.
Quick freezes out in the West Texas are not uncommon and in addition to creating power loss quick freezes can impact crude oil hauling and other things. And so, so far we’ve been fortunate, we’ve restored power in most of our fields, but of course, we’re still in the early days of winter and we could experience similar disruptions from time-to-time.
So looking at our capital spending plans this year, we expect to spend just under a $100 million, a large component of our capital would be spent in the Permian and Ark-La-Tex which should be no surprises, those are the largest areas. We have lots of low risk projects spread out across our asset base, nothing sexy just good old blocking and tackling workovers like well reactivations and installing electric submersible pumps and then we have recompletions and infield drilling also in our program as well as some service facility work.
This capital program allows us to generate the production uplift to not only keep production flat but to grow it modestly. There has been a lot of discussion this year about maintenance capital and the math around it and we’ve had investor, enough of investor interest we thought it would be helpful to transparently just layout the math for you here. This is the first time we use a slide. It’s not new news since the IPO, we’ve consistently given out the numbers that allow you to run these calculations but we’ve consistently defined our maintenance capital since the IPO by estimating the amount of dollars required to keep production flat over a five year period. And that’s based on our existing assets and to find projects within our existing assets.
So the key inputs or the math if you will is the base decline which for us is about 10% a year and then the second number you need is the capital efficiency which for us is about $37,000 per flowing barrel. And so if you run that math on our existing asset base, you’ll come up with the number of about $70 million a year and that’s where we are with our maintenance capital today.
We do this evaluation annually in a real formal process that includes third party engineers that do their own numbers on our reserves. But we also do it quarterly when we relook at our quarter just to double-check that this number is still good. It is a five year look, so it shouldn’t move around that much from quarter-to-quarter. But, we think by assembling the right kind of assets for an MLP with a low base decline rate that we can achieve modest capital spending requirements and we think again, we are in the top quartile with our decline rate of around 10%.
So now, I’ll take you through a few of our more significant fields that where we’re spending our capital dollars organically, I’ll start with the East Texas oilfield development. Last year, we’ve made $215 million acquisition in the East Texas oilfield and we also added another $109 million acquisition this year in August. The East Texas oilfield is a legendary field. It’s the largest oilfield ever discovered in the lower 48, 7 billion barrels original oil in place, it’s been producing for 80 years, it’s probably going to produce another 80 years, it’s exactly the kind of asset that we want in our portfolio.
And so, today, we operate about 25% of the production in this field, which is to say there is 75% that could be available at some point for us to bring in particularly some that’s in the hands of smaller producers that at some point might want to sell. If you notice from the map here, you can see that the oil wells that we acquired in the red and the green overlap our existing acreage much of that is gas acreage in East Texas, Cotton Valley and so on. But it overlaps and gives us a lot of operational synergies, we’re able to lower our operating cost by combining the field teams and getting a more productivity.
I will tell you that also both of these acquisitions that we’ve made were accretive to our decline rate. So they are not just accreted to immediate cash flow but when we look at it, we really look over the longer time horizon and so the deal we did last December had a base decline of about 6% to 7% and the deal we closed in August was about 7% to 8%. So both of which were accretive to our 10% decline rate overall. So perfect MLP assets and this year, we’re going to spend about $8 million continuing our work over program there, we’re doing things like reactivating old wells. We’re adding the electric submersible pumps, recompleting additional zones and we’re doing some deepenings of existing wells. There is also some water flood potential here that we’re currently evaluating but nothing’s been started on that front. So that’s East Texas.
Now with in the Permian, we’re in over 20 counties there but the Turner-Gregory developments one of our bigger more active areas, it’s a West Texas water flood that produces from the Upper Clearfork at about 5000 feet, you can see on the map, the drilling density offsetting our acreage is much greater than the acreage where we own which is in yellow. We’re currently drilling on 20 acreage spacing. We drilled six wells this year, spent about $10 million, but you can see the offsetting acreage from some of our competitors is in much tighter spacing, 10 and even some five acreage spacing and so that gives us really good insight when we go there lower the risk profile for us when we can see what others have done and how it’s performed before we go spend our dollars.
We have a good inventory there of infield drilling and water flood optimization for some time to come and so you should look for us to spend capital there in the years ahead. During the year, these six wells, four of them were producers and two were injection wells.
So the last field that I would show you is, the J field it’s in the Panhandle of Florida. Again, it’s a classic MLP type asset. It’s a billion barrel original oil and place field that was discovered by Exxon in the early 70s. Last year, we acquired it from our sponsor in a drop down for $145 million. Our sponsor acquired it in 2006, so we’ve had a good number of years as a team operating this asset. That’s important and particular here because it’s a very complicated asset. It’s in tertiary recovery, which is nitrogen, water, alternating flood, we produced our own nitrogen at the field through air separation units and we’re getting great productivity out of this field. We’ll spent about $19 million at J this year. Our primary objectives have been to install facilities in the plant that allows to improve the NGL recovery and ultimately increase the price that we received for certain components of the NGL stream by separating the products.
Secondly, we’re also working to clean out injection wells which increases the water volume, we can put in the reservoir that improves our performance and gives us even an uplift on the production profile.
And lastly, we’ve done other facility work to increase the throughput and maximize our injection rates. The more water and nitrogen, we can get in the ground, the more oil we’re going to get out, it’s really that simple. So we continue to have excellent results from our capital program here at J and the production profile as I mentioned is continuing to improve. We recently completed the NGL capture program and the fractionation plant, which enhances our NGL production in the field and again, allows us to separate those NGLs and get better pricing closer to crude pricing for some of those upstreams.
So when you look at our combined portfolio and the commodity mix, you can see that we’ve been -- by focusing our capital spending and acquisition dollars on higher margin oil assets, we’ve increased our oil production mix by 20% over the past year to currently 60% on a Boe basis. That’s the top pie.
The second pie shows you that on a cash flow basis to see the more significant than that 80% of our cash flow coming from oil. If you looked at those pies a couple of years ago, you would have been closer to 50:50 more balance. But, the margins are much better for oil and today, you can see on the right that we’re one of the top oil and liquids producers in our sector.
We’ve got about, we do this because of the margins, in fact, I’ll just skip to that on the next page and you can see that our margin per Boe in total oil and gas combined just over $41 of Boe and our peer average is about $31. So that gives us the big advantage we think by having higher margins and better cash flow and again, those are the assets we’ve developed. I also failed to mention, we have a good amount of gas inventory that we’ve been deferring those capital dollars because we do think there may be (big) for gas but certainly for now, the oil inventory is more compelling to prosecute.
I mentioned earlier hedges are really big deal in terms of getting your profile right and your cash flows stabilize for an upstream MLP. So we’ve got a robust hedging strategy that we’re very proud of. We typically put most of these hedges on at the time of an acquisition. We’re disciplined in doing that. We signed a PSA, we were typically going to put on five or six years of hedges, we look at the total portfolio and make adjustments but we also look at it all the time, every month, I’m sorry, every quarter our Board has a thorough review of our hedge portfolio when we would look at adding on over years or topping up as we increase our production. But you can see here that we’ve got a very high percentage of our oil and gas production hedge compared to our peers, we have a significant amount more hedge particularly in the outer years, we’ve got close to a 100% of our oil hedged in natural gas through the end of the next year and the majority hedge to 217. Sometimes you can say well of the commodity price where to go up that puts you just advantage, there is some through in that, well, I’ll tell you our first priority is protect the cash flows or in MLP, we know who we are and we need to protect those cash flows and make sure there is assurance of that distribution in the coming years.
And the second thing, I would tell you, as if you look in the outer years for gas, about half of our gas hedges and 16 and 17 are in the form of puts. So we’ve purchased puts at around $4 an Mcf and so that allows us to protect the cash flows and at the same time benefit from upside should gas prices pick up in the outer years.
Most of our hedges are in the forms of swaps. We do have a few collars, I mentioned those gas puts, those are deferred premium puts, the premium expense at the time the put matures and they will be expensed against our distributable cash flow that’s being a frequent question. We have about a dozen hedge counter parties, so we do diversify amongst highly rated banks like Wells Fargo and others to make sure that these hedges are going to be good when it’s time to collect. So we’re proud of our hedge position, we’re one of the top hedgers in our space and you should look for us to continue to do that.
Look at the acquisition market; this is the market that we look too to grow. Our coverage ratio on our distributions last year, we made just under $600 million of accretive acquisitions. We’ll continue to do that as I mentioned earlier this has been a soft year. You can see it in the chart there. On the right 2013 year-to-date, onshore material asset supply has been welled behind 2011, 2012 numbers. We think 2009 and 2010 were down as you’re just coming out of the recovery and we’re optimistic the deal flow will pick backup in the $20 billion to $25 billion a year area that I mentioned earlier. It is junky and we have to be opportunistic in this business to take the deals when they come to you. But we’ve seen deal flow picking up more recently and so I’m optimistic at ’14, this going to be a much better year for us and our peers than this year. It’s a good market to play in.
Again, I think the thesis still sound where C-Corps are going to need to sell off the old stuff to keep their balance sheets in check when they pursue large deals. The Devon announcement recently is a classic example where they’re going to spend big dollars in the Eagle Ford and they are likely going to sell some stuff out the back door that would be perfect fit for MLPs.
So in closing, we think we will stay true to the -- what we believe are the Upstream MLP fundamentals, we’ve got the right kind of assets long live, low decline, highly developed, we’ve demonstrated our ability to grow through third party acquisitions as well as accretive dropdowns, we’ve had significant reserve in production growth and increased our distribution, 18% since the IPO and we think we’re again in good position to grow from here. We’ve got over $300 million of liquidity and a good market we think to play in.
And so, really with that that’s it, I think that summarizes our story and I think we’ve got a couple of minutes left; we could take a question or two.
Could you talk about the prospects for distribution growth in 2014, 2015 what kind of goal do you have and also your coverage ratio goal?
Sure. Questions about prospects for growing the distribution and the distribution coverage ratio in 2014 and 2015 in particular and that is the number one target we have in the house. Every quarter we do and all employee meetings review how we did in the quarter and we’ll talk about our goals and so on and the number one goal we give everybody, because people are doing their own thing, whether they are line man or an accountant or an engineer, but the number one goal is to grow distributable cash flow per unit. And out of that you can grow your coverage ratio or your distributions or both.
And our goal is to maximize those opportunities and grow distributable cash flow per unit as quickly as we can, its opportunistic and we do it over the long haul, so when we buy things it may not be as accretive next year as a deal that as a higher decline, but our goal is to have accretive deals over the long haul, so we look for accretion in the outer years particularly.
We are at 1.1 times coverage last quarter, our goal is to get north of that to be in a position to grow the distribution, its going to take accretive acquisitions to do that and unfortunately the market is kind of choppy and you can always predict what kind of assets are going to come to market and are they going to fit? I’ll tell you that half of the deals that we bid on are indicatives on last year. The good news is they didn’t get sold at all.
So I think that shows good discipline in our peer group, we – they certainly didn’t meet our price threshold, we bid kind of what we thought we were willing to pay, but neither did any of our peers on half of those deals. And so, I’m optimistic that the deal flow will come in, but that’s what it’s going to take to grow the coverage ratio, the cash per unit which puts you in a position to grow your distribution. And that’s the goal for us, we want to grow that distribution, we certainly want to protect it and we’re doing things like hedging and so on in a disciplined way to protect the distribution, but the goal is to grow it over time. And we are looking to do that as the opportunity allows, I can’t give you a number, because I can’t just, I can’t predict what kind of deal flow would come and what kind of how accretive it would be.
Had a question about your preferred units, when you think they can convert?
Preferred units, I have the -- the investor has the opportunity to convert now. That opportunity, conversion option opened up October 1 of this year, so they have not converted, they are owned by the sponsor, sponsor has vested interest in this MLP owns about a third of the stock and so they have not converted at this point, so that option exist. At October 1, 2014 they automatically step up to the common distribution rate. And so from our standpoint it will be a non-issue next October and between now and then, we don’t expect the sponsor to convert early. And so we’d try to guide everybody to expect October 1 of 2014.
Will that change your coverage ratio?
Sure, good question, when the sponsor converts will that change the coverage ratio. Yes in fact we look at that, we’ve been looking that for a long time, we’ve known about this. And so our coverage ratio in the third quarter was 1.0x fully diluted which assumes a conversion rather than the 1.1x that was the actual number. So we’re watching that and that’s what we need to grow, coverage ratio from a 1.0 to -- fully diluted to a greater number to be in a position to grow the distribution.
I think the economies of scale, in other words, if two or three of you upstream companies got together and consolidate it, are there any benefits that would be meaningful to your shareholders, number one and number two are there any opportunities in your sector to do the kind of Crosstex deal that, they’ve recently concluded with Devon?
Sure, good questions. Certainly there would be economies of scale, we’ve long believe that getting bigger gives you those certainly the G&A, but also operating synergies and just ability to take on lager deals and so on it gives you just a – more, bigger opportunities set can lower your cost of capital. If you look at the rating agencies, typically the number one thing they look at is how you’re sized and diversity of your asset base. So there are a lot of advantages to being larger that’s certainly true, you can bet that the bankers have been bringing around the Crosstex deal to me and every other CFO, I’m sure in the space and so that is something that’s, its an interesting idea, it could have potential application, but it always gets down to deal specific. And so, sure I think that could happen, but obviously that it’s just -- takes two parties to get together for that to make sense.
Okay. Thank you, everyone.
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