I have read hundreds of earnings transcripts of US shale companies. Analysts ask all types of questions regarding finances, engineering, well characteristics, M&A, and etc. I am yet to hear the most important question that is never being asked:
What will you do when you run out of other people's money?
It's become such a norm for shale oil executives to outspend internally generated cash flows that I don't believe it ever enters their mind that money being spent down the hole is somebody else's money. They proudly state "we have so much liquidity with cash being this much and revolving facility that much". Do they realize it's not their money? I don't blame them entirely, Pioneer Resources (NYSE:PXD) just issued $1.4 billion of stock, all of which was gobbled up. Diamondback Energy (NASDAQ:FANG) issued an additional $226 million or 6% of the current float, which also was promptly gobbled up. Is cash burning a hole in the pockets of these investors or are they so naive to understand that these guys will drill themselves into oblivion?
Those stock offerings will be used to support drilling activities when North Dakota Sour sells for $0.50 per barrel. Yes, I know that neither PXD nor FANG have anything to do with North Dakota, but my point here is that oil price is too low to drill new wells. PXD and FANG are getting $25 per barrel or less on the unhedged portion of their production, and this unhedged portion is produced using freshly printed money from stock offerings.
I read an article recently on PXD, which claimed that stock offering is a great idea because the company has hedges in place. Sure, it has hedges in place, but they would still be easily covered with production from existing wells despite whatever exponential decline these wells would experience over the next 12 months. There was no need to spend $2.5 billion on drilling in 2016, sell at depressed prices all in the name of a production increase by 25k boe/day.
Furthermore, most of those hedges are three-way collars and only have a $19 uplift from spot WTI price. When one accounts for WTI-wellhead differentials, PXD's hedged portion of production will generate revenues below $50 per barrel of oil. At $50 WTI per barrel, the company as an overall entity is bleeding cash like there is no tomorrow. Same holds true for Diamondback. It will spend $350 million next year just to hold production steady compared to Q4 2015 levels of 36-38k boe/day. They realized $35 per boe before hedges in Q3 and had an adjusted income of $26 million, of which $17 million was "other income" and $35 million was "hedging gains". The company was a loss-making enterprise when WTI averaged $47 per barrel; how bad would things get when WTI averages less than $40, $35, $30?
This article is not meant to pick on these two particular companies, as a matter of fact, both FANG and PXD are some of the best operators in the shale oil patch and are Wall Street darlings. If these are the best companies in the industry operating in the most attractive Permian Basin, what to make of dozens of other shale operators that are both highly leveraged and operate in areas where production economics are significantly inferior?
All US shale companies have squandered hundreds of billions of investors' money over the past 18 months and look to continue doing the same thing. FANG, PXD, and maybe a half dozen other companies can still use their relatively expensive stock to generate additional funds to throw down the hole. For everyone else, it's up to the banks to keep "liquidity" available via revolving credit lines. The noose is tightening, and there is no tomorrow. Equity will be wiped out soon, and debt is essentially worthless for all those companies that have operating costs per BOE higher than realized prices. At $19 per barrel for North Dakota light sweet and $20 for Permian sweet, banks will never see a penny of their loans back simply because nobody will bid for those loss-making properties when it will be time to sell during bankruptcy proceedings. The only hope is oil prices at $60+, and hope is all that is left.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.