Important Note: This article is not an investment recommendation and should not to be relied upon when making investment decisions - investors should conduct their own comprehensive research. Please read the disclaimer at the end of this article.
As U.S. E&P operators report their year-end 2015 proved reserve data, investors should brace up for potential disappointments: using a flat price assumption for crude oil of $50 per barrel, value estimates for proved reserves will be low.
In some cases, the disappointment may be bitter, as the PV-10 metrics provided by companies will show very wide gaps between stock prices and the values of underlying reserves.
Pioneer Natural Resources (NYSE:PXD) is one of the first large-capitalization E&P operators who has reported value estimates for its year-end 2015 proved reserves.
The preliminary report that the company released today after the market's close illustrates how severe the impact of the collapse in commodity prices is.
Under SEC guidelines, E&P operators will use the following flat NYMEX prices to estimate their year-end 2015 proved reserves and related PV-10 values:
- ~$50 per barrel for crude oil (West Texas Intermediate);
- ~$2.60 per MMBtu for natural gas (Henry Hub).
(The PV-10 is the net present values of future cash flows discounted at 10%, before tax.)
Using these price assumptions, the PV-10 value of Pioneer Natural Resources' year-end 2015 proved reserves is $3.2 billion, based on the company's independent reserve engineers' report:
(Source: Pioneer Natural Resources' - Feb. 10, 2016 press release)
Please note that the calculation of the PV-10 value does not capture the impact of the company's general and administrative expenses (and possibly certain other "above the field level" expenses).
There is no simple way of estimating the impact of corporate overheads on value. However, the following illustrative calculation may be helpful.
I will start with the company's latest quarter G&A per unit of production of ~$4.18 per BOE and assume that one-half of that expense, or $2.09 per BOE, is what is approximately required to enable the production of the existing proved reserves and the other half is what is approximately required to enable growth.
After applying this allocated cost of $2.09 per BOE to Pioneer's year-end 2015 reserves of 664 MMBoe and discounting, the PV-10 deduct for corporate overheads comes at roughly $0.7 billion (I apply a time-value discount factor derived from the company's year-end 2014 reserve disclosure).
As a result, the adjusted PV-10 value of the company's proved reserves after corporate overheads comes out at approximately $2.5 billion, using the SEC price case.
How does this metric compare to Pioneer's enterprise value?
Using the price of $108.68 per share (today's close), the company's enterprise value is ~$18 billion.
While recognizing that Pioneer is endowed with some of the best assets in the industry, at $50 per barrel the gap between the company's enterprise value and the value of its proved reserves would be virtually impossible to bridge. Therefore, Pioneer's current stock price appears to imply an assumption of oil prices recovering to levels substantially above $50 per barrel.
Furthermore, I would argue that if one were to assume a flat $60 per barrel WTI price, one would need to stretch valuation assumptions beyond reasonable in order to substantiate the stock's current price.
It is worth noting that Pioneer's PV-10 value at year-end 2014 was $10.4 billion. The estimate was based on SEC prices of $94.98 per barrel of oil and $4.35 per MMBtu of natural gas. To achieve a comparable PV-10 value for year-end 2015 reserves, one would need to assume a commodity price deck of above $75 per barrel for WTI and ~$3 per MMBtu for Henry Hub, based on my estimate (particularly if I assume some cost re-inflation at those price levels).
The PV-10 metric reported by Pioneer also suggests that the current strip curve is incompatible with many stock price in the E&P sector. The convergence will have to occur either via higher commodity prices or further downward re-pricing for the stocks.
In its press release, Pioneer outlined its operating plan for 2016. The drilling and completion capital for the year is reduced to $1.85 billion, which represents significant outspending relative to pre-hedge cash flows.
Pioneer estimates that its 2016 oil production volumes are ~85% hedged in 2016, which means that the remaining 15% of the volumes will be sold at market prices.
Pioneer's decision to commit significant capital in 2016 to bringing new wells on production is difficult to rationalize in light of the current strip pricing. While it is obviously important for Pioneer to preserve operational capability for the upcycle, it is difficult to imagine that a positive return on capital can be achieved if flush production from the new wells is sold at current prices.
Notwithstanding the giant valuation gap, the view of the stock's risk/reward profile is not as straightforward as it might seem. Pioneer has been reporting strong well results and the outlook for the stock is obviously strongly dependent on one's view on the trajectory of commodity prices.
However, the value gap highlighted by the company reserve report raises significant concerns.
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Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment, tax, legal or any other advisory capacity. This is not an investment research report. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. The author explicitly disclaims any liability that may arise from the use of this material.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.