Oasis Petroleum - No Hope For Growth

| About: Oasis Petroleum (OAS)

Summary

The company has $2.3 billion in long term debt, none of which is due until at least 2019.

Interest expense added more than $8 to each BOE produced.

Without hedging, many of the wells drilled have marginal profitability at best. So costs need to decrease.

The bank line was decreased for the third time to $1.15 billion and covenants have been added though the company remains in compliance.

The company may survive but there are better opportunities elsewhere.

Oasis Petroleum (NYSE:OAS) has made some mighty strides towards profitability, however, its debt may be too much to handle in the current environment. As such the company will be periodically heading to the cash trough as long as it can in whatever way it can to get by until either things get better or the company ends. This is not a good situation for shareholders, but it may be the only choice that the company has for the time being. While the company had the foresight to sell stock and raise some cash, not only might that move not be enough, but even if it is there may be better investment opportunities elsewhere.

At year end the company reported about $2.3 billion (click on the 10-K for 2016) in long term debt. $138 million and some letters of credit of that long term debt was on the bank line with a $1.15 billion borrowing base.

Source: Oasis Petroleum February, 2016, Investor Relations Presentation

With no long term debt due until 2019, the company has time to work out its problems, however, things are getting tight. The banks have cut back the revolving credit line every time they got a chance lately. The credit line is now less than half of what it was more than a year ago. Thank goodness it is relatively unused, however the cash balance is pretty low, even with the recent stock offering.

Interest expense was $150 million. When that is divided by the 2015 production of 18,424 MBOE, the interest expenses added $8.14 to the cost of every BOE produced. In a low commodity price environment like the current one, with only 70% of the oil hedged (and no gas and liquids hedging), that much interest expense can be a back breaker.

The company showed cash flow from operations of $360 million for the year, with a one time benefit of a decrease in accounts receivable of $108 million partially offset by a decrease in accounts payable of $72 million. This change was caused by decreasing commodity prices and probably will not recur again to the magnitude seen in 2015. The cash flow in the fourth quarter was only about $80 million, and can be expected to decrease more in the first quarter of 2016. The company hedges about 70% of its oil production and nothing else for the current year. While that is better than no hedging, the company is still very exposed to commodity price declines.

The company made a big deal about free cash flow in the slide above, however, if the cash flow from operations does not increase significantly, there is no way to pay back all that debt due in a few years. So the company may need to do some debt swaps (for new debt or common stock) while it can. Currently, it does not have the cash to grow its way out of its situation.

With the bank credit line having covenants against incurring more debt, the company decided to issue more stock in February, 2016. the money raised will most likely be used as part of the capital budget for the year. With the current lack of cash flow from operations, the company would either have to decrease the capital budget next year if low commodity prices persist or issue more stock. There is always the outside chance that operational improvements would allow for a far lower capital budget next year without issuing stock or increasing debt. Just don't hold your breath on that one. It appears the noose is slowly tightening and commodity prices don't appear to be much help now or in the future.

Source: Oasis Petroleum February, 2016, Investor Relations Presentation

The company produced about 85% oil for the fourth quarter of 2015. With the hedges, the wells drilled will be about half paid for by the end of the first year using the above figures and the latest production cost guidance. When the company talks about hedging 70% of its 85% (NYSEARCA:OIL) production, that is really only is only 60% of its total production. The low amount hedged will really affect payback. To offset that differentials have improved and there is far less flaring, however, that is peanuts compared with the exposure to oil price decreases (or at least it seems like it).

The company plans on switching to 100% sand to save about $500K per well and lower the well cost to about $6.5 million. But the big issue is that the hedging will decrease this year (and next year), and as shown in the lower right hand corner, these wells are marginal economically at current pricing. They are going to take more than two years to pay off, and that is not good in any pricing environment. Continued exposure (due to inadequate hedging) to the current pricing environment when combined with debt incurred at higher commodity prices is crippling and may be fatal in the long run.

Source: Oasis Petroleum February, 2016, Investor Relations Presentation

The company made good progress reducing many of its operating costs. Lease operating expense was actually $6.85 in the fourth quarter and it needs to drop it more, if only because that cost is one of the few costs that can still drop. The interest expense can only decrease by increasing production to spread the expense over more units or by paying down debt. If anything, the interest rate will likely increase in any refinancing deal. The company does not have the money to do any of those alternatives. The company shows its credit rating, but credit agencies are notoriously reactionary when it comes to lowering ratings. So the only choice management really has is to continue lowering operating costs to make room for less hedging next year. While that is an uphill battle, praying for higher commodity prices has not worked too well lately.

Oasis Petroleum 2015 FY Costs
2015
Lease Operating Expense 7.84
Marketing, Trans & Gathering 1.72
Production Taxes 3.78
Depreciation, Depletion, Amortization 26.34
General and Administrative Expenses 5.02
Interest Expenses 8.14
Total Expenses 52.84

Source: Oasis Petroleum 2015 10-K, Author Table

The biggest problem is that Oasis currently shows costs well in excess of current pricing. The hedges will help but they will not solve the problem. For great hedging programs see my articles on Antero Resources (NYSE:AR) and Memorial Production Partners (NASDAQ:MEMP). The hedging of Oasis is far less comprehensive than those two programs and investors are going to pay for it.

If the costs of the wells go down and the EUR's increase that will mean that depreciation will decrease going forward. But will depreciation drop until the interest expense is covered and the company becomes profitable?? That is highly unlikely. Depreciation is a mixture of past costs and current costs, and therefore changes slowly over time unless the activity level of the company increases dramatically. In the current case, the company activity level will decrease dramatically yet again, so the older higher cost wells will continue to predominate depreciation. However, if the company gets its costs for new wells down, then it should drill new wells that are profitable at these prices. The problem is that even if the costs decrease, it would need a lot of new low cost wells to offset the older higher cost wells and increase cash flow enough to get out of financial danger. Right now that is not a going proposition (without hedging), even from the company's own presentations, which is probably another reason for the stock offering. Equity cash does not have to be repaid and gives management time to lower the operating costs more.

So an investor has several choices. One is to stay invested in Oasis Petroleum and hope for commodity price increases or some superb operational improvements. Those are both possible but are probably long-shots. The other is to find companies that the investor can swap into until the current low price commodity environment relaxes a bit. Several low cost producers come to mind with fairly low debt. Murphy Oil (NYSE:MUR), Husky Oil (OTCPK:HUSKF),Granite Oil (OTCQX:GXOCF), Antero Resources, and Birchcliff Energy Ltd. (OTCPK:BIREF) all are motoring through the current industry conditions with debt that is very manageable. Oasis Petroleum's long term debt to cash flow from operations ratio was more than six-to-one. That ratio will probably increase in the first quarter which is getting pretty challenging to manage. None of the companies listed have ratios anywhere near that, and as a result are getting through the current environment in decent shape.

Short of a massive stock offering, Oasis has no hope for growth unless commodity prices double (roughly), and the wells that the company is drilling are marginal at best using current pricing without the hedges. That does not leave investors much of a future unless prices rise materially. But if prices do rise, the stocks of the other companies will also increase with the price rise and they do not have the risk of company failure that Oasis currently has. So that group should outperform Oasis Petroleum in the long run. Taking on a lot of debt during a period of high commodity pricing has its risks, and the is company is a poster child for those risks. The company bankers have issued a warning by cutting the credit line at every redetermination for some time now, now it is time for the stockholders to pay attention.

Disclaimer: I am not an investment advisor and this article is not an investment recommendation. Investors are urged to read all of the company's filings and press releases to determine for themselves if this company fits their investment profile.

Disclosure: I am/we are long GXOCF.

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.