Sanchez Energy Demonstrates Solid Q2 2016 Production Results

| About: Sanchez Energy (SN)

Summary

Sanchez Energy's production continues to exceed guidance and only modestly declined quarter-over-quarter. Full year production could end up at 55,000+ BOEPD.

Oil had a slight uptick as a percentage of total production, in contrast to previous quarters where oil production typically kept declining as a percentage.

NGL pricing appears to have returned to 2015 levels, modestly benefiting Sanchez in Q2.

Due to hedges on oil and natural gas, NGLs have the most impact on Sanchez's financials in 2016 since they are unhedged.

In 2017, oil becomes very important due to the lack of hedges, while NGLs still have secondary importance as the new processing plant increases yields.

Sanchez Energy (NYSE:SN) reported Q2 2016 production results that demonstrate that it is able to keep production declines to a modest level with its current capital expenditure budget. Sanchez's previous guidance indicated some steep production declines, but Sanchez's production only fell by 1.1% quarter-over-quarter. Another positive is that Sanchez's oil production slightly increased as a percentage of total production, stopping a trend in which Sanchez delivered strong production numbers fueled by increasing percentages of lower value products.

Going forward in 2016, Sanchez will be mostly affected by changes in NGL prices since it is essentially fully hedged on oil and mostly hedged on natural gas for the year. NGLs are also expected to increase in importance when the Raptor processing plant becomes operational in early 2017.

Q2 2016 Production Details

Sanchez Energy's production fell 1.1% from Q1 2016 to Q2 2016, with Q2 2016 production coming in at 55,898 BOEPD. This exceeded the high end Sanchez's production guidance of 50,000 BOEPD to 52,000 BOEPD for the quarter by 7.5%. However, I've noted before that Sanchez appears to issue conservative guidance, so the magnitude of the production beat doesn't surprise me. My default model already assumed 55,000 BOEPD production in 2016 for Sanchez, well above its full year guidance for 48,000 BOEPD to 52,000 BOEPD.

One positive from Sanchez Energy's Q2 2016 production numbers is that oil production didn't fall very much in terms of absolute numbers, and actually increased as a percentage of total production. Average daily oil production fell 0.3% compared to Q1 2016, while increasing from 31.9% to 32.1% as a percentage of total production.

Most of the production decline came from NGLs, which fell 10.1% quarter-over-quarter, while natural gas production increased by 6.5% quarter-over-quarter. Sanchez is probably still getting a slightly higher price for natural gas than for NGLs, so the effect of the 1.1% production decline on revenues is probably closer to 0.6%.

Pricing Of NGLs

Figuring out realized pricing for NGLs is a bit trickier than it is for oil and natural gas. The reference prices of oil and natural gas are widely published and each company's differential to those prices is relatively stable from quarter to quarter. On the other hand, there are many different types of NGLs (such as ethane and propane) with varying values. Each company has a different mix of the various NGL components, but that mix percentage is usually not published. Hence, the best we can do is look at the Mont Belvieu composite price for NGLs and estimate a company's realized price for NGLs based on that composite price.

The EIA mentions that the composite price is "derived from daily Bloomberg spot price data for natural gas liquids at Mont Belvieu, Texas, weighted by gas processing plant production volumes of each product as reported". The composition of the composite barrel can therefore change, and the relation of a company's realized price versus that composite barrel price may also change depending on the company's NGL production mix compared to the composite barrel, and how the prices of the various components change. For example, if a company's production has a higher than average percentage of propane, and propane prices increase more than the other components of the composite barrel, it is likely that the company's realized price for NGLs will increase relative to the price of the composite barrel.

I've put together a table showing the Mont Belvieu composite price per MMBtu and Sanchez Energy's realized price per barrel of NGLs during the last five quarters. The differing measurements do not matter since we are just looking at relative pricing.

Q1 2015

Q2 2015

Q3 2015

Q4 2015

Q1 2016

Mont Belvieu Composite

$5.43

$5.20

$4.68

$4.63

$4.02

Sanchez's Realized NGL Pricing

$12.36

$12.06

$11.30

$12.31

$8.91

Relative Multiple

2.28

2.32

2.41

2.66

2.22

Click to enlarge

I estimate that the Mont Belvieu composite price for Q2 2016 was a bit above $5 per MMBtu. That means that Sanchez Energy probably realized close to $12 per barrel for its NGL production during Q2 2016, close to the prices in 2015, and significantly improved from Q1 2016.

Q2 2016 Financial Results

Sanchez's Q2 financial results should be slightly improved from Q1 2016. Oil, natural gas and NGL prices all increased during Q2. Sanchez is heavily hedged for 2016, so the effect of the increased prices is muted though, especially after factoring in the commensurate increase production taxes.

Sanchez is around 100% hedged on oil and 76% hedged on natural gas for Q2 2016, so it doesn't benefit much from the increases in those prices. However, Sanchez doesn't have NGL hedges, so it will fully benefit from the increase in NGL prices. Overall the net benefit to Sanchez appears to be around a few million dollars.

Conclusion

Sanchez Energy's production results continue to be solid, with the slight increase in oil production as a percentage of the production mix being a positive for the quarter. During the rest of 2016, NGL prices are probably the most important to Sanchez's financials and that will also be fairly important in 2017 due to the lack of NGL hedges and increased yields from the Raptor processing plant. Oil doesn't affect Sanchez's financial results much during 2016 since it is essentially 100% hedged. Lower oil prices would actually slightly benefit Sanchez financially due to lower production taxes, although the effect of that isn't large enough for Sanchez to actually want oil prices to collapse. In 2017, oil becomes extremely important to Sanchez though as it currently has no oil hedges for that year. Natural gas is over 50% hedged in 2017, so it would be the least important of the three for Sanchez's financials. I am now neutral on Sanchez since its share price has come down to around my estimated fair value range.

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