Whiting Petroleum (NYSE:WLL) presented at the Bank of America Merrill Lynch Global Energy Conference ("BAML Conference") on Thursday, November 17, and the presentation touched on many topics. One, in particular, piqued our interest. We've known for a while now that Whiting has been preparing its two natural gas processing plants in North Dakota for sale, the Belfield plant in the Pronghorn field and the Robinson Lake plant in the Spanish field. The Robinson Lake plant has a 130 mmcf/d capacity, whereas the Belfield plant has a 30 mmcf/d capacity.
Whiting has a 50% interest in each of the plants, having sold the other half in Robinson Lake in 2009 and Belfield in 2012.
Lo and behold, four days later, Whiting announces the sale of the plants for $700 million to an affiliate of Tesoro Logistics Rockies, LLC (NYSE:TLLP). Whiting's share of the sales proceeds will total $375 million.
Last year, Oppenheimer estimated that together the two plants generated close to $50 million in EBITDA, and at the BAML Conference, Michael Stevens, Whiting CFO, stated that a fair multiple would be 8x-10x. As such, we believe the likely increase in value was due to Whiting's efforts to reconfigure its contracts with third-party producers.
Recently, the company renegotiated the fees for third-party producers that pipe gas into the two gas plants, converting the contracts from a percentage of net proceeds model (i.e., 25% of net) to a flat fee of $1.55-1.65 per mcf ($2.00 per mcf for the Belfield plant).
We surmise the new methodology sets a healthier revenue floor for the facilities, while providing price certainty for upstream companies that use the facility. Given the volatility of natural gas and NGL prices, this amendment reduces the plants' direct exposure to commodity prices (albeit commodity prices may still affect the total volumes producers send to the plant). On balance, the change increased the value of the plant today and, in turn, Whiting's ultimate sales price.
The sale of the plants will increase Whiting's lease operating expenses ("LOE") because the company now becomes a customer of the plants' services, likely under the same flat fee terms it has negotiated with other third parties. Whiting also loses the 25% net proceeds it currently receives from processing the inputs of third-party producers. How much has yet to be determined, and we'll know more as the company discloses additional information. For now, it's important to understand what it plans to do with the proceeds.
Paying off October 2018 Senior Subordinated Notes
At the BAML Conference, Whiting revealed that it planned to use the proceeds to pay off the 2018 Senior Subordinated Notes ("2018 Notes") that were issued in September 2010. These notes mature on October 2018 and yield 6.5%. A portion of the note has already been converted to equity, and a remaining $26 million will likely be converted.
Debt @ 3/31/16
Post-exchange, $275 million of the 2018 Notes will be outstanding. At 6.5%, the interest expense for 2017 will be approximately $18 million. Paying off the 2018 Notes early should reduce interest expense by the same amount per year.
Repaying the 2018 Note will relieve some of the pressure on the company's bond covenants. Whiting's bond covenants require that the company maintain a greater than 2 to 1 ratio of consolidated cash flows to fixed charges (interest expense). As of September 30, 2016, this ratio stood at 2.67 to 1 and should deteriorate further, because commodity prices have been weaker in 2016 than 2015. We believe the ratio will decline to 2.5:1 when Q4 2016 cash flows replace Q4 2015 cash flows for purposes of computation. Consequently, repaying the 2018 Notes early will reduce fixed charges by $18 million, or provide $36 million of EBITDA cushion (i.e., 2x interest expense), should commodity prices weaken further in 2017.
Ultimately, we'll be able to better judge the impact of the sale once the company provides additional details as to the LOE impact. Meanwhile, we're anticipating Whiting's Q4 2016 earnings to remain depressed, but are optimistic that OPEC can come to an agreement on November 30th to bolster oil prices as we look forward to 2017.
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Disclosure: I am/we are long WLL.
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.