Richard Zeits

Oil & gas, commodities, long/short equity, research analyst
Richard Zeits
Oil & gas, commodities, long/short equity, research analyst
Contributor since: 2012
Hi Calculus,
I agree it would be nice to buy back equity, but I think WPX's greatest challenge is leverage. Stocks without debt are doing relatively well, stocks with high leverage are being carried out.
Frankly, the lack of a clear message that the proceeds will be used to reduced debt as much as possible is a concern, in my humble view.
Mr. Smurf,
I actually recognize the "dividend hypnosis" as a real factor and risk that needs to be taken into consideration. In COP's case, I would argue that the dividend factor has not been enormous - if compared to situations like LINN Energy, for example...
Somehow I have difficult time thinking of investors and sell-siders as a particularly naive bunch. A real conundrum...
There are many moving parts in the capex, as well as in the revenue line, associated with large projects coming online. And then there is deepwater, corporate, R&D, etc.
Goes back to the question, what kind of company COP is going to be two-three years from now.
I think "OPEC production talks" may indeed an inflated news line, at least of this moment. I posted several observations in my newsletter why this might be the case.
Walter Scott,
The answer to your question appears to be a function of what you view as "former levels" for oil. If it is $100, COP has tremendous leverage in its existing production. Unhedged, reasonably oily.
If your view is $50 per barrel, it's a different story.
I would also argue that one does not need dividend to be declared to do well if oil prices skyrocket.
Thank you for the update, most helpful. This would be great news for the stock.
Good points - however, if one cannot trust the company with money in the bank, what is the purpose of investing in that company first place? Let's not forget that every investor voluntarily gives cash "from the left pocket" when making the initial investment and has the opportunity to get the cash back (or whatever remains of it) if the investor believes that the trust has been lost. After all, the dividend decision is a rounding error relative to potential accretion or destruction that can be made to the "principal value." LINN is the case in point. Great distributions for a long time, but the outcome...
First, I think it still remains to be seen what COP's sustaining capital is. As I mentioned, one of the challenges is that low-decline production is being replaced with higher-decline production (hence the low reserve replacement metric despite the growing volumes).
Second, the issue is not whether COP will survive but what the potential price for the stock is - which is, in my view, a function of the market's common wisdom with regard to the oil price trajectory. The perception at the moment appears to be above the strip curve, if I judge by stock prices. Will this perception move lower or higher from here? How soon? How more sacrifices will COP and peers will have to make on the way?
I agree. However, sometimes views after the fact are essentially the same as before the fact. Conoco's outspending, vulnerable credit ratings and unsustainable cash balance in the low-price commodity price environment have been very visible for some time. May I refer you to my earlier notes:
I think your comment is right on target. I think that the business model remains to be defined.
The challenge is of course that the view on long-term oil prices is a significant driver.
In the meantime, the company's cost structure has remained quite high (the "mini-major" legacy) whereas the ability to be the operator of mega-projects is limited by the relatively small size and stretched footprint.
So is Conoco a Continental Resources or a Royal Dutch Shell? It is difficult to be the latter without scaling up and re-focusing (and it is not obvious if this is the model of prosperity from a return on investment perspective). It is difficult to be the former without scaling down and substantially reducing costs and improving operational performance.
You wrote: "The company's hedging and integrated business model certainly softens the blow."
Are you sure about hedging? How much of XOM's production is hedged?
You also wrote: "So I will give Exxon a 25% differential between crude difference and the company's earnings difference. This gives us a 30.8% drop in earnings QoQ for Exxon's Q1 2016."
Is this the way the relationship works? Given that the revenue line moves a lot quicker than the cost line, shouldn't one expect to see operating leverage? Have you actually tried to put together a quick model in excel?
Hi Benni,
Thank you for the comment. It is an interesting topic.
I will avoid the debate as it is difficult to generalize. Some operators may be making a margin on "flush" barrels at WTI price as low as $15. On the other hand, mature production, particularly if not supported by low-cost access to midstream, may not be covering cash costs even at $30 per barrel. In addition, one needs to add various externalities into the equation: continuous drilling requirements; the cost of laying down a rig or terminating service contracts; the cost of losing operating capability within the organization; minimum throughput commitments, etc. These externalities make production more resilient on the way down. By the same token, they raise the threshold on the way up.
Would you agree?
James -
The multiple is illustrative.
I would argue, however, that a meaningful portion of the SG&A is there to stay, even under a different management. Therefore, it is a "low-risk" deduct against cash flows and should be capitalized at a relatively high multiple (akin to what one would apply to bond coupons).
One could equally argue that a portion of the SG&A can be reduced and should probably be capitalized at a much lower multiple.
Another angle: the multiples that the market has been willing to pay for LINN's cash flows overall.
Even if this illustrative 10x multiple is high, my point was that corporate overheads and other potential deducts not captured by the PV-10 calculation need to be accounted for - they will certainly be accounted for when the banks will present their case, should a reorg process be initiated. At $50 per barrel, LINN's cash flow is very thin on a pre-hedge basis. At $40 per barrel, I suspect the cash flow is negative on a pre-hedge basis, in large part due to the heavy SG&A burden. SG&A does matter.
The assets obviously have value even in today's environment, even if cash flows are negative. However, an auction is the only way of proving that.
Terrific thoughts on macros. Thank you for sharing.
A very interesting point. I wonder if this is a way for unsecured bondholders to get a piece of the pie.
Thank you for the kind word. Thank you for reading.
I think the bonds have for a long time been trading in the distressed market where investors have a very keen sense of what is the likely outcome, so I would take clues from the bond prices at this point as a rough indicator.
As I said, vulture traders do not seem to think that another coupon is possible on LINN unsecureds. I tend to agree. Let's not forget that Chapter 11 does not have to be voluntary.
With regard to the DrillCo and AcquisitionCo deals, I have been wondering myself - how did those initiatives fit on the company's agenda at the time when financial distress was obvious and all management focus was needed to attempt a restructuring. Already then these deals appeared to be gimmicks, contributing to the company's $250 million per year SG&A line.
Great observations. Indeed, deep Utica appears to be a logical market for ceramics.
Obviously, there is a strong desire by operators to use sand as proppant -loadings are giant and the difference in cost is quite significant.
The intuition might suggest that sand would be a risky solution for this type of pressures. It is interesting that RRC's Sportsmans Club well lost volumes very rapidly (I wonder if the completion design had something to do with it). Only time will tell.
This is a very good point indeed. I agree.
Senior credit agreements typically explicitly prohibit this type of actions as by buying out unsecured or second lien notes LINN would effectively give money to junior lenders by taking money from the senior lenders. In situations like this, the borrower typically needs to receive consents from senior lenders for this type of action.
Given the environment, senior lenders are unlikely to give any further consents. (That's one of the reasons why the junior bonds are trading at essentially nothing.)
As I wrote on multiple occasions, early on LINN had the opportunity to offer its equity to unsecured noteholders as part of a comprehensive restructuring offer. The company could have also repaid some of its bank debt from cash flow instead of paying high distributions. Some options could have opened up as a result.
Thank you for the update. A great well indeed.
Raw Energy,
I saw that, not looking good at all... oh well...
Raw Energy,
I would argue that the strategy should work well through the cycle - drill and complete while costs are low and "slow back" volumes with the hope that prices recover. On the other hand, drill less when costs are high.
The problem, of course, one needs a strong balance sheet to be able to do something like that.
Raw materials are bauxite, manganese, dolomite, etc. Feedstocks are mixed and crushed into powder than go through a process that includes high-temperature sintering and cooling.
There are multiple competitors to CARBO, both China- and U.S.-based, most of which are not publicly traded.
lol wut,
I think it is important to take what you are saying in the context of the bigger picture of this cycle. Will the Bakken be "called upon" for supply in the near term?
If it will, then OAS's core acreage should be economic to develop. If it is, teh value of PDPs would probably also be higher.
So the real questions are: what is currently the "baseload supply" and what is the timing of the upcycle.
I believe that initially the purpose is to give Oasis a chance to develop this block that they view as very promising. Third volumes may not be a big factor at this point.
Hi DanielHolzman,
I think there are two factors that impact my view here.
First, Chevron is likely to have the following priority order in terms of sacrifices. Capex for new projects will be (and has been) cut first. Assets will go on the auction block second. Credit rating will be sacrificed to a certain degree, if unavoidable. Dividend will be among the last steps. I would not call my view cheerful - I am not trying to advise the company as to what the best course of action would be, I am just trying to figure out what would the most likely course of actual events be.
Can one draw an analogy with KMI or SDRL? I would say that a better one would probably be LINN (and i have written a tremendous amount on how critical it was for LINN to cut its distributions early on). I think Chevron is very far from looking like LINN in terms of leverage and asset profile, however.
The second important element is the trajectory and timing of oil prices which are not static.
Hi Gary,
A very keen observation.
Are you using the cash flow sensitivity on a quarterly basis or an annual basis? My estimate is for the quarter.
I am using 160-165 million barrels of liquids production in Q1 2016, including equity interest in affiliates' volumes. Some volumes are protected with PSA-style mechanisms. Some volumes are not oil but NGLs which may not have a 1:1 sensitivity to oil prices. I am also factoring in the decline trend in operating costs and cash tax impact.
The price decline in WTI from Q4 to Q3 is ~$8.75 per barrel. The decline in Brent is actually slightly wider. So, with some (admittedly not perfectly informed) assumptions, I come up with a change in cash flow of slightly below $1 billion per quarter. If your number is for a full year, we are actually not too far apart.
Hi 21793061,
I do not necessarily take a view on the strip price here (as I have to reserve that discussion for the OIL ANALYTIC subscription).
But I totally agree with your point that many things depend on whether the strip is viewed as the base case.
I agree, hedges would cap the upside relative to less hedged producers.
But it is a luxury problem to choose from - small upside or big upside.
The trade-off is some peace of mind with regard to downside.