Back in early December, I did an instablog on California Resources (CRC), mentioning a small position and taking a wait and see attitude. With the stock under $6, the potential of $20 if oil would go back up to where it was came into view.
As oil continued to tank, CRC followed it down, and I started systematically adding to the position. At first, it was 100 shares every time it went down another 10 cents. Then it was a fixed position size, 70% of my normal, and buying another 100 shares every time I needed to bring the dollar amount up to the target size. Sort of an exercise, how many midgets can you cram into a Volkswagen.
That really isn't much fun, and I finally gave it up somewhere under $4 and let the last little bit of the bottom go by without adding. But I worked the average cost down to $5.23, from a $5.90 starting point.
So now we learn Soroban has taken up a 9.98% position. Predictably, and also driven by the increase in WTI, the shares made their way back up over $6. I sold a few hundred, at 10 cent intervals, and brought the position down to 100% of normal.
Now What?
Morningstar updated their analysis, and they now have a target of $17 on the shares, based on oil futures as they now stand and the assumption that eventually oil stabilizes somewhere between where it is now and where it was for several years before.
CRC has hedged their production for 6 months at $50 a barrel. They have a variable capex plan, to respond to the situation as it develops over time. Their financials provide enough information that you can project based on the prices of oil and natural gas. I sort of browsed it a bit and then I figured let's wait another quarter when we can see what their realized prices have been compared to the benchmarks.
There is quite a bit of debt here, a private placement, somehow I just couldn't seem to get the details. There is also a large credit line, by several of the big banks, with covenants. The thought does come up, the interest rate on the private placement was probably a little bit on the high side. But if a major oil company with a strong credit rating bought CRC and assumed the debt, it would be easy to trade publicly at a higher price than it originally commanded.
Major oil companies have a problem, to grow reserves in the face of ongoing production. Extensions will be more difficult than they have been recently, for the fact that economic feasibility is more difficult with the commodity priced at current levels. So there will be some motivated buyers out there.
Hedge funds are like a bunch of jackals, they're all over any opportunity for easy pickings. It wouldn't be surprising if Soroban had some company, soon enough. The most likely thing is that they will agitate for a sale of the business.
Perils of Pauline?
If the price of oil doesn't go back up, at some point cash flow will go negative and covenants will start to come into play, then there will be waivers to discuss and pay for, then things will get complicated. I don't think it will go that far.
Stay Right Size
After looking at this for a while, I plan to sell into any increase in price, so as to keep my position at normal size. There's nothing wrong with taking a few bucks off the table. I won't be selling covered calls, because there's always the possibility that it will gap up.