Continental Resources Cannot Grow At 25% With Oil At $65

| About: Continental Resources, (CLR)
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Summary

Richard Zeits leaves unanswered his own question of whether Continental can grow 25% with oil at $65.

Simply presenting company data without doing a cash flow analysis is not enough to prove a thesis.

If the premise is to maintain current production levels by being cash-flow neutral Continental fails to do so at $65 oil.

Richard Zeits is a reputable oil analyst, but somehow left open his own question as to whether Continental Resources (NYSE:CLR) can grow in a $65 oil environment. He took the company's headline statement and several slides from its investor presentation to restate Continental's case of high RORs at an oil price of $80 and suggested that, at $65, the company's new production would still be economically viable by using company supplied math.

Viability of production in my view is the ability of the company to produce a certain quantity of a product and generate positive cash flows while doing so. I will examine whether Continental can simply maintain its current production and stay cash-flow neutral at a price of $65 per barrel.

Here's Continental's cash flow statement for the past nine months:

Continental has been running around $1 billion cash flow negative for the first nine months of 2014 at an average realized oil price of $89.02.

Granted a large portion of capex will turn into production next year, however, there is empirical evidence using well decline rates to project what amount of capex is needed to sustain production for various tight oil plays. For Bakken, it's a bit higher and for SCOOP a bit lower, but approximately 65% of current year's capex is needed to maintain production at similar levels.

Bear in mind that lower 2015 capex will result in lower 2016 production, but as of right now I will focus on 2015. This assumption does not take into account the fact that completion costs will be lower next year and there will be a meaningful uplift from model type curves, as shown in Continental's presentation. A 20% cash flow increase due to better IP rates and lower completion costs lowers capex requirement down to around 50%.

So let us optimistically assume that CLR can achieve 185,000 BOE per day with oil representing 70% of the production, i.e. mix stays the same, with half of 2014 capex or $2.3 billion.

This is slide 22 from company's latest investor presentation. If oil averages $65 per barrel Continental will realize $55, whereas natural gas realization price will be $5.5 if Henry Hub averages $4 per mcf.

Here's what I get for cash inflows and outflows:

Cash inflow

Oil (OTCQB:BBLS)

Natural gas (NYSEMKT:MCF)

Volume (daily)

129,500

330,000

Volume (annual)

47,267,500

120,450,000

Price

$55

$5.50

Total

$2,599,712,500

$662,475,000

Total cash inflow: $3,262,187,500

Cash outflow

Volume BOE (annual)

Cost (per BOE)

Total

LOE

67,525,000

$5.75

$388,268,750

Production tax

$3,262,187,500

8%

$260,975,000

G&A

67,525,000

$2.50

$168,812,500

Interest Expense

$295,000,000

Total cash outflow: $1,113,056,250

Capex: $2,300,000,000

Net cash shortage: $(150,868,750)

Here's what would happen if Continental does go ahead with the proposed $4.6 billion capex budget in a $65 oil price environment and produces 26% more, which is the mid-point of the current guidance.

Cash inflow

Oil

Natural gas

Volume (daily)

163,000

415,000

Volume (annual)

59,495,000

151,475,000

Price

$55

$5.50

Total

$3,272,225,000

$833,112,500

Total: $4,105,337,500

Cash outflow

Volume BOE (annual)

Cost (per BOE)

Total

LOE

85,081,500

$5.75

$489,218,625

Production tax

$4,105,337,500

8%

$328,427,000

G&A

85,081,500

$2.50

$212,703,750

Interest Expense

$370,000,000

Interest expense is higher as cash shortfall would be covered by tapping into revolver completely and selling some assets as revolver is insufficient.

Total cash outflow: $1,400,349,375

Capex: 4,600,000,000

Net cash shortage: $(1,895,011,875)

I will go ahead and answer Mr. Zeits' question, Continental cannot sustainably grow its production 25% next year with oil at $65. Moreover, if CLR attempts to keep 2016 production levels inline with 2015 it would have to actually increase 2016 capex from 2015 levels and at $65 oil it will continue to be an exercise in futility in literary terms. In financial terms, it will result in continuous negative cash flows and eventual bankruptcy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.