Laredo Petroleum (NYSE:LPI) reported its Q4-2015 and year-end operating results and a couple of things stood out for me in the press release and later during the conference call that I wanted to relay to my readers in this article.
1) PV-10 of company's proved reserves is now less than company's total debt, however LPI owns 49% of the Medallion pipeline, $280 million of hedges are not part of the reserves calculation, and PUD have been "underbooked" according to management due to changes in methodology, thus for now LPI seems fine.
However, should strip prices average below $50 in 2016 the value of properties may take another dive lower at the end of the year, whereas debt is expected to increase because company's 2016 capex is higher than expected operating cash flows. A year from now hedges will also have significantly lower value, rendering LPI's equity negative.
2) Let's take a look at operating cash flows for a moment. LPI is well-hedged in 2016 with 85-90% of expected oil production having a price floor of $70.84 per barrel. That's a nice position for any oil company to be in yet LPI will not be able to generate free cash flow in 2016 even when selling its oil at such high prices. The CEO states that company's drilling inventory of best locations provides a 12% return at current strip, yet the company is cash-flow negative at $70 per barrel. Somehow, I cannot reconcile those two facts together.
Let me point out that LPI will spend $345 million on capex, yet production will decrease around 4-6% from 2015 levels. In essence, $345 million is not enough to maintain current output, which is being sold at slightly less than $65 per barrel at the wellhead. When hedges run out how is the company planning on keeping output steady with oil at $25 per barrel at the wellhead? Let's assume prices move higher and WTI trades at $50-55 per barrel in late 2016. LPI would still be cash-flow negative and have a decreasing production profile.
3) Management stated on the conference call that Midland Basin horizontal wells have a "dramatic" first-year decline rate of 75%. That's an impressive decline, moreover, in the subsequent years gas content increases, making the scale of oil decline even stronger. An operator choosing to flush $6 million down that well must produce north of 250k barrels of oil (net of royalties) over the initial 12 month period to justify such an expenditure at wellhead prices around $30 per barrel. LPI mentioned its wells are exceeding 1.1 MBOE type curves, but obviously even such a great well performance cannot keep the company cash-flow positive.
Unless prices improve north of $60 per barrel over the next twelve months, LPI shareholders and unsecured bondholders may end up with very little of their original investment. Unsecured bonds are already trading around 58 cents on the dollar indicating potential financial stress down the road.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.