Abraxas Petroleum: Expect Improving Per Barrel Margins

| About: Abraxas Petroleum (AXAS)

Summary

Abraxas should see improving margins per BOE even if oil and gas prices stagnate.

Lower lease operating expense, higher oil percentage and narrowing differentials could increase margins by over $4 per BOE without commodity price changes.

Continued outperformance of new wells versus type curve could add upside to Abraxas's production expectations.

Earlier equity raise should cover 2017 capital outspend versus cash flow despite lower oil prices.

Abraxas appears to remain slightly undervalued even if long-term oil price expectations are reduced to $50 instead.

Abraxas Petroleum's (AXAS) Q4 2016 results looked quite solid and its outlook for 2017 looks strong. It is set for substantial production growth, and its margins per BOE should also increase significantly even without an increase in oil prices. The increased margins are driven by a combination of a higher oil percentage, decreasing lease operating expense and narrowing differentials. As a result, Abraxas could potentially increase its margins by over $4 per BOE with flat oil and gas prices.

Q4 2016 Results

Q4 2016 production averaged 7,955 BOEPD, which was in-line with Abraxas's guidance and pretty close to my expectation that Abraxas could hit 8,000+ BOEPD in Q4. In addition to the production growth (up from 5,585 BOEPD in the first three quarters), Abraxas's oil percentage is creeping up higher, rising from 60% in the first three quarters to 62% in Q4 2016. This trend is expected to continue, with 2017 guidance for 66% oil production. Abraxas's lease operating expense has also decreased significantly, dropping to $6.28 per BOE in Q4 2016 compared to $8.89 per BOE during the first three quarters of the year.

Overall, Abraxas looks set up for a strong 2017 (mostly in the latter part) as it completes a substantial number of new wells that should boost its exit rate production to over 9,500 BOEPD and allow it to average 8,200 BOEPD at its 2017 guidance midpoint. Abraxas mentioned that the recent outperformance of its Bakken and Delaware Basin wells versus type curve have not been baked into its production guidance.

Increasing Production Margins

Bakken/Three Forks production represented approximately 67% of Abraxas's 2016 production, but the Bakken only accounts for 38% of Abraxas's 2017 capital expenditure budget. Meanwhile, the Permian/Delaware Basin represented only 12% of Abraxas's 2016 production, but 38% of its 2017 capital expenditure budget. As a result, the Bakken is likely to account for a lower share of Abraxas's 2017 production, while the Delaware Basin increases in importance. The Delaware Basin has lower differentials, so Abraxas's average differential should decrease with this shift. As well, the Dakota Access Pipeline completion should help Abraxas's Bakken oil differential as well.

In addition, Abraxas's production in becoming more heavily oil-weighted, reaching 66% oil in 2017, up from 61% in 2016.

% Of Production

2016

2017

Oil

61%

66%

NGLs

16%

12%

Natural Gas

23%

22%

The combination of narrower differentials plus a larger mix of oil results in Abraxas's revenue increasing by nearly $3 per BOE even if there was no change in oil and gas prices. The following table shows estimated revenue and expenses at $50 oil and $3 gas using 2016's production mix and differentials and then 2017's production mix and differentials.

Per BOE

2016 Mix

2017

Revenue

$29.95

$32.80

Lease Operating Expense

$8.05

$6.50

Production Taxes

$2.88

$2.95

Production Margin

$19.02

$23.35

With lease operating expense potentially going down to $6.50 per BOE (guidance midpoint of $7.00, but I think that is a bit conservative given trends and the focus on lower cost production areas), Abraxas's production margin per BOE may increase by over $4 compared to 2016 with no change in oil and gas prices.

An Updated Look At 2017

Oil prices have gone down a bit since I last looked at Abraxas's expected 2017 results. At $50 oil and $3 natural gas now, Abraxas is expected to generate around $103 million in revenue. Abraxas's hedges (around 44% hedged on oil production) offset a decent amount of the decline in oil revenues though.

Units

Price Per Unit

Revenue ($ Million)

Oil (Barrels)

1,975,380

$44.00

$87

Natural Gas[Mcf]

3,950,760

$1.95

$8

NGL (Barrels)

359,160

$10

$4

Hedge Value

$4

Total

$103

As well, I think Abraxas's lease operating expenses will come in lower than the midpoint of its guidance, given that it lowered LOE to $6.28 per BOE in Q4 2016. Thus I have put that in at $6.50 per BOE in this estimate. As a result, Abraxas is expected to burn around $48 million in 2017 as it grows production, similar to my previous calculations at mid-$50s oil. Abraxas's previous equity offering is more than enough to pay for its 2017 capital program.

The decrease in oil prices has been offset by improved differential expectations, hedges, and reduced production taxes combined with the $0.50 per BOE reduction in lease operating expense expectations.

$ Million

Lease Operating Expense

$19

Production Tax

$9

Cash SG&A

$11

Interest Expense

$2

Capital Expenditures

$110

Total

$151

Conclusion

Abraxas should be able to deliver strong results in 2017 even if oil prices don't rebound from current levels, as its production margins per BOE should be over $4 better in 2017 than in 2016 in a $50 oil scenario for both years. It has made significant strides in reducing lease operating expenses and may be able to push that down into the $6 to $7 per BOE range in 2017. Abraxas's differentials are expected to narrow with the Dakota Access Pipeline completion plus an increase in Delaware Basin production. Abraxas also benefits from its partial oil hedges and its very low interest costs due to its minimal debt. I previously estimated Abraxas's value at around $2.40 to $2.90 per share with $55 long-term oil. This estimate would drop somewhat if long-term oil expectations are $50 instead, but would still be a bit higher than Abraxas's current share price at an estimate of $2.10 to $2.50 per share.

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Disclosure: I am/we are long AXAS,.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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