Stock Performance: 2017 a mixed bag
The Forge River Research Permian Pure Play fourteen-stock Universe finished out 2017 strong with an average stock performance of +3.96% for the past four weeks, up 0.46% for the last week of the year.
Resolute Energy (NYSE:REN) up 4.8%, Lilis Energy (NYSEMKT:LLEX) up 4.3%, and Approach Resources (NASDAQ:AREX) up 3.9% were winners last week. While Rosehill Resources (NASDAQ:ROSE) down 5.2% and Ring Energy (NYSEMKT:REI) down 5.1% were the big losers.
In the past month, AREX is up 18.9% benefiting from significant insider buying activity (see our Insider Activity section for details). While in the past month, Rosehill Resources is down 12.5% (after announcing very expensive financing to fund acquisitions).
While our Permian Pure Play Stock Universe had a strong finish to 2017, on average it was up just 0.88% on average; significantly underperforming the overall market which increased 19.40% (based upon the SPDR S&P 500 Trust ETF (NYSEARCA:SPY)). 2017 was a mixed bag for our Permian Pure Play Stock Universe, with five stocks posting annual double-digit positive returns and five stocks posting annual double-digit negative returns.
See chart below for details of the stock performance of our Forge River Research Permian Pure Play fourteen-stock universe (note, RED is weekly underperformance and GREEN is weekly overperformance versus the SPDR S&P 500 Trust ETF).
Crude oil pricing ends week at multi-year highs
West Texas Intermediate (WTI) crude oil price ended the week at $60.41 per barrel, at the highest levels since June 2015. WTI crude oil prices increased $2.01 (or 3.44%) from the prior week close. WTI crude oil prices are up 12.47% in 2017. Brent was up 2.81% for the week closing at $66.87.
WTI crude oil moved into deeper backwardation with M3, M6, and Jan. 2019 trading at ($0.32), ($0.84), and ($2.75), respectively.
The Brent-WTI spread ended the week at $6.45. The increase in U.S. crude oil production in Texas and pipelines bringing crude oil from other areas is putting downward pressure on the WTI crude price. It is hard to imagine how high the spread would be if not for record America crude oil exports.
2017 Permian basin oil production breaks 44-year old record
The Energy Information Administration (EIA) December 18, 2018, Drilling Productivity Report showed estimated Permian basin production for December 2017 at 2,726,216 barrels of oil per day, up 28.7% from December 2016.
The Permian basin will break a 44-year-old oil production record of 790 million barrels set in 1973. Using EIA’s Drilling Productivity Report monthly figures, we estimate the Permian basin will produce approximately 885 million barrels of oil in 2017.
American oil exports continue to reach new highs
American oil exports are at near 2017 highs, averaging 1.51 million barrels per day for the past 13 weeks, up more than three-fold since the beginning of 2017 and 317% from the year-ago 13-week period.
With Permian basin and American oil production reaching new all-time high levels, we believe significant and growing U.S. exports are here to stay. Permian basin light tight crude oil will continue to be supplied at rates far greater than domestic refinery demand for high API gravity crude oil stocks, driving exports and sustaining the Brent-WTI spread.
The EIA believes that the continued growth in crude oil production from the Permian basin in 2018 will result in a $4.00 Brent-WTI spread (EIA Short-Term Energy Outlook, December 2017). We believe that the EIA’s spread forecast may prove conservative, but infrastructure constraints and exports may hold Brent-WTI spread to $4.00 after all. As new crude oil transport and port infrastructure comes online in 2018 and 2019, America crude oil exports should continue to achieve new record levels.
China exports an important and developing story
We estimate that America has exported 63.484 million barrels of crude oil to China in the first 10 months of 2017 versus 7.973 million barrels of crude oil exports to China for all of 2016. Importantly, the growth has been accelerating, with an annualized 163.520 million barrels of U.S. crude oil exports to China in the month of October 2017.
Will service cost increases bite into profit growth potential in 2018
With increased drilling activity in the Permian, oil field service costs have increased. Current incremental service contracting costs are now reflecting constrained markets for additional rigs, rig crews, and completion fleets/crews. 3Q17 management earnings conference calls by our Permian Pure Play companies discussed service cost increases and a recent Barclays survey provides strong further evidence with 51% of respondents expecting rising oil field costs would erase at least 75% of efficiency gains shale companies had fought hard to earn since the 2014 downturn in oil prices.
We believe services and takeaway constraints are playing a role in the massive growth in Permian basin drilled but uncompleted (DUC) wells. We wrote extensively about our thoughts on the growth in the number of DUCs, which have increased 112% over the past year to a record 2,613 wells in our article “Permian Basin DUC Wells Up 112% Y/Y, Backlog Grows To 2,613 DUC Wells.”
In addition, Permian rig count growth has been relatively flat over the past several months (see our Permian Basin Rig Count section below). If crude oil prices remain above $55, we would expect the Permian basin rig count to rise, but will have to see if caution or completion backlogs and constraints hold off additions.
Company-Specific News within Our Permian Pure-Play Universe
Most of the companies in our Permian Pure Play Stock Universe continued to be quiet during the holiday season.
AREX stock ended 2017 at $2.96, down 11.6% (with a 52-week range of $1.93-3.695).
AREX’s recent impressive stock performance continued with a 3.90% gain this week and an 18.90% gain in the past four weeks. We believe insider buying activity during the week (see the Insider Activity section below for more information on the week’s buying) and sustained for the month was the primary driver (along with the high short interest position) of optimism and the share price gains.
In a December 29, 2017, filing with the Securities and Exchange Commission (SEC), the Wilks Brothers reported ownership of 44,089,713 shares of AREX common stock, representing approximately 46.86% (ownership limited to no greater than 48.61% per a January 27, 2017, agreement, leaving a potential 1,646,507 shares available to purchases) of issued and outstanding shares of common stock, based on 94,086,131 shares of common stock outstanding as of December 1, 2017.
In the month of December, the Wilks Brothers reported the following purchases of 2.16 million shares of common stock:
On December 21, 2017, AREX filed with the SEC that it had entered into the fourth amendment to its Amended and Restated Credit Agreement originally dated as of May 7, 2014, with JPMorgan Chase Bank, N.A., as the Administrative Agent, and each of its Lenders.
We believe that AREX’s disclosures provide a very clear understanding of the impacts of the Fourth Amendment:
- Extends the maturity date of its credit agreement from May 7, 2019, to May 7, 2020;
- reaffirms the borrowing base at $325 million;
- revises AREX’s minimum permitted ratio of EBITDAX to consolidated cash interest expense to: I.) 1.50 to 1.00 as of the last day of any fiscal quarter through December 31, 2017, ii.) thereafter 1.75 to 1.00 as of the last day of any fiscal quarter through December 31, 2018, iii.) thereafter 2.25 to 1.00 as of the last day of any fiscal quarter through December 31, 2019, and iv.) 2.50 to 1.00 as of the last day of any fiscal quarter thereafter;
- adds a maximum permitted ratio of total debt to EBITDAX of i.) 5.00 to 1.00, as of the last day of any fiscal quarter from March 31, 2019, through June 30, 2019, ii.) thereafter 4.75 to 1.00 as of the last day of any fiscal quarter through December 31, 2019, and iii.) 4.00 to 1.00 as of the last day of any fiscal quarter thereafter;
- requires unanimous Lender approval to waive or amend the maximum permitted ratio of total debt to EBITDAX with respect to the fiscal quarter ending March 31, 2019;
- increases the interest rate margin applicable to loans by 50 basis points;
- increases the minimum percentage of mortgaged proved oil and gas properties from 90% to 95%; and
- requires AREX to enter into hedges, not later than February 5, 2018, covering 50% of AREX’s reasonably anticipated 2018 oil and gas production.
On December 20, 2017, pursuant to the terms of the previously disclosed Stockholders' Agreement, dated as of January 27, 2017, by and among AREX, Wilks Brothers, LLC and SDW Investments, LLC, James H. Brandi, a member of AREX’s board of directors delivered AREX a conditional notice of resignation, effective December 31, 2017. The resignation will become effective December 31, 2017, in the event that Wilks Brothers, LLC and SDW Investments, LLC own 40% or more of the outstanding common stock of AREX as of such date. Pursuant to the Stockholders Agreement, the AREX board has approved, conditioned on the effectiveness of Mr. Brandi’s resignation on December 31, 2017, a reduction in size from eight members to seven members.
Centennial Resource Development (NASDAQ:CDEV)
CDEV stock ended 2017 at $19.80, up 0.4% (with a 52-week range of $14.10-22.11). CDEV showed some weakness to end the 2017, down 3.9% over the past four weeks.
On December 24, 2017, Seeking Alpha contributor Gary Bourgeault published an article titled “Centennial Resource Development's Output Will Soar Over Next 3 Years.” The article focuses on Chairman and CEO Mark Papa’s comments made during CDEV’s 3Q17 conference call that the company “will continue on a path towards 60,000 barrels of oil a day in 2020, which is a highest four year oil growth CAGR of any E&P.”
While CDEV’s growth rates will be impressive we will continue to focus on its ability to generate positive free cash flows and the extent to which growth helps CDEV achieve this benchmark.
Mr. Bourgeault briefly discusses the impact of the tax reform act President Trump signed into law on December 22, 2017, on CDEV. We believe a couple of points not covered in the article are important.
First, the corporate tax rate will be reduced from 35% to 21% effective January 1, 2018. We expect CDEV’s net income to be approximately $120 million (in a $55 crude oil and $3 gas price environment) in 2018, so the savings would be about $16.8 million - we estimate this at about 2.2% of 2018 capital expenditures.
Second, Mr. Bourgeault states: "the company did say in terms of cash flow, that it would be likely to outspend it during the period of increasing production growth. The tax cut could possibly change that outcome." We have simply one word, "no."
All other things held constant, any tax savings would not even come close to denting, never mind overcoming the negative free cash flow CDEV will burn through over the period Mr. Bourgeault discusses - again this is in the ceteris paribus $55 crude oil, $3 gas environment. In 3Q17, CDEV’s negative free cash flow was $112.2 million, while we expect some economies of scale; we expect 2018 negative free cash flow to be in excess of $300 million.
Third, oil and natural gas prices will be the primary driver of CDEV’s cash flow fortunes in 2018 and beyond. The tax cut will help immediately (CDEV does not have any net operating loss carry-forwards like some other Permian E&Ps) and the savings will add up, but the lever that matters is pricing.
Finally, it is important to note that CDEV is less hedged than most of the rest of our Permian Pure Play Stock Universe and should benefit significantly from the recent increases in oil prices.
Callon Petroleum (NYSE:CPE)
CPE stock ended 2017 at $12.15, down 20.9% (with a 52-week range of $9.34-16.32). On the bright side of a brutal year for common stock shareholders, shares of CPE have gone up 5.7% over the past four weeks.
Concho Resources (NYSE:CXO)
CXO stock ended 2017 at $150.22, up 13.3% (with a 52-week range of $106.73-155.05). CXO finished 2017 strong, with the common stock price up 6.2% in the past four weeks.
Energen Corporation (NYSE:EGN)
EGN stock ended 2017 at $57.57, down 0.2% (with a 52-week range of $46.16-60.21).
EGN was quiet for the week other than an insider share purchase (see the Insider Activity section below for more information).
Diamondback Energy (NASDAQ:FANG)
FANG stock ended 2017 at $126.25, up 24.9% (with a 52-week range of $82.77-127.45).
FANG continues to see sustained insider selling activity with another $1.25 million in stock sold week, after last week’s sales of $1.86 million (see the Insider Activity section below for more information). Despite the recent sales, FANG ended 2017 on a tear with the stock gaining 13.8% in the past four weeks.
On December 25, 2017, a note was written by Seeking Alpha contributor Williams Equity Research titled “Is Diamondback Really The Best Pure-Play In The Permian?” Getting past the regrettable second bullet, which “for context” incorrectly claims the stock doubles every 18 months with a compound annual growth rate (CAGR); the article is a very good read and makes several strong points as to the “why” of FANG’s common stock continues to outperform its peers.
Most notable positive point made by Williams Equity Research to us is FANG’s impressive cash flow margins, which YTD 3Q17 are 79.2%, which we note is 1,380 basis points better than our Permian Pure Play Stock Universe average of 65.4% (see our Selected Valuation Metrics Section below for more comparative analysis on FANG below).
Other excellent points are FANG’s low cost structure, its ownership interest in Viper Energy Partners LP (NASDAQ:VNOM), and its strong balance sheet position.
Jagged Peak Energy (NYSE:JAG)
JAG stock ended 2017 at $15.78, up 10.1% (with a 52-week range of $10.96-16.55).
JAG has insider sales during the week (see the Insider Activity section below for more information).
LLEX stock ended 2017 at $5.11, up 16.7% (with a 52-week range of $2.90-5.69).
Parsley Energy (NYSE:PE)
PE stock ended 2017 at $29.44, down 16.5% (with a 52-week range of $22.98-37.72). On the good news front, PE ended the year strong up 7.3% over the past four weeks.
REI stock ended 2017 at $13.90, up 7.0% (with a 52-week range of $9.22-15.13). REI performed poorly to end the year, down 5.1% in the week following its Annual Meeting of Shareholders.
REI saw some insider activity during the week (see the Insider Activity section below for more information).
REN stock ended 2017 at $31.44, down a terrible 23.6% (with a 52-week range of $23.64-49.14).
REN saw some insider selling activity during the week (see the Insider Activity section below for more information).
ROSE stock ended 2017 at $7.86, down 24.3% (with a 52-week range of $5.52-11.69). ROSE ended the year horribly, with the stock down 5.2% for the week and down 12.5% for the past four weeks. The poor performance came following came after the announcement of an acquisition and financing transaction.
We covered the details of the initial acquisition and financing transaction and our reaction to the news in our article published on December 15, 2017, titled: “Rosehill Resources Guides To 2018 Cash Burn Of $200M+, Completes Delaware Basin Purchase.”
Finally, ROSE has seen very active insider selling activity in the past few weeks, including the continued sales by one of its largest shareholders, Geode Diversified Fund (see the Insider Activity section below for more information).
RSP Permian (NYSE:RSPP)
RSPP stock ended 2017 at $40.68, down 8.8% (with a 52-week range of $28.76-46.92). RSPP stock finished the year on a tear up 7.8% in the final four weeks.
Viper Energy Partners (VNOM)
VNOM stock ended 2017 at $23.33, up 45.8% (with a 52-week range of $14.76-24.00).
This week we saw some insider selling activity AREX, FANG, JAG, REI, REN, and ROSE. See details in the chart below. Highlights of the week were the continued substantial AREX insider buying. The insider selling at FANG continues and in ROSE another conversion that will likely lead to continued sustained selling by a major shareholder.
Net insider activity for the week were sales of $4.13 million ($0.0 million in insider buys and $4.13 million in insider sales).
Permian Basin Rig Count
On Friday, December 29, 2017, Baker Hughes reported that the Permian Basin oil rig count was unchanged from the prior week at 398. Total U.S. oil rigs total 747, no change from the prior week, with the Permian Basin accounting for 53.28% of the total.
In a useless, but interesting fact, for the 361 consecutive weeks (since 2/4/11) Baker Hughes has been reporting oil rig counts by basin; never have both the Permian basin and overall rig count had no change from prior week.
The number of Permian basin oil rigs has grown 50.8% since last year’s 264 rigs reported on December 30, 2016. Over the same time period, total U.S. oil rig count has grown 42.3% and all other basins (excluding the Permian) have grown 33.7%.
Selected Valuation Metrics
Forge River Research’s Permian Pure Play universe of fourteen stocks saw an average 0.46% increase in share price this week. The average run-rate 3Q17 EV/EBITDAX for our stock universe remained unchanged at 13.8x. However, with oil prices rising recently and higher expected production levels, we expect EBITDA levels to increase substantially in 4Q17 that should lower EV/EBITDAX valuations.
Permian Basin Mergers and Acquisition (M&A)
All was quiet on the Permian Basin merger and acquisition front.
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