Whiting Petroleum Showing Some Signs Of Improved Profitability Prospects, Given Higher Oil Price

Summary

• Whiting reported very deep operating losses for the whole of 2017, despite the higher oil price compared with 2016.
• Looking at its own EUR estimates and well production curves, one would have expected a different financial outcome, as well as better prospects for the future.
• I prefer to look at CAPEX as a percentage of expected revenue as a way to asses the approximate comparative acreage quality currently being drilled, therefore profitability prospects.
• Looking at CAPEX to revenue prospects for 2018, Whiting may have a chance to report some positive quarters, potentially giving its stock a boost.

While the shale story has once again turned towards the return of spectacular production gains when it comes to the financial performance of individual companies, the story is not necessarily as bright as one would be led to believe. I covered recently Sanchez Energy (SN), which I temporarily owned and sold in late December, as I correctly figured that it would be a last chance to sell at break even, before the stock continues its down-trend, even as oil prices continue to improve. I also covered Chesapeake (CHK), which is stuck with a lot of debt and few viable ways to get rid of it, in the absence of oil and gas prices going much higher. With most such struggling shale producers, it is mostly about the acreage they are operating in, which is less than ideal, compared with those industry peers which are actually able to break even or even turn a profit. Whiting Petroleum (WLL) is definitely not looking like it can thrive or even survive in the longer term in current oil price conditions, given its past financial performance. All the stories of shale resilience seem very misplaced when looking at the operating results of companies such as this one. There are however some signs that at the very least for a little while, it may be able to put in some more positive quarterly results thanks in large part to higher oil prices.

Size of loss in 2017 staggering

For the whole of 2017, Whiting reported an operating loss of $1.24 billion on revenues of $1.48 billion. These results do not look much better compared with 2016, even though the average price of oil in 2017 was $51/barrel as opposed to $43/barrel in 2016. Even for the fourth quarter when the average price of WTI oil was around $55/barrel, it reported a significant loss on its operations. Looking forward, I don't believe that even the current oil price range which so far this year is well over $60/barrel will be enough to close the profitability gap. It may, however, lead to at least a few quarters where it might break even.

Looking at the main reasons for the loss, unlike Sanchez, which occasionally looks like it could perhaps break even if it would not have to pay those interest costs, as well as preferred share dividends, Whiting would not necessarily manage to do so within the current oil price environment. It managed to cut its interest costs in 2017 to just under $200 million, which works out to about 13% of total revenue. It was a great improvement compared with 2016 when interest on debt amounted to almost 47% of revenues. It is, nevertheless, still very high.

Impairment costs did play a very significant role in the magnitude of the loss that Whiting suffered for the year. that alone came to over $900 million. Even though it is a great sum, this too on its own is not solely responsible for the loss. Interest and impairment costs together still do not add up to the size of the loss it incurred for the year. This is therefore simply a story of not enough money coming out of the ground, given how much gets pilled into it. It basically comes down to acreage quality not being there, as is the case with most other shale producers that are currently struggling. This is something that investors as well as oil market analysts should in my view pay close attention to, because given the large number of shale producers that are currently struggling financially, we can interpret it as there being a lot of drilling in unprofitable acreage still taking place. What this means is that there will eventually be another collapse in production, similar to what we have seen in 2016, even if we will not revisit those oil prices, because contrary to popular belief, there are still many companies that are less than resilient within the current oil price environment. These companies have been reporting significant operating losses for many years now, meaning that they are already financially weakened.

Whiting's acreage quality

Over the years, I found that shale profitability variation among drillers comes down to a very simple to understand factor, namely acreage quality. Some companies may be sitting on mostly profitable acreage, some may be looking at a mixed bag, while others may be siting on mostly inferior drilling locations. When it comes to Whiting's acreage quality, it seems to me that one can get confused in regards to what exactly may be going on. Whiting claims that it is looking at drilling wells with an average EUR of about a million barrels of oil equivalent, which would obviously suggest that they are looking at a profitable operation. Well production curves they are presenting also suggest that they are drilling profitable wells.

Source: Whiting Petroleum.

The well production data that we see here would be indicative of Whiting more or less recovering its drilling costs from a typical well after only about 140 days of production, even if we were to assume its average oil-equivalent sale price of $35/barrel. It is reporting average well costs between $6.5-7.1 million, therefore there should be no reason for the financial losses we are seeing from this company. I found over the past few years that such company estimates have been a very poor indication of actual profitability prospects.

I personally prefer to look at CAPEX versus expected revenue, based on production outlook as an aproximate gauge in regards to what we should expect in terms of profitability. In this regard Whiting is estimating capital spending to be about $750 million for 2018, while production will average 128,000 b/d in oil equivalent. In order to estimate revenue for the year, I looked at the average realized price of its products, which was $40/barrel last year. I will assume that the average realized price will rise to $50/barrel this year, while production is estimated to be 9% higher compared with last year. In other words, revenue should be boosted 25% by the higher price of oil (assumed), as well as 9% due to higher production volumes. According to its Q4 report, total revenue came in at $1.48 billion for the whole of 2017. When adjusting for higher prices and higher production, we can estimate that this year total revenue should come in at about $2 billion. In other words, CAPEX will be about 38% of revenue.

As I pointed out last year in a series of articles that was partially meant to be a comparative study of shale companies, based on how much money goes into the ground in terms of capital spending, versus what is coming out, last year most shale companies were looking at a CAPEX to revenue rate of at least 40%. Companies like EOG (EOG) were among the few that I estimated back then to be able to keep their CAPEX as a percentage of revenue under 50%.

Source: SA.

Note: I included oil majors in the graph as a comparison to shale drillers.

Looking at what this meant in practice for a company like EOG, for 2017 it reported operating profits before taxes of over $660 million, on revenue of over $11 billion. In this respect Whiting is reaching the point of potential profitability, given that this year it seems that capital spending as a percentage of revenues will be slightly bellow the approximate levels that EOG operated with, which did produce a slight operating profit for them. We should remember however that there are many other factors which might lead to a different outcome from what one might expect solely based on this one metric.

Whiting does have a relatively high interest on debt burden that it still needs to contend with. Other operating costs may differ as well. We should also keep in mind the fact that while we tend to talk of EOG as a shale player, it is in fact not a pure shale company, which also makes a significant difference in my view. Having said that, it does seem like Whiting's prospects of at the very least putting in a few quarters with operating profits have increased dramatically, thanks in large part to better oil price prospects. It is by no means an indication of positive longer term prospects, because I do believe that it is currently drilling through some of its best acreage, leaving it with increasingly inferior prospects with every year that passes. It does mean, however, that in the event that we will see significantly higher oil and gas prices in coming years, it might have an opportunity to improve its financial situation, improving the prospects of the stock in the process.

Analyst’s 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.