This report updates with 2018 Q1 results my initial report on the U.S. shale Eagle Ford Shale E&Ps. For definitions of terms and explanations of methodology, please reference the initial report published on 5/8/2018 US Shale: NAV Analysis of Eagle Ford Shale E&Ps covering Carrizo Oil and Gas (NASDAQ:CRZO), SM Energy (NYSE:SM), EP Energy (NYSE:EPE), Sanchez Energy (NYSE:SN) and Penn Virginia (NASDAQ:PVAC). Subsequently, I moved SM to the Permian Basin – Midland Basin E&Ps group.
Here is a summary of the results I will describe in this report.
Since my last report on the Eagle Ford shale group, there have been no material events or operational changes to the companies in the group.
Regarding the specific companies and my investment views, in my prior report, I stated PVAC was very undervalued. Since then, PVAC’s stock price has increased 81% and now is richly valued on a NAV basis but fairly valued on a DCF basis. I also stated CRZO was under-valued. Since then, CRZO’s stock price has increased 40% and is now somewhat richly valued on a NAV basis and overvalued on a DCF basis. I stated that SN was about fairly valued. Since then, SN’s stock price has increased 47% and is now fairly valued on a NAV basis and highly overvalued on a DCF basis. Finally, I stated EPE was somewhat overvalued. Since then, EPE’s stock price has increased 13% and is now fairly valued on a NAV basis and highly overvalued on a DCF basis. The entire Eagle Ford group has benefited from investor rotation out of Permian E&Ps. Eagle Ford E&Ps benefit from premium gulf coast oil prices and modest basis differentials, as ample pipeline capacity is available to get oil to market.
I continue to maintain a long position in PVAC.
I continue to assume commodity prices in 2018 are $65 WTI oil at Cushing and $2.75 natural gas at Henry Hub. I reduced my assumption for NGLs at Mont Belvieu from $35.75 per barrel to $32.50 per barrel. In 2019 and beyond I assume $62.50 oil, $31.25 NGL and $2.75 natural gas, with NGL pricing decreasing from $35.94 in my prior report. These commodity prices are before basis differentials.
Share prices are as of July 20, 2018.
Oil and Gas Resource Potential
Chart 1 below shows the Proved Reserves and potential resource from future drilling sites for each company as well as by geography for the companies I research.
There are no material changes from my prior report to the information in the above table.
Oil and Gas Drilling and Completion Costs and Profitability of the Production
Chart 2 below shows the D&C cost per adjusted BOE for each company and the various geographies.
By changing my assumption for NGL prices, all companies’ D&C Costs per Adjusted BOE were slightly impacted. Otherwise there were no material changes to the above information since my last report.
Chart 3 below shows EBITDA excluding hedging per BOE for each company and the various geographies for the past four historical quarters and my 2018 full year estimate.
WTI at Cushing averaged $62.87 in Q1 2018 vs $55.40 in Q4 2017. At the same time, NGL prices decreased to $30.87 per barrel in Q1 2018 from $32.12 in Q4 2017.
From Q4 2017 to Q1 2018, PVAC realized about a $5 increase in EBITDA per BOE at nearly $40 in Q1 2018, making PVAC one of the most profitable E&Ps I follow. PVAC’s oil price realizations were at a premium to WTI at Cushing. EPE realized about a $3.50 increase in EBITDA per BOE. CRZO and SN experienced no change in EBITDA per BOE, which is disappointing relative to the experiences by the other shale E&Ps and given the overall strong oil price realizations at the gulf coast compared to Cushing.
I have updated Permian Basin basis since the last report. I am now assuming $12.50 in basis for 2018, but I am also including basis hedges put on by the various E&Ps. Thus, the 2018 EBITDA excludes commodity hedging but it does include basis hedging. As a result of this and my reduction in NGL pricing, 2018 EBITDA per BOE for the Permian Basin-Midland group is down from $35.91 in the last report to $33.46. And, the Permian Basin-Delaware group is down from $33.05 in the last report to $30.57.
Chart 4 below shows (1) the price discount or premium to WTI at which basis hedges, if any, are struck, (2) the % of Permian production with basis hedges and (3) the Permian price discount or premium at which oil is forecast to be sold in 2018 relative to WTI at Cushing taking into account basis hedges. Also, if an E&P has firm transportation agreements out of the Permian such that they will receive WTI at Cushing or gulf coast pricing, the below numbers take this into account.
CRZO and EPE have Permian acreage. CRZO has protected 77% of Permian oil production around $0.10 below WTI at Cushing, but the remainder of production will be sold at spot WTI at Midland pricing. Therefore, PDCE should realize a $3.00 discount to WTI at Cushing on Permian oil production in 2018. EPE has protected 100% of Permian oil production at $1.02 below WTI at Cushing.
Due to the changes in basis differentials, assumed NGL pricing and any other changes to 2018 production or expenses, 2018 estimated EBITDA per BOE changed as follows compared to the prior report: CRZO +$1.08, EPE -$0.83, PVAC -$0.16 and SN -$2.21. Due to SN’s high weighting to NGL production, they were impacted strongly by my change in NGL pricing assumption.
E&P Equity and Enterprise Values
Chart 5 below shows the equity value and enterprise value for each E&P and various geographies.
There are no material changes to the above information since my last report.
Relative and Absolute Valuation Analysis
Chart 6 below shows the two calculations to value future drilling sites for each E&P and the various geographies.
Of the two analyses, I place more weight on EV Less PV-10 since the reservoir engineers calculating PV-10 have significantly more detailed information than I do. There are no material changes since my last report other than the changes in stock prices and resulting impact on valuation ratios.
Chart 7 provides the production growth rate assumptions for the E&Ps and various geographies.
There are no material changes since the last report.
Chart 8 provides the levered and unlevered DCF analysis equity results.
Since the last report, Unlevered DCF analysis implied stock prices changed as follows: CRZO -15%, EPE -100%, PVAC -2% and SN -100%. The declines are due primarily to decreasing expected future NGL prices. As a result, EPE and SN are now estimated to have no equity value on a DCF basis. In summary, based on DCF analysis, PVAC is fairly valued, CRZO is overvalued and EPE and SN are worthless.
Chart 9 provides leverage and free cash flow metrics for the E&Ps and the various geographies.
There was little change from the last report for CRZO and PVAC. EPE’s leverage ratios degraded somewhat from lower 2018 EBITDA expectations, and SN’s leverage ratios degraded materially from lower 2018 EBITDA expectations.
Chart 10 provides commodity hedging metrics for the group.
To derive the above numbers, I calculated swaps, 2-way collars and 3-way collars separately. Also, remember that my assumed commodity prices of $65 oil, $32.50 NGL and $2.75 nat gas impact the collars and thus the average prices realized in the above table.
CRZO, EPE and SN are pretty fully-hedged in 2018. For EPE, 86% of oil production is hedged at $60.45. EPE’s reported EBITDA will decline by 7% due to $61 million in hedging loss settlements. For CRZO, 85% of oil production is hedged at $58.48. CRZO’s reported EBITDA will decline by 11% due to $85 million in hedging loss settlements. For SN, 78% of oil production is hedged at $52.46. SN’s reported EBITDA will decline by 13% due to $77 million in hedging loss settlements. PVAC is the best positioned if oil prices average greater than my assumed $65 in 2018, with 57% of oil production hedged at $53.39. PVAC’s reported EBITDA will decline by 12% due to $42 million in hedging loss settlements.
Chart 11 provides price realizations by commodity during 2018 Q1 for the group.
Oil price realizations for the group are strong as the group sells directly to the gulf coast, which prices off of Brent instead of WTI at Cushing. PVAC and CRZO oil price realizations were a premium to WTI at Cushing, and EPE and SN only realized modest discounts to WTI at Cushing. As CRZO and EPE announce 2018 Q2 results, the decline in Permian basis differentials should result in lower oi price realizations and thus larger discounts to WTI at Cushing.
NGL price realizations for the group are weak, with discounts to benchmark OGIS prices ranging from $8.00 for CRZO at the low end to $12.93 for PVAC at the high end.
Nat gas realizations vary across the group. CRZO, PVAC and SN have very strong realizations ranging from a $0.05 discount to $0.14 premium to the benchmark Henry Hub price. EPE’s realizations are weak at a $0.91 discount to benchmark pricing.
Since my last report, there have not been any material changes to my views on the Eagle Ford shale group. They benefit from superior oil pricing given their proximity to the gulf coast. But, since my last report, the market has priced in this fact and share prices have increased materially. I continue to maintain a long position in PVAC given its superior profitability and high oil production weighting, despite the 81% return since my last report. CRZO is no longer under-valued but instead is now about fairly valued. EPE and SN are close to worthless. SN suffers from a low weighting to oil production. And, SN’s high exposure to NGLs is problematic as I have reduced my long-term NGL pricing assumptions. EPE’s oil and NGL weightings are better than SN’s but are still only around 48% for oil and 22% for NGLs. SN and EPE have large asset bases and if oil prices were to make a large move upward, they have high leverage to oil prices. I would not necessarily short SN and EPE, but I don’t see any compelling reason to own them.
Disclosure: I am/we are long PVAC.
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.
Additional disclosure: Disclaimer: Opinions expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisor capacity. This is not an investment research report. The authors opinions expressed herein address only select aspects of potential investments in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The authors recommend that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the authors cannot guarantee its accuracy. Any opinions or estimates constitute the authors best judgment as of the date of publication, and are subject to change without notice.