Pulling The Plug On Shale

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Includes: APA, APC, DVN, PXD, XEC
by: Daniel Dicker
Summary

Systemic issues in shale production continue to haunt independents.

Company specific problems are varied, but with the same theme -- expensive, non-profitable growth vs. disciplined slow death by debt.

BOTTOM LINE - Oil doesn't rally fast enough to save the sector.

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No burying the lede folks, I’m pulling the plug on almost all frackers here.

Just too many negatives are building for the group, seen almost without respite during the 4Q 2018 reports from the independents during the last two weeks. I’ll talk a bit about the systemic problems for them all, then highlight some of the individual companies and their specific problems. Finally, I'll get to the few (very few) who are still worth investing in... although all at lower prices.

Let’s go.

First, remember that the fourth quarter of 2018 was relatively good to oil, with a realization for most somewhere in the mid to high $60 area, even seeing above $70 a barrel for WTI before the quick disaster in October sank prices towards $40. We must look at the 4Q reports in this light and think about where all those numbers will be for 1Q 2019 with realizations of far closer to $50 a barrel. Keep that in mind as we dissect the subsector.

Systemic Issues

  • Capital raising currently continues to be nearly impossible for the group, both in PE and bond and share issuance. We know that this 'easy money' game was what kept many of the less robust and more leveraged companies alive from 2014-2016, when many would have otherwise needed to close shop.
  • Speculative futures open interest continues to increase, indicating that there is plenty of bullish appetite, but oil prices are stalling still. This is not a good sign, and has been a key metric I've used successfully for my entire trading career.
  • Consolidation inside the sector becomes less probable to ease problems. No one has spare cash (except the majors who are for sure done, as indicated by the Chevron (NYSE:CVX) and ExxonMobil (NYSE:XOM) calls).
  • New lateral drilling tech showing that it is not the silver bullet it looked to be at first glance, instead delivering fast declines and some interference with other close wells already operating (Mother and Child) (source: WSJ)
  • Declines are eating up capex with overwhelming replacement costs (source: HFIR). Yet production continues. Up to 12.1m b/d. See Sanchez energy, delisted, but still increasing production to save bondholders.

Nothing stops them. 4Q conference calls for the independents have similar themes, promising further efficiency gains, disciplined capex spends, better return on equity, free cash flow and, despite all this, significant production gains. This is my favorite generic chart from their presentations, and it hardly matters whose presentation it came from, it is always the same -- promising an endless, linear improvement on breakevens. If this were true, we should expect it to ultimately cost nothing to get oil out of the ground.

Endlessly Declining Breakevens

The problem as I see it is that oil will not rally soon enough to save the sector from a massive disaster of capital shortfall and necessary restructuring – And I don't want to be holding them when this happens, I want cash to pick up the pieces afterwards.

Some Specific Company Takeaways From 4Q Reports

Devon (DVN): Finally selling Barnett and Canada Oil sands to raise capital, but is this a good thing? Stock went up 6% on news, but to me it's another strike on Devon. In this case, Oil sands are at their depths and their sales will be bottom of the market discounts. Besides the horrible timing, Devon is signaling their desperate need for cash to continue towards liquids. -- NO NO NO.

Anadarko (APC): More flexible than most with their portfolio and can hardly be classified as merely a fracker, yet still showed only $100m profit on $3.3b of revenues. After 3 years of adjusting to the bust cycle with this level of optionality and $60 crude prices, there’s only one way to describe this report. -- PATHETIC

Pioneer Natural Resources (PXD)– Sheffield, Dove were the models for "Keep calm and frack on" during every cycle, relying upon oil prices and their premium acreage to solve everything. Suddenly, now they’re changing strategy? Now they're talking patience and discipline? After drilling like madmen for 5 years? -- NO THANKS

Apache (APA): Still banking on Alpine High, but pouring money into new infrastructure and losing, their ALTUS spin off of midstream assets cost a fortune ($2b) and still those shares almost immediately dropped nearly 50% – a very heavy bet that looks to be getting bleaker to me. -- Apache is a long shot I no longer want.

Cimarex (XEC): Lowering production forecast again, and further announcing a fresh floating Shelf offering to find new capital, which should at the least have a diluting effect on share prices – Once one of my favorite Permian plays, Cimarex has long overstayed its welcome with me, falling into many of the pitfalls of other, lesser frackers.

I could go on -- and I will in a follow up column -- outlining some of the other specific companies who reported recently. In that next column, I'll also outline some of the very few who reported that represent the kind of solid returns and prospects in a marginal $50-60 oil world who can not only survive, but quite likely thrive.

But it should be noted overall that the subsector of independent oil companies is looking close to the precipice of another stock price disaster, where fresh capital from Private equity or premium buyout from the majors and mini-majors will not happen. We might in fact be in for the kind of bankruptcy/restructuring scenario of larger small caps and medium sized mid caps that probably should have happened in 2015/16.

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.