Cimarex Energy: Improved Permian Natural Gas Prices Partially Cushion The Impact Of Low Oil Prices
- Cimarex's production is over 40% natural gas, of which 60% is from the Permian.
- Permian natural gas prices have fallen to zero or below at times due to lack of spare takeaway capacity.
- The fall in associated gas production due to low oil prices, plus new takeaway capacity, should alleviate this issue.
- Improved realized natural gas prices should offset part of the impact of low oil prices on Cimarex's financials.
- At $40-45 WTI oil, the company may be worth 50% more than its current price, and it also has the financial strength to survive until oil prices get back to that.
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Cimarex Energy (XEC) may end up doing better than expected due to the effect of low oil prices on its natural gas production. Over 40% of its projected 2020 production is natural gas, and around 60% of that (25% of its total production) is Permian natural gas.
One side effect of low oil prices is that it reduces associated natural gas production. This should particularly help Permian natural gas prices, which have been at or below zero at times due to production reaching or exceeding takeaway capacity.
Permian Natural Gas Takeaway
Permian natural gas production butting up against the limits of takeaway capacity has been an issue for a while. WAHA averaged under $1 during 2019, and at times went negative. The Gulf Coast Express began full commercial service in September 2019, helping to temporarily alleviate this problem, but continued Permian natural gas production growth was expected to continue to pressure prices.
When I looked at Cimarex in February, WAHA futures for July 2020 were under $0.50. The oil price crash and resulting expectation for declining Permian natural gas production has significantly improved matters. The July 2020 WAHA futures are now around $2, and the December 2020 WAHA futures are now around $2.60.
The combination of declining production and increased takeaway capacity (in the form of the Q1 2021 Permian Highway pipeline) should result in there being plenty of excess capacity for 2021. This has pushed 2021 WAHA futures up to around $2.20 as well. It should be noted that the Permian Highway pipeline has been running into some regulatory challenges, although it is still progressing as it works through those challenges.
While the increase in natural gas prices does not fully make up for the fall in oil prices, for Cimarex's financials, a $2 improvement in WAHA prices offsets a roughly $8 or $9 decrease in oil prices. As well, Cimarex's Mid-Continent gas production is looking as improved pricing (although not as much improvement) as well. Thus, a situation with $40-45 oil and current natural gas strip prices in 2021 should be fine for the company.
This is still well above current oil strip prices, but does show that Cimarex doesn't need as much oil price improvement as most producers.
The company has further reduced its 2020 capex budget to around $500 million (excluding capitalized interest). It also mentioned that it curtailed around 30% of its May volumes in response to low prices.
With the curtailments and reduced capex budget, I estimate that Cimarex will end up with around 80,000-83,000 barrels of oil production per day in 2020 now (although this will depend on whether there are additional curtailments). This would represent an 8% drop from its Q2 to Q4 2019 (post Resolute acquisition) average oil production.
The reduced capex (and improved WAHA gas prices) should allow the company to deliver some positive cash flow in 2020 despite very weak oil prices.
Leverage And Valuation
Cimarex should be able to keep its leverage relatively low if oil prices end up rebounding into the $40s. At 2020 production levels (excluding curtailments), $45 WTI oil and $12 NGLs, the company's net debt-to-unhedged EBITDAX would be under 1.5x with natural gas prices at 2021 strip.
Cimarex traded at approximately 4.5x unhedged EBITDAX a few months ago. A similar valuation now based on 2021 EBITDAX (using 2021 natural gas strip and $40-45 WTI oil) would value the company at around $30-40 per share.
This is above current oil strip for 2021, but I do believe that strip is generally underestimating longer-term oil prices, and Cimarex has the financial strength to get to a period with better oil prices anyway.
Cimarex had previously been hurt by low natural gas prices (especially in the Permian) when oil prices had been okay. The oil price crash has resulted in a much-improved outlook for Permian natural gas prices, as well as some improvement in overall natural gas prices. This is due to the expected declines in associated natural gas production, which should particularly benefit the takeaway issues in the Permian.
While this does not fully make up for weak oil prices, the improvement in natural gas prices should allow Cimarex to do fine with $40-45 WTI oil. At those oil prices, it should be worth $30-40 per share, approximately 50% more than its current price.
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