Laredo Petroleum (LPI) has long made do with some fairly gassy acreage. Management did well for shareholders for a long time with that acreage. But this latest downturn gave the company the opportunity for a profit upgrade. Management has been taking advantage of that upgrade. Now management has moved operations to the superior acreage. Shareholders should just love the results.
New Strategy
From the initial success, the company now has a new strategy that will likely be executed opportunistically.
Source: Laredo Petroleum January 2021, Corporate Presentation
The company made several acquisitions shown above. Those acquisitions have landed the company in several oilier areas that are expected to be more profitable in the long run than the company's current acreage before this series of acquisitions.
Because of that management has been moving any operations to the new acreage effective immediately. The Howard County acreage is expected to have the greatest oil percentage of total production. Therefore, drilling will commence on those leases first.
Mr. Market has not been really impressed because the current acquisitions only have a few years of drilling possibilities. But a lot can happen in this industry in those few years. In the meantime, production from the current acreage can act as an "ATM" to get production going on the new acquisitions. Even though acreage prices will firm as oil and natural gas prices continue to rally, small acreage positions often sell for considerable discounts to market prices. Therefore, small bolt-on acquisitions to the properties already acquired are a realistic proposition (at bargain prices).
Cost Progress
In the meantime, cost progress continues. Therefore, the company acreage will become more competitive in the future as technology improvements continue.
Source: Laredo Petroleum January 2021, Corporate Presentation
The acquired acreage is the Western Glasscock County and Howard County figures above. Any well that pays for itself in the first year (like those acquired leases are very likely to pay for themselves) will be extremely profitable to operate. In theory, a well that pays for itself within a year allows the operator next year to have the generated capital plus the cost of the wells drilled in the previous fiscal year. That means that cash flow will grow very quickly.
Even though the leases acquired only have enough drilling locations for a few years. Those acquired drilling locations appear to be profitable enough to fuel a cash flow explosion. This is demonstrated by the bar graph on the left showing that the percentage of oil produced will increase even though established production tends to become more gassy over time.
Even if management were to decide to maintain production rather than grow it, cash flow is likely to improve significantly due to the increasing oil percentage of production. Any production growth will magnify the cash flow increase.
Source: Laredo Petroleum January 2021, Corporate Presentation
Interestingly, significant well performance improvement is still happening even though the quality of sand has not been addressed for a couple of years. Before the latest technology improvements, quality sand or even ceramic proppant was thought to improve well performance up to 20%. However, much of that proposed improvement was back-end loaded. Since technology improvements cause a fair amount of reworks and other production improvement measures, the quality of sand has not been as important as other things that improve production.
Debt Structure
Management has also restructured the debt to take advantage of any bargains that might become available in the future.
Source: Laredo Petroleum February 2021, Corporate Presentation
Rallying natural gas prices helped to offset some of the oil price weakness. That kept the debt ratio within acceptable limits for the lenders. Management also floated some bonds to refinance some debt and increase the amount available on the bank line.
The new acreage and increasing natural gas prices shielded this company from some of the concerns in the oil patch regarding the six month evaluation of the bank line. In this case, the bank line was maintained. The newly acquired leases probably can take a fair amount of credit for that favorable outcome.
Source: Laredo Petroleum January 2021, Corporate Presentation
Interestingly, management has now got the lease operating expense down to levels that compare to dry gas producers in other basins. That's important because the liquids production is a relatively small percentage of the total production. Therefore, the impact of oil and other liquid production goes straight to the bottom line (with only minimal cost impact).
Dry gas producers that maintain those dry gas costs but increase the amount of liquids produced often become very profitable. Clearly Laredo management hopes to duplicate that experience. Laredo Petroleum is technically an oil producing company. However, the natural gas produced can sometimes approach nearly half of the total production. Therefore, the low costs shown above will be an important competitive asset going forward.
Source: Laredo Petroleum January 2021, Corporate Presentation
The completions in the fourth quarter were emphasizing Howard County. Once those wells completely clean up and reach full production, they are expected to produce almost all oil.
Source: Laredo Petroleum February 2021, Corporate Presentation
Because Howard County is being emphasized currently, the costs above ended up slightly higher than the January slide shown previously. Management has guided to higher costs when the oil percentage produced is higher. But the margin obtained by selling oil makes the higher costs worthwhile.
Transportation costs often are different for oil and natural gas. But the "game" remains the same. Management will try to hold the line on costs (and appears to be largely succeeding) while capturing the extra margin obtained by producing more valuable liquids like oil.
Management has worked at maintaining well costs even though these wells are in a different county.
Conclusion
Any budget announced for 2021 is going to be extremely flexible. The only certainty is that the acquired acreage will be developed in the new fiscal year.
In the meantime, management will opportunistically add to the acreage in the more profitable areas. The company was working on increasing the percentage of oil produced in the current acreage. That work appears to have been successful. But the acquired acreage improves over that work.
Therefore, this year should show significant cash flow growth under a wide variety of industry scenarios. The longer the coronavirus demand destruction continues, the more likely this company is to pick up bargains in profitable places (like Howard County).
In the meantime, management is off to a very good start at improving future company profitability. Mr. Market is not yet impressed. But a very patient management will likely pick up more acreage at bargain prices in the future.
The bank line has the space and banks will listen if a big deal comes by that exceeds the available credit line. Some of the properties were acquired with existing production. That meant that the acquisition was already somewhat self funding.
This company has a very good future. But it has been ignored by the market for some time. That may be about to change.
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