Ring Energy: Hedges Limit Its Cash Flow Upside For 2021
Summary
- Ring has managed to make good progress with cost reductions and its unhedged margins should be quite strong with $60 WTI oil.
- It is over 110% hedged on its oil production for 2021, and may have slightly decreasing cash flow with oil price improvements above $55.
- Debt situation is improving, although further debt reduction is needed to get its leverage to ideal levels.
- Share price isn't cheap, with Ring valued at around $60,000 per flowing BOE.
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Ring Energy (NYSE:REI) is able to deliver quite strong margins before hedges after its cost reductions and with $60 WTI oil. However, it appears to be more than 100% hedged on its oil production in 2021, and that may limit its positive cash flow generation to approximately $30 million to $35 million in 2021.
Ring's shares also appear to be pricing in high-$50s long-term oil prices, so I don't consider it a great value at its current price despite the improvements to its cost structure.
Hedges
Ring appears to have oil hedges covering 9,000 barrels per day of production in 2021 now. Half of the hedges are costless collars with an average $54.64 ceiling and the other half are swaps at an average price of $45.43. Ring's oil production is expected to be around 8,000 barrels per day in 2021, so it has hedged approximately 113% of its 2021 oil production.
Source: Ring Energy
This means that any oil price increases above $55 may actually be slightly negative for Ring's 2021 cash flow. Each $5 movement in 2021 oil prices above $55 reduces Ring's 2021 cash flow by an estimated $2.5 million. This is due to Ring's hedges decreasing in value by approximately $16.4 million with a $5 increase in oil prices (above $55) while its revenues (net of production taxes) would go up $13.9 million in that scenario.
The increase in near-term oil prices may allow Ring to add more 2022 hedges at a decent level though, as 2022 strip is in the mid-$50s.
Ring's 2021 Outlook At $60 WTI Oil
Ring may end up averaging 9,300 BOEPD in total production during 2021, with 8,000 barrels per day of oil production (for an 86% oil cut). This represents close to 6% production growth compared to Ring's 2020 average production, and roughly equal to its Q4 2020 average production.
At $60 WTI oil, Ring would then be expected to generate approximately $178 million in oil and gas revenue, assuming a negative $2 oil differential. Ring's hedges have around negative $33 million in value at $60 WTI oil though.
| Barrels/Mcf | $ Per Barrel/Mcf (Realized) | $ Million | |
| Oil | 2,920,000 | $58.00 | $169 |
| Natural Gas | 2,847,000 | $3.00 | $9 |
| Hedge Value | -$33 | ||
| Total Revenue | $145 |
Ring is budgeting approximately $46 million for capital expenditures in 2021, which leads to an estimate that it will have $112 million in cash expenditures. This includes the effect of its reduced G&A costs and production expenses of approximately $10.25 per BOE (a couple of dollars lower than pre-2020 levels).
| $ Million | |
| Production Expenses | $35 |
| Production Taxes | $11 |
| Cash G&A | $7 |
| Capital Expenditures | $46 |
| Cash Interest Expense | $13 |
| Total Cash Expenditures | $112 |
Thus, Ring is expected to generate $33 million in positive cash flow at $60 WTI oil. As noted before, once oil prices get above $55, Ring's projected 2021 cash flow will decrease slightly with further increases in oil prices due to its hedges.
Ring should be able to deliver relatively quick paybacks (under a year) from its well at current oil prices. From a calendar year perspective though, adding to its $46 million 2021 capex budget would likely decrease its 2021 cash flow, but increase its cash flow in 2022 and beyond.
Debt And Valuation
Based on Ring's current guidance, it is projected to end up with $255 million in net debt at the end of 2021. This is approximately 2.3x its unhedged EBITDAX based on $55 WTI long-term oil. Ring is starting to get more breathing room under its credit facility, but will still need to reduce its debt further to get to a more comfortable level. Thus, a scenario with modest production growth and continued debt reduction seems most likely.
Ring's shares appear to be pricing in solid longer-term oil prices already. At $2.40 per share, it has an EV to unhedged EBITDAX multiple of approximately 5.0x based on 2021 production levels and $55 WTI long-term oil. It is also valued at approximately $60,000 per flowing BOE.
Conclusion
Oil prices for 2021 have pushed above $60 now, but Ring won't see much benefit from strong near-term oil prices. It is more than fully hedged on its oil production, and thus appears limited to around $30 million to $35 million in positive cash flow in 2021. The ideal situation for Ring would be one where oil prices stabilize at $55+ rather than continue to increase. Further near-term oil price increases result in a risk of a market correction by the time Ring is no longer fully hedged on oil.
Ring stock appears to price in high $50s longer-term oil already, so its stock isn't all that cheap despite its reduced production expenses and G&A.
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