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Market Sentiment Watch: China trade talks bore no fruit, China representatives rumored to be leaving a day early. In today's post please find the oil inventory review (mixed bag, bigger than expected oil build, bigger than expected product draws (see distillates now down 9% to 5 year average in front of winter - Chart F4), comments on the OPEC Monthly (no reduction to 2020 demand this month, increased call on OPEC as non OPEC supply forecast growth erodes), the natural gas preview (smaller than last week still tracking to peak just above the five year average but well below record levels), requested comments and a cheat sheet update on LPI, and some other odds and ends. We get the IEA monthly tomorrow. Questions about today's post or the site? Contact us at zman@zmansenergybrain.com
Ecodata Watch:
- We get Jobless Claims at 8:30 am EST (F = 220,000, last read was 219,000),
- We get CPI at 8:30 am EST (heading forecast = 0.1%, last read was 0.1%; Core forecast is 0.2%, last read was 0.3%).
In Today’s Post:
- Holdings Watch
- Commodity Watch
- Oil Inventory Review
- Stuff We Care About Today - LPI
- Odds & Ends
Holdings Watch:
ZLT
- Yesterday's Trades: None
- The Blotter is updated.
Commodity Watch:
Crude oil closed down $0.04 yesterday at $52.59 after EIA reported the mixed bag of a report as noted below. Note, over the last week we have retooled the yellow section at the top of the oil inventory slide stack to be more user friendly. This morning crude is trading up on a number of positives in the OPEC Monthly as noted below.
- Ecuador Watch: Production continues to be impacted by unrest. At last check a little over 40% of the country's 540,000 bopd recent output level was off line and the 360,000 bopd pipeline for exports declared force majeure overnight.
- Nigeria Watch: Nigerian production target for OPEC lifted to 1.774 mm bopd from prior 1.685 mm bopd. Nigeria says it will comply with the new target. Last known Nigerian production was 1.866 mm bopd as of August.
- Exports Watch: Reuters reports U.S. oil exports to Europe hit a record this week at 1.8 mm bopd, double the prior week's rate while shipments to Asia were halved to 0.5 mm bopd on tanker availability issues due U.S. sanctions on COSCO. Higher tanker rates and smaller vessel used for the short journey favor Europe over Asia. They also note the boost off the bottom for the WTI-Brent spread as well favoring European destinations.
- Mid Cush Update Watch: Differential holding at 75 cents over better to WTI all months out through 2024.
OPEC Monthly:
Natural gas closed down $0.054 at $2.23 on medium volumes with weakness being attributed by traders to warm temps, another bearish injection expected for today (a lot less bearish than last week's number), and comments from EIA's winter fuels outlook which projects storage will be above the five year average by the end of October (this is not a surprise and storage peak, which will come a week or two later is not going to be a record figure). This morning gas is trading up slightly.
Natural Gas Storage Preview
Street is at +95 Bcf for today's report. This looks a bit low to our math.
- Last Week: +112 Bcf
- Last Year: +91 Bcf
- 5 Year Average: +89 Bcf
Oil Inventory Review
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Stuff We Care About Today
LPI (Unowned) - Requested Look ~ Bottom Fish Trade Idea Candidate
The Basic Story: Gassy Permian player. Operationally we see them as fairly well run, data driven and logistically well thought out. They have already taken a hit for spacing (they moved to wider spacing in 2019). The name offers little in the way of growth, is modestly levered, and is expected to deliver modest free cash flow. They have a buyback program in place but it's been gathering dust this year. We see the name as overdone to the downside but it could stay that way for some time. We see the name benefiting from NGL prices when they restrengthen. In the meantime, management has cut costs and pushed the company slightly into free cash land and in 2Q19 they generated $40 mm of free cash flow (ahead of schedule) and should have generated free cash in 3Q19 as well. The stock has not taken notice other than a brief bounce around earnings.
Note: We used to own this name but left with the stock at $8.77 in March of 2018. The stock is now at $2.08. We have been watching it fall and watching them attempt to right the ship both operationally (via up spacing) and financially.
The Plays: Midland Basin.
- Primarily Upper and Middle Wolfcamp and the deeper Cline in a portion of Glasscock County,
- U and M WC wells - bread and butter program - no codevelping and where economic planning to add the Cline to the pads as well.
- Enhanced fracs in Cline drive 30% increase in oil productivity. Cline now competitive with their U and M WC program.
- Up spacing - they moved to double the spacing in 2019 of the 2018 program,
- Widely space pilot showed 30% uplift in oil production on a per foot basis vs tightly spaced offset (announced with 2Q19, few cared). Please see the Yellow Rose well curves in the acreage section at the bottom of the cheat sheet.
- Modeled well costs have fallen from an original $7.5 mm to current $7.0 mm for WC and from $8.9 mm to $8.2 mm for the Cline.
Production Metrics:
- Production: 2Q19 was an all time record - see chart D below,
- Production per share: Also easily a record - see chart E,
- Oil Cut: Slowly slipping - see chart D.
Balance Sheet:
- Net debt to 2Q19 annualized EBITDA of 1.6x,
- Net debt to TTM EBITDA of 1.7x,
- Revolver debt declined by $35 mm from 1Q19 to 2Q19 and they noted a further reduction of $20 mm in July.
- Cash also built by $11 mm from 1Q19 to 2Q19.
Other Items:
- Hedges: Highly hedged: For the rest of 2019 (90% of oil volumes > $60) and for 2020 75% of expected oil production with an average floor of $58.79 (which right now looks pretty good). See the cheat sheet for details.
- Operating Cost: Trending slightly lower with a move to reduce overhead the biggest portion of the reduction (3Q guidance fell from prior $2.00 to $1.70 per BOE cash G&A. Their costs are very low which is good given their unfavorable production mix.
- Dividend: None.
- Repurchase Program: $200 mm program begun in 2018; So far $97.1 mm at $8.78 average was bought in 2018 but there have been no reported repurchases in 2019. The program is set to expire in February 2020. If they used the authorized remaining $103 mm at current prices they could take in a whopping 21% of shares outstanding.
- Short interest: 17% of float; 13% of shares outstanding. Short interest has eroded of late,
- Bonds are trading: They have two senior notes due in 2022 and 2023 presently trading at ~92 and ~85 respectively.
- Free Cash in 2020: Modest, helped by an expectation of flat capex, another year of limited attempt to grow vs lower decline rates, and the strong hedges.
Items likely concerning investors:
- Leverage - just the amount of debt, not the metrics,
- New team in place: This was a planned succession with management having been almost replaced by all but one long term employee over the 18 months. New president arrives from an operations position at Chesapeake in May.
- Production mix - no one ever likes to see rising natural gas in the mix. This is somewhat irrelevant however given the rise in oil productivity on the new wider spacing. With time, if results at Yellow Rose are representative, we should see more oil per well if not a greater oil cut (though it looks like, given a lack of planned bump up in their total production curve that oil may be shifting higher).
- Inventory: A move to twice the spacing would suggest half the wells. If this is the case they should still have over 3,000 locations which at the current 52 per year run rate is beyond plenty. If we call it 2 zones across all acreage with 4 wells in each and an additional zone (Cline) on a portion of the acreage we get about 2,000 locations and if we haircut that by 1/2 for extreme conservatism call it 1,000 locations. At 50 a year that's still 20 years.
- The company stopped listing their oil inventory of > 7,000 locations last year.
- They now list a "high graded inventory" of 350 to 500 in the U and M Wolfcamp and another 140 to 160 in the Cline, all at 4 wells per section spacing (vs the prior 8) and stresses again that this is the best of the rock. Even at just the high graded level this is plenty of inventory (well in excess of 10 years) at their current activity level.
- Poor Sellside Call Attendance: The 2Q19 call was very poorly attended (just Stifel and Goldman) and the call was only 17 minutes long. This one used to be close to an hour as the company walked through the importance of the earth model and of the on the group preparations. Lately, they just cut to the chase more.
- Lack of (Oil) Growth: Lack of oily production growth this year and when that will turn. They did move from 11% total growth and -2% oil growth guidance to 14% total growth and flat oil volumes with the 2Q call. More of that would be welcome and they've previously said to expect flattish oil volumes in 2020 (set for an upgrade as long as spending doesn't take a big hit when they guide) and then single digit growth in 2021.
- Natural Gas Prices: - Waha pricing was terrible in the first half but has been improving recently with incremental takeaway capacity. While Henry Hub is still weak this is one source of pressure on the name that should have seen the bottom with the 2Q numbers (they realized $0.11 / Mcf pre hedge / $1.17 /Mcf post hedge during 2Q). Revenues during 2Q were minimal gas so it will be nice to see them contribute more in the back half.
- LPI plans to report 3Q results on November 5th.
Valuation Metrics:
- TEV to 2020 and 2021 E EBITDA are both sub 3x,
- Reserves: $6.28 / BOE - very low,
- See Chart F. This is the enterprise value of LPI / production. Down by over 50% from year ago levels even as things began to improve and as noted, at an all time low.
Nutshell: Trading Idea. The name is basically off most radars and forgotten. Due to the guidance increase with the second quarter update the 2019 EBITDA estimates have migrated $22 mm higher (4%) since mid year while the stock has fallen 28%. We see it as a bottom fish candidate for a trade in front of 3Q earnings which should show further free cash and more verification of the wisdom of the move to upspacing. It's highly shorted and could easily move in large % terms without really bothering valuation metrics. Management has definitely gotten the message on spending and free cash and we expect them to act accordingly. A move to just $2.50 (20% from here) would only take the stock to 3.0x this year's EBITDA estimate and would simply not stretch any other valuation metrics.
Odds and Ends
Interesting reading watch:
Analyst Watch:
- Evercore ISI taking down oily name targets in typical post quarter mark to market / mark to reality action.
