Striking A Balance

Trying to strike the right balance between short-term and long-term goals continues to be a precarious pursuit for many E&Ps. Multiyear projects in, say, the offshore are almost a rarity, and instead the focus has been on short-cycle unconventional projects that, ideally, can move into “manufacturing mode” in a matter of months. But apparently even such projects risk giving investors heartburn in today’s market.

An example is offered by Concho Resources Inc. in releasing its second-quarter results and providing guidance for production and capex levels following its merger with RSP Permian Inc. Full-year 2018 production guidance was close to Street estimates, albeit with fourth-quarter volumes trailing expectations, while full-year 2018 capex guidance came in roughly 10% above expectations.

Intraday, Concho’s stock fell as much as 6.8%, to a low of $133.42, in the wake of the higher capex.

In explaining the rising capex—yet lagging output—a Raymond James note pointed out that Concho “was jump-starting development on multiple large-scale projects,” involving five- to 13-well pads and a total of 31 wells on RSP’s legacy acreage. On its own, RSP would not have been able to tackle the projects, which would “ultimately result in lower capital intensity and optimized well performance.”

The positive impact in terms of production would be seen entirely in 2019, noted Raymond James. “As such, we see the higher guidance less as a capex ‘miss’ and more as a natural result of hitting the ground running with large-scale development on RSP assets to demonstrate the net present value uplift” expected on the legacy RSP acreage.

Not surprisingly, Raymond James increased its 2019 estimates for Concho’s revenues and earnings by a few percentage points apiece and raised its target price to $246 per share, up from $240. Raymond James predicted Concho would still be cash-flow neutral using strip pricing in 2018, despite the bump in capex, and forecast Concho would underspend cash flow by 13% in 2019.

Meanwhile, Concho’s stock struggled to gain traction, closing the second trading session post-earnings release at $133.50, a hair above the previous intra-day low.

The Concho example was not an isolated one in what has generally been an unforgiving market. In its first week, the earnings season could “politely be described as a challenging week for most E&Ps,” said a note by Macquarie. That said, it added, “We must start to ask at what point have E&Ps been sufficiently punished for capex and capital efficiency challenges, while having seen limited reward from investors attributable to higher oil prices?”

If energy equity markets are unnerved merely by misalignments of growth rates and capex levels, it may come as no great surprise that little credit has been given to growth projects expected to hit their stride a few quarters or years away. To varying degrees, EOG Resources Inc., Anadarko Petroleum Corp., Chesapeake Energy Corp. and Devon Energy Corp. all disclosed advances in their Powder River Basin (PRB) programs, but with little to no immediate improvement in their stock prices.

Perhaps most comprehensive in its PRB disclosure was EOG. The company said it had expanded its count of locations in the Turner, a conventional sandstone target, but more importantly had de-risked unconventional plays in the Mowry and Niobrara shales. All three formations are designated as offering “premium locations,” and provide more than 30 years of drilling inventory at the current pace.

In the Mowry, EOG has some 880 net locations with an estimated net resource potential of 1,230 million barrels of oil equivalent (MMboe). In the Niobrara it has 560 net locations with a net resource potential of 640 MMboe. In the Turner it now has 405 net locations with a net resource potential of 200 MMboe.

In EOG’s earnings release, second-quarter capex came in about 15% above expectations, while third-quarter oil production guidance was “light,” according to a Simmons & Co. note. While some may have wanted to see more oil production growth, it said, “adding significant resource inventory (+26%) that meets the premium location hurdle via (two new plays) in the PRB materially increases intrinsic value.”

The EOG news failed to lift its stock on the day it released earnings, but it is this type of resource creation that will help offset the decline in reserves facing many producers. According to a Bernstein report, the reserve life of the majors has fallen 30% to 10 years, down from 15 years in 2000. (See Oil and Gas Investor, August 2018 issue.)