Could This 66% Yield Be the Buy of the Year

By
Keith Schaefer
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A Texas court case this Friday, February 26 will set a precedent that will either see all US pipeline and “midstream” stocks have a monster rally—or get crushed (even more!).

That’s when Crestwood Partners (CEQP-NYSE) will defend its fee structure in transporting the natural gas of defunct Quicksilver (formerly KWK-NYSE) through bankruptcy.

Quicksilver has a buyer for the company—on the condition that its pipeline fee structure with Crestwood be thrown out.  There is also a second buyer for Quicksilver that has no stipulation—but it’s a lower bid.

There is tens of billions of market cap at stake here for investors—mostly retail investors who bought these new pipeline companies called MLPs—Master Limited Partnerships.  These companies have high debt yet pay out very high dividends.

I’ll explain the (relatively simple) details of the case below, but the outcome is binary—if Crestwood wins, the Market would take that to mean that the guaranteed “take-or-pay” revenue streams for pipeline companies are good as gold, and will get paid through bankruptcy.

But if Quicksilver wins, the Market will not trust any revenue streams coming from highly indebted E&Ps to pipeline companies.  I expect those revenues will be discounted to near zero as soon as the court issues its judgment—though there will likely be appeals.

Investors will find this a powerful and drama-filled story for several reasons:

1) These stocks represent the Ultimate Betrayal for millions of retail investors in 2015.  The Mom and Pop investors who own these MLPs religiously believed these dividend payments didn’t have exposure to commodity prices; that the pipeline companies had guaranteed “take-or-pay” provisions from the producers, with minimum volume commitments (MVCs).  It turns out they were wrong.  Example—Crestwood’s revenue dropped 40%, or $400 million, from Q3 2014 to Q3 2015.

2) This court case is happening just as investors like Warren Buffett are finding value in MLPs—where stock prices have declined 50-90%, just like producers.  This has created some incredible yields for investors—Crestwood is now paying a 66% yield—sixty six percent!  Other stocks with 25-35% yield are now common in this space.

3) MLPs are mostly owned by retail investors—Mom and Pop.  So this isn’t big nameless and powerful hedge funds losing money…this is your neighbor.

It’s a powerful lesson for everyone in the Market—where investors in MLPs are now questioning everything that they once believed to be true about this seemingly invulnerable sector.  Everybody wanted to believe in take-or-pay, and in little to no exposure to commodity pricing.

But as quarterly results came in through 2015 and revenue started to decline, investors got nervous.  Many of these MLPs have high debt, building out thousands of miles of new pipe (Canada can only stare across the border in envy and bewilderment on that).

As the Market realized US oil production would have to contract to see the oil price recover, MLP prices fell hard.  Look what happened to one of the biggest and best—Kinder Morgan (KMI-NYSE):

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It went from $44-$12 in 9 months, a 73% drop.  Crestwood is off even more – 95% as it fell from $150 to $8 in just over two years.

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Here’s the story of how investors got into this mess—and how they might get saved by the gavel.

If It Seems Too Good To Be True….

It wasn’t that long ago that the MLP sector was the darling of investors.

It had everything going for it.

Surging U.S. oil and gas production created a huge need for the oil and gas infrastructure that the MLPs provide.

This created huge growth opportunities.

Thanks to ZIRP (Zero Interest Rate Policies, MLPs could use almost free debt to build out that infrastructure.

This created extremely wide margins between revenue and cost.

As a tax-advantaged “pass-through” entity, income earned by the MLPs are not taxed at the corporate level.

This created bigger dividends for the shareholders (who then have to pay taxes on those dividends).

And then the kicker—the MLPs were able to virtually guarantee secure dividends to investors because revenues were based on fixed fee contracts and have almost no impact by commodity prices.

This removed the risk.

Growth, wide margins, tax advantaged and low risk.  What wasn’t to like?

Well seemingly nothing on the surface, but investors didn’t fully understand the rules of the game.

Toll Roads With Guaranteed Traffic Flow….

In a zero interest rate world investors fell in love with the secure dividends provided by the MLPs.

The yield on the MLPs was attractive, but the perceived security of the payments the real selling point.

The security of the dividend was tied to the specifics of the contracts that the MLPs entered into with the oil and gas producers using the MLP gathering systems (pipelines).

The fixed fee nature of the contracts meant that the MLPs were believed to function much like toll roads. Because the fees were fixed, the revenue allegedly did not fluctuate with the price of the commodity that their customers produced.

And the contracts were even better than that.  Known as “take-or-pay” contracts, the agreement was that the producers would pay the MLPs even if they didn’t ship any oil or gas through the pipeline.

The producers were willing to agree to those “take-or-pay” terms to ensure that they had space reserved in the pipeline for their production.

Having production but no means to get it to market was not a risk a producer can take.

With both volume and price seemingly locked in, the revenues, cash flows and dividends of these MLPs looked very secure.

That meant these stocks became VERY highly valued between 2011-2014; MLP stocks did very well for a time.

As the oil price started crashing in 2014 and into 2015 the stock prices of E&P companies cratered along with it.  Initially the stock prices of the MLPs held up very well.  Investors held on comfortably believing those fixed fee “take-or-pay” contracts protected the cash flow that the MLPs could generate.

That began to change in the summer of 2015 when the price of oil went for its second big leg down.  Investors became concerned.

The very slow descent of the Alerian MLP ETF (NYSE:AMLP) began to pick up pace—see the stock chart below:

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Concern turned to panic late 2015 when the market started to digest the idea that there was a real threat of bankruptcy for the second largest natural gas producer Chesapeake Energy (NYSE:CHK) concern turned to panic.

Chesapeake represents a huge amount of revenue to many MLPs and the idea of it heading into bankruptcy started to raise questions about what would then happen to those rock solid contracts.

MLP stock prices crashed and yields in the MLP sector went through the roof.

A quick skim of the highest yielding stocks reveals multiple MLPs now yielding over 30% and Crestwood hitting 66% yield in early February.  The low-risk appeal of the MLP sector was gone.

When A Deal Isn’t A Deal….

The fixed fee contracts are real.  And so are the “take-or-pay” agreements.

The producers happily signed up to those terms.

The complication is what happens when the producer on the other side of that agreement declares bankruptcy.

Does bankruptcy negate the contract?

If you ask a lawyer working for an MLP the answer will be no.

The MLP lawyer will tell you that these contracts are to be treated in the same manner as a property interest.   What that means is that the terms of the contract are passed on from the prior owner of the property to the new owner.

An example would be if you purchased land upon which there are certain building restrictions.  Those building restrictions would pass from the previous owner on to you.

The MLP lawyers believe that these contracts “run with the land” and pass from one owner of the oil and gas assets to the next.  If the first owner of the oil and gas assets declares bankruptcy the contracts continue to operate under the same terms subsequent to the declaration.

The trustee lawyers for the creditors that have taken over bankrupt E&P firms disagree with the “run with the land” assertion about these contracts. These lawyers have presented the argument that the contracts with the MLPs can be broken under Section 365 of the U.S. bankruptcy code.

The two sides are obviously very motivated to argue their position.  The MLPs want to keep their revenues intact and the bankruptcy lawyers want to help the creditors they represent recover as much as possible.

The crazy thing is that nobody knows for sure which side of the issue is correct.  This specific issue has never been litigated to conclusion so there is no clear-cut precedent.

We will soon get some clarity one way or the other with the Crestwood-Quicksilver case.

But the MLP and midstream industry has already had one bit of bad news:

A subsidiary of Cheniere Energy (NYSE:LNG) named Nordheim Eagle Ford Gathering is also in court, this time with the bankrupt producer Sabine Oil and Gas.  Nordheim argues that its contract is sound while Sabine believes that it can get out of the contract under bankruptcy.

In a February 2 hearing on the Sabine/Nordheim case the judge presiding expressed skepticism that the contracts could survive the Chapter 11 bankruptcy.  This undoubtedly sent shudders through many an MLP boardroom.

The precedent set in these two cases will impact many other bankruptcy proceedings that are sure to follow in 2016.  It will also determine whether the MLP sector is a tremendous bargain today or in for more pain in the months ahead.

EDITORS NOTE–my biggest long position profits as energy prices drift lower.  Maybe that’s why it has already increased its dividend in 2016.  How many energy companies can say that?  And you know what happens when dividends increase–stocks go up.  Tired of watching your stocks go down? Get the name and symbol RIGHT HERE

Keith Schaefer

Goodbye Shale Revolution, Here’s the New Revolution

By
Keith Schaefer
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The Last Big Revolution in Energy in the 2000s was underground—The Shale Revolution.

The Next Big Revolution in Energy is above ground—The Smart Grid, and the Internet of Things (IoT).

What is a Revolution? It’s where disruptive change comes into a market, creating Big New Winners.

And that’s happening now with the US electrical grid.  The massive US utility network is figuring out how to meet society’s demand for more renewable power—wind and solar.

The utilities have to find the right business model to incorporate these—because they need to keep revenues up to replace a very old, rusting power grid.

These big, old, staid, utilities are getting pressured on both ends—as they get de-regulated, revenues are under threat as costs are going up.

They need help; they need innovation.

I wanted to find a company with a proven track record in helping these utilities adapt.  A company that increases their revenues, and helps them cut costs.

Not only did I find that company, I found they have:

  • unbelievably high margins on hardware
  • a super high margin recurring revenue stream from software sales
  • more than $80 million in net cash
  • contracts with some of the biggest utilities in America
  • leading edge technology that other companies are using; it’s becoming THE standard

The SmartGrid Revolution is where The Big Money is moving in energy.  This company is getting more than its fair share.  I’ve just recently started buying it.  It’s growing, it’s well funded and it’s sexy.  The Market will take this stock and run. Get the name and symbol RIGHT HERE, risk-free, along with my full report.

These Numbers Show How High Oil Must Go—and Fast

By
Keith Schaefer
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What did Chevron accomplish in 2015 by outspending cash flow by $19 billion?

Increase production a paltry 2%. Barely replace reserves–107% of production.

That is what Chevron managed to achieve in 2015 by spending $31 billion while generating just $19 billion of cash flow.  And that is actually incredibly bullish, despite the fact that the oil price has come down hard already in 2016.

Investor sentiment–from both the shareholders and the lenders–is forcing ALL producing companies to move closer to spending within cash flow.

What would Chevron’s production and reserve growth look like if they do that?  I’m guessing it would be MUCH less.
Their capex in 2016 is going down 22% $26.6 billion, but the savior for the company in 2015–its downstream refinery business–is getting crushed right now.

Refinery margins were huge through most of 2015–they contributed $7.6 billion in profits to Chevron in 2015–but crack spreads have recently fallen a lot.  And with a glut of some 160 million barrels of refined products in the USA, that won’t change much this year.  (I got short refineries in January.)

This all reads like bad news, but it’s actually very bullish.  These numbers say how far the oil price must go up for western companies to make money.  And now asset sales are slow, and lowly priced (everyone is a seller), debt is being reined in and equity is a non-starter for all but the best companies.

If That Was 2015 What Is 2016 Going To Look Like?

If you want the truth you have to look directly at the numbers.

Chevron’s Q4 and full year 2015 numbers speak volumes.  They tell us that something has to give. And as I show you at the bottom here, that may be happening now.  In Q4, they generated $4.6 billion in cash flow, and spent $9.4 billion on capital and dividends.

Here is how the full year 2015 cash inflows and outflows look for Chevron:

 In Billions 2015 2014
     
Cash Generated By Operations $19.5 $31.5
     
Capital Expenditures ($30.6) ($36.8)
     
Dividends Paid ($8.0) ($7.9)
     
Share Repurchases $0.0 ($4.4)
     
Net Cash Outflow ($19.1) ($17.6)

It isn’t a pretty picture.

When you include both capex spending and cash required for its dividends, Chevron spent $38.6 billion while generating only $19.5 billion from operations.

That is a net cash outflow of $19.1 billion!

Talk about living beyond your means.  The obvious question is how did Chevron finance all of this outspending?

Well, they did it like anyone who lives beyond their means would.

First they dipped into their savings.

Chevron’s cash and net working capital balances decreased by $2.6 billion in 2015.

Then they borrowed.

In 2015 Chevron’s long term debt increased by $10.8 billion.  That is an increase from $27.8 billion to $38.6 billion in total debt.

And then they started selling off some of their belongings.

Proceeds from asset sales in 2015 totaled $5.7 billion.

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Source of image: Chevron’s Q4 2015 Earnings Presentation

By massively outspending cash flow, running up debt on its balance sheet and selling assets Chevron managed to maintain its dividend and keep its production basically flat. (At least they didn’t spend any money on share buybacks, like the $4.4 billion they did in 2014.  Watching these companies buy back stock during the good times when the stock prices are high and then buy back none now must be irksome to more than a few shareholders.)

If Chevron had lived within cash flow, you have to wonder what the dividend might have been and what production and reserve growth would have looked like.

It is not a pretty picture.  2016 is shaping up to be significantly worse considering that oil prices in 2015 were on average $20 per barrel higher than where they sit today.

Last year would have been much worse for Chevron if the company didn’t have its own refineries. Chevron’s downstream operation (refineries=downstream, pipelines=midstream, producers=upstream) actually benefits from low oil prices and that helped significantly cushion the blow.

Chevron’s downstream operations recorded a profit of $7.6 billion in 2015.  Without that this company would be in far worse shape.

The Real Battle Is The Fed (Not The Shale Producers) Vs The Saudis

This is what life looks like for Chevron.  A company with a very mature low decline production base and the benefit of a profitable downstream operation.

No wonder the shale guys are feeling so much pain.  They have young, very high decline production and no diversifying downstream business segment.

Seeing how Chevron allowed its balance sheet to deteriorate in 2015 once again underscores the point….

The biggest threat to the Saudis is not from the shale producers, it is from the Federal Reserve and its ZIRP (zero interest rate policy).  Can you imagine Chevron allowing its long term debt to increase by nearly 40% in just one year if interest rates were at 8%?

Chevron’s massive outspending in 2015 is how the shale boom was built right from the start.  The shale producers had access to billions and billions of dollars of low cost funding.

Low oil prices have ended that party.  Reasonable interest rates would have done the same.

What is abundantly clear is that 2016 is going to be a year of very hard decisions for a lot of people in this industry.  For Russia and OPEC it is about cutting production.

For Chevron, that hard decision could involve its dividend.  If Chevron completely eliminated its dividend in 2015 it would still have outspent cash flow in by $11 billion.  That was with considerably higher oil prices.

To me, the sign that the supermajors are really feeling the fiscal pain is a sign that investors can have realistic hopes of a re-balancing–and the ending of the (allegedly) big global production surplus.

We are potentially seeing that happen right now, as the American Petroleum Institute (API) issued its projection of a surprise 3.3 million barrel draw in crude inventories this week.  The weekly EIA numbers could prove very interesting later this morning.

EDITORS NOTE–Few business models in the energy patch work at $30 oil.  But I found one that does–they actually have already raised their dividend in 2016 already, as oil prices sank to their lowest prices in over a decade.  That’s where I want to be with my money–The Sure Thing.  Click Here to get the name and symbol.

Keith

 

Resource CEOs on the Hot Seat

By
Keith Schaefer
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Top Energy and Mining CEOs on Hot Seat March 5 in Toronto. Investors, Here’s Your Free Invite

hedgefund guy

Hedge fund activist investor Zach George of FrontFour Capital will deliver the keynote address at the Subscriber Investment Summit on March 5, 2016 at the Hilton Toronto. Photo: Colleen De Neve / Calgary Herald (Source)

Contrary to popular belief, investors are still making money in resource markets.

The price for energy metal lithium has been surging, and shareholders of Frank Giustra-backed lithium exploration play Lithium X have also seen strong gains since the company went public on November 30.

Shareholders of NexGen Energy have more than doubled their money over the last year as the company outlines a large and high-grade uranium deposit in northern Saskatchewan.

Both companies are among the firms handpicked to present at the annual Subscriber Investment Summit in Toronto March 5. The Summit’s track record has made it a valuable stop where investors learn about many of the top resource companies in Canada directly from the CEOs and before the mainstream.

There’s even money to be made in the beaten-down oilpatch. Shareholders of junior oil producer Canamax Energy — a Summit presenter in 2015 — almost doubled their money overnight on Dec. 5 when management said they would go private.

This year’s conference is looming, but a few free tickets remain.

The Subscriber Investment Summit is hosted by three of Canada’s leading independent financial publishers: Oil and Gas Investments Bulletin, HRA Journal and CEO.CA.

These editors hand-pick the best companies in the junior resource space to present to their paying subscribers — and investors who sign up before the show sells out.

This year, 14 high-quality mining and energy management teams are presenting, and you will hear directly from the CEOs.

In addition, hedge fund activist investor Zach George of FrontFour Capital will make a rare public appearance, delivering the keynote address on Saturday afternoon.

NexGen Energy’s Arrow uranium discovery has been described by Toronto hedge-fund manager Warren Irwin as “the next Voisey’s Bay.” CEO Leigh Curyer will make a highly anticipated presentation.

Continental Gold CEO Ari Sussman will discuss the rich Buritica project in Colombia.

NovaCopper CEO Rick Van Nieuwenhuyse will introduce one of the top undeveloped copper districts in North America.

Lithium X Executive Chairman Paul Matysek has sold three companies for a total of more than $3 billion in his career. Lithium is arguably the hottest commodity in the world right now, and Mr. Matysek will outline the growth path for Lithium X.

That’s just a small sample of some of the high-calibre CEOs presenting.

To keep things moving, no CEO is allowed to speak for more than 10 minutes. But investors will have plenty of time to connect one-on-one with chief executives — one of the great features of the event.

Keynote speakers include leading fund managers and analysts. In addition to Mr. George, clean energy expert Nathan Weiss will share his latest contrarian bets, including an update on his Tesla “short” thesis.

Keith Schaefer, editor of the Oil and Gas Investments Bulletin, has proven himself nimble as the bottom falls out of the oil market. He’ll be presenting his best and latest ideas.

Eric Coffin, veteran editor of the HRA Journal, has seen a few bears and bulls come and go over the years. He’ll share his macro outlook and top picks for a junior mining rebound.

CEO.CA founder Tommy Humphreys will talk about how technology is changing the investing game and unveil the latest features ofCEO.CA Terminal, a fast-growing chat-based app focused on Canadian securities.

The venue is the Hilton Hotel in Downtown Toronto (University and Richmond) on Saturday, March 5, 2016 – 9:00am-4pm.

THIS IS A FREE EVENT and tickets are available on a first-come, first-served basis. The event sold out last year — RSVP now to reserve your seat. You never know who could be in the seat next to you.

For more information, vist www.subscribersummit.com.

Here’s a full list of the companies presenting:

  • Painted Pony Petroleum
  • Tamarack Valley Energy
  • Nevsun Resources
  • Arena Minerals
  • Continental Gold
  • Crius Energy
  • Erdene Resource Development
  • Lithium X Energy
  • Marquee Energy
  • Morien Resources
  • NexGen Energy
  • NovaCopper
  • Renaissance Oil
  • SilverCrest Metals

 

Tommy Humphreys

Rice Energy Will be A Natural Gas Survivor

By
Keith Schaefer
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By Bill Powers

Winter started late, destroying demand for natural gas in America.

Natural gas storage touched record levels at the end of the refill season.

NYMEX Henry Hub futures briefly traded below $2 per MMBTU and have staged only a modest rebound with the onset of colder weather.

Dozens of North American energy companies are under severe stress and many will not be able to hang on for the inevitable rebound in prices from today’s unsustainable levels.

More importantly, what will the future look like for the companies that can weather the storm and who will make it?

In this article I will detail the many smart steps taken by Rice Energy (RICE-NYSE) over the past nine years that have put it in an excellent position to profit mightily from the inevitable rebound in prices.

In a follow-up article I will detail the missteps of a former Wall Street darling, Ultra Petroleum (UPL-NYSE), that is facing a far more difficult future due to its debt-laden balance sheet and forays into unprofitable project areas.

After founding of its predecessor company, Rice Energy, LLC in 2007 by longtime Blackrock and State Street energy analyst Dan Rice III, the Canonsburg, PA-based company began the acquisition of Marcellus shale acreage.

Through a series of farm-ins and acreage acquisitions prior to the start of the huge ramp up activity in the Marcellus in 2012, Rice was able to establish a meaningful foothold into the highly prospective Marcellus shale of southwestern Pennsylvania.

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Today Rice holds 91,000 net acres of Marcellus acreage in Washington and Greene counties in Pennsylvania as well as 56,000 net acres of highly prospective Utica acreage in Belmont County, OH.  Additionally, Rice Energy is the operator and 50% owner of a gas gathering and water handling company, Rice Midstream Partners (NYSE:RMP) that services its areas of operation.

While there are numerous companies with more acreage than Rice in both the Utica and the Marcellus, there is virtually no company operating in either of the those two plays that has higher quality acreage, a history of drilling more prolific wells and, most importantly these days, the balance sheet to exploit its existing asset base in a higher price environment.

As with any unconventional resource play, the financial success of any driller is directly linked to its acreage being located in the core of the play where virtually all of the economic wells are located.

By comparison, Ultra Petroleum’s acreage in the Marcellus lies well outside the most prolific part of the play and has yielded poor drilling results to date.  As you can see from the below graphic, in both the Utica and the Marcellus, Rice’s concentrated acreage position is located in the core of the core:

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Rice’s acreage position in both the Marcellus and the Utica has yielded some spectacular production results to date.  For example, the average initial production (IP) rate for the 114 Marcellus wells put into to production since 2010 was 10.1 million cubic feet per day (MMcf/d).

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Source: Company Presentation

Additionally, the strong performance of the company’s wells over the early portion of their lifetime allowed Rice to produce an average of 410 mmcf/d, or 3.6 mmcf/d per well, in Q3 2014 from its 114 Marcellus wells.  The company has also been able to achieve substantial cost reductions per drilled and completed (D&C) foot.  The 14 Marcellus wells put into production in Q3 2015 had an average cost of approximately $7 million each, down 16% from the 2014 average well cost.

Though nearly all of Rice’s Marcellus wells have been on production for less than three years, we still have enough production history to make reasonably informed predictions for estimated ultimate recovery (EUR) per well.

The below graphic taken from a recent company presentation shows Rice’s Marcellus wells have outstanding performance across both the 1-year and 2-year timeframes:

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Source: Company presentation

Due to the lack of the Rice-operated Marcellus wells older than three years and given that, according to the company, less than 10% of its Marcellus acreage has been developed, it is reasonable to expect the company’s average well to produce 8 bcf over its lifetime.  I will further discuss the company’s Marcellus assets in the Valuation section.

In the underlying Utica, Rice’s drilling effort is off to an excellent start.   As you can see in the below table, the company has had consistently good results in the 16 wells it has drilled through the end of Q3 2015:

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Source: Company Presentation

Despite only 19 net Utica wells producing during Q3 2015 Rice had average production of 199 mmcf/d, or 10.5 mmcf/d per well.  Though the company has drilled a very small portion of its 56,000 net Utica acres, its outstanding production history indicates it is reasonable to see Rice’s average Utica well produce 10 bcf over its lifetime.

Valuation

Valuing a rapidly growing company like Rice Energy at a time of 14-year low natural gas prices is quite difficult, due to:

  1.  the depressed nature of the futures strip,
  2. the rapidly changing drilling cost structure and
  3. the uncertainty over the company’s rate of acreage development.

However, examining the company on a sum-of-the-parts basis we can gain meaningful insight into the value of Rice shares.

In the Marcellus, the company has 91,000 net acres and assuming 75% of it will eventually be developed (since some will have undoubtedly have access issues or impediments to development), and assuming four wells per square mile (640 acres), Rice can be expected to drill 427 net Marcellus wells.  Should each of the company’s wells produce 8 billion cubic feet (bcf) over their lifetime, 3.42 trillion cubic feet (tcf) of potential production lies on the company’s existing acreage.

If we assume that Rice’s Marcellus acreage would be valued by a potential buyer at $2 per mcf of gas in the ground, it is easy to see Rice’s Marcellus acreage fetch a value of $6.83 billion.

In the Utica, should 75% of the company’s 54,000 net acres be prospective and the company is able to drill four wells per 640 acres, the company has the potential for 253 locations on its existing land base.  Therefore, using an EUR of 10 bcf per well, Rice’s Utica acreage contains approximately 2.53 tcf and can be assigned a value of approximately $5 billion.

Rice’s 50% ownership of Rice Midstream Partners (RMP-NYSE), its gas gathering and water handling system into which it has dropped the majority of its Pennsylvania midstream assets, can be conservatively valued at $200 million.

Rice is in the early stages of delineating the potential of its Pennsylvania Utica acreage that sits directly beneath its existing Marcellus acreage.  To date the company has drilled one well on its Pennsylvania Utica acreage that was tied into sales in August 2015 and according the company was flowing at 12 mmcf/d.  While this a promising start, much more information is needed before assigning value to Rice’s Pennsylvania Utica potential.

Normally, I would be very concerned with financial health of a company such as Rice that generated only $366 million in revenue in the first 9 months of 2015 carrying a debt load of $1.52 billion.   (Source: http://www.sec.gov/Archives/edgar/data/1588238/000158823815000020/riceenergy10q-sep302015.htm )

However, Rice Energy is unlike all of its peers since it has the highest quality acreage in both the Utica and the Marcellus that has allowed it to reach over 600 mmcf/d of production with the drilling of only a modest number of wells.

Through savvy hedging and the marketing of a significant portion of its production outside of the Appalachian Basin, Rice was able to achieve a realized price for its gas of $3.18 per mcf in Q3 2015 and has 95% of Q4 2015 output hedged at a fixed floor of $3.78 per MMBTU.

A similar strategy is in place of 2016.  Rice has hedged 489 MMBTU (about 80% of expected production) at a fixed floor of $3.51 per mcf.  Even with today’s NYMEX prices below $2.50 per MMBTU, Rice is sufficiently hedged to allow the company to generate enough cash flow to continue it delineate its high quality acreage and a large increase to its debt load.

By comparison, Ultra has more than twice as much debt as Rice and only modestly higher production but has been unhedged since October 2015.   UPL’s realized price for its gas production will be approximately 40% below the realized prices Rice receives for its production in Q4 2015 and Q1 2016.

Given Rice’s Enterprise Value (EV) of approximately $2.7 billion and its $12 billion of identifiable long-term value, there is a lot to like about Rice Energy at today’s near all-time low share price.  Despite today’s weak prices, I expect Rice to add materially to its existing $3 billion reserve base next spring when its year-end financial come out due to continued strong performance from its wells and falling drilling costs.

Conclusion

At the end of this natgas bear market, there will be two kinds of companies:

  1. many zombie companies that are too indebted to take advantage of rebounding prices and
  2. a handful of financially strong, well-run companies able to capitalized on a changed market environment.

With Rice’s outstanding acreage position, history of drilling top performing wells, strong financial position and ability to further reduce costs, there should be little doubt that the company is well positioned to participate in a turn in the natural gas market once brighter days arrive.

EDITORS NOTE—My biggest position just increased its dividend in January—the only energy company in North America to do that so far in 2016.  At least one analyst says this company could increase its dividend every quarter this year.  Get the name and symbol of this growing dividend payer before the next increase! Click Here.

My Next Big Win—Right On Time

By
Keith Schaefer
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My experience is that in the stock market, wealth is built in steps.

My portfolio is flat for 12-18 months, and then a Big Win comes.  Flat again, then Big Win.  Repeat.

(The hard part of investing is keeping that money, during the flat times.)

Big Wins actually come along regularly; every 2-3 years in my experience.

It has been just over two years since my last Big Win—Pacific Ethanol, which I bought in November 2013 at $3/share.

Nine months later it was $23/share and my wife was half a million dollars richer.

And right on cue, my next Big Win has showed up, just over two years later.

That’s right now.  I think I’m staring my next Big Win right in the face, right now.

I’ve followed the business for just over a year.  Revenue is soaring.

That’s because there are very few businesses the world actually needs—but this is one of them.

This stock is my next step up.  If you miss this, it could be another two years.  Don’t wait.

Step up to new riches, RIGHT HERE.

What Went Wrong at Ultra Petroleum?

By
Keith Schaefer
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0

 

By Bill Powers

Which natural gas producers will make it through this winter of low prices?  I’ll tell you one that I think will survive….but first I’ll tell you one today that probably will not.

Natural gas prices on the NYMEX dipped below $2/mmBTU in December 2015 for just the second time in eight years.  At other natgas hubs—like in the Marcellus in the US Northeast—prices went below $1.

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With a warm winter and high , prices could stay low—which hurts all producers.  But it could be the final gasp for ones who have debt-soaked balance sheets.

Ultra Petroleum (NYSE:UPL), a company that transformed itself from a penny stock (under $1!) 15 years ago to a peak valuation of  over $100/share, (this is one of very few 100-baggers ever) or $14.8 billion in 2012, is one of many natural gas-focused fallen angels.

While the company still has the same management and operates in largely the same areas it has for most of its existence, things have changed drastically at the company over the past six years.  And because of that, I don’t see the company surviving this time of low prices.

I’ll walk you through how this train-wreck went off the rails.  Really, it’s a story of  the company continued to drill uneconomic or marginal gas wells while overpaying for entry into new areas (acreage in the Marcellus and Uinta) while financing these activities with debt.

Even though UPL is still a low-cost operator, the company now has a debt-soaked balance sheet and interest costs that are rapidly destroying shareholder value.

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By no means is Ultra the only company that has lost its way in recent years.  Nearly the entire industry chose to lever up to chase new oil plays while outspending cash flow to simultaneously grow natural gas production.

By examining the details of the transformation of Ultra Petroleum from Wall Street darling to a company fighting for its life will we will get a better understanding of the precarious position the entire industry finds itself in.

The strategy of UPL stands in stark contrast to that of Rice Energy which has spent far less money, drilled far fewer wells and taken on much less debt wells to achieve a comparable level of production and larger cash flow.

Ultra Petroleum has three concentrated areas of operation: the Pinedale/Jonah area of Wyoming where it produces tight, dry gas; northern Pennsylvania where the company produces from the Marcellus and the Uinta Basin where UPL is pursuing a secondary recovery project in a medium gravity oil field.

UPL has operated for more than a decade in Wyoming and currently holds 67,000 net acres in the Pinedale and Jonah fields that produce approximately 750 mmcf/d for the company.  Below is a graphic containing a snapshot of its acreage:

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Source: Company Presentation

In 2015 the company spent approximately $435 million to drill 137 net  vertical wells in Pinedale, or spent about $3.2 million per well.   Due to the long production history of wells in Pinedale and Jonah, where there have been more than 4,000 wells drilled over the past 25 years, it is reasonable to expect the average well to produce approximately 4 bcf over its lifetime.

As might be expected given UPL’s long-term presence in Wyoming, the majority of the company’s value rests here.  Assuming 75% of Ultra’s acreage is drilled over the long-term, and using 40-acre well spacing, the company has a total of 1,256 net locations that would yield it approximately 6 tcf over the lifetime of the wells.

However, due to the extensive drilling that has already occurred on UPL’s acreage, it has a working interest in 2,500 wells, and the high initial decline rate of its wells, it is reasonable to assume that approximately 3 tcf of future production remains on Ultra’s Pinedale and Jonah acreage.  Assigning a value of $1.50 per mcf for the remaining reserves in Wyoming values UPL’s Pinedale/Jonah property at $4.5 billion.

In October 2013 UPL entered the Uinta Basin through the purchase of the 9,000 acre Three Rivers field that was producing 4,000 barrels of oil per day (bopd) at the time of purchase.   Ultra financed this $650 million purchase entirely through debt.  Below is a snapshot of the company’s acreage:

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Source: Company Presentation

Though the Three Rivers field was considered a mature field at the time of purchase due to its extensive development, UPL management justified its purchase price due to the potential for additional recoveries through an infill drilling and waterflood program.  During 2014 the company drilled 74 new vertical wells into Three Rivers at a cost of $1.7 million each (about $150 million total) and ramped production up nearly 3-fold over the course of the year.    According to the company, the Three Rivers field exited 2014 at over 11,000 bopd.  (Source: Company 2014 10K)

Unfortunately for shareholders, the timing of a massive ramp up in production from Three Rivers could not have been worse.  Due to the waxiness of the crude oil in the Uinta Basin (it is priced off a benchmark called “Black Wax Crude”), Ultra and others receive a discount to NYMEX WTI of between 10 and 20% and sometimes even higher.  Receiving large discounts and falling NYMEX prices has made much of the recently added production rather unprofitable.

Due to the weakness in Uinta pricing over the past year UPL drilled only 19 wells in 2015 and did not complete any of them.  However, in the first half of 2015 Ultra initiated a waterflood on Three Rivers that it hopes will greatly improve recoveries.

While it is still early days with regards to the success of the waterflood, I am somewhat skeptical a material increase in recoveries can be achieved in a field with 18 to 20 API gravity oil.  Time will tell.

The lack of new wells coming online in 2015 and the early stage nature of the waterflood caused production at Three Rivers to collapse 60% in the first 9 months of 2015 to only 4,750 bopd according to a September 2015 presentation.  I expect further declines in production in 2016 as minimal activity is likely to occur due to today’s weak prices and the heavy discount on Uinta crude.

After spending over $800 million on the acquisition and development of Three Rivers over the past two years, UPL has little to show for its efforts.  With production from the field falling and it producing negative cash flow in today’s price environment, Ultra has destroyed nearly $600 million of shareholder capital in a very short period of time.

A fair value for UPL’s Three Rivers field, assigning a value to its proved developed producing reserves of $14 per barrel, would be approximately $200 million.

UPL’s foray into the Marcellus at a time of skyrocketing land costs has only slightly outperformed its investment in the Uinta Basin.   Ultra’s first entry into the Marcellus occurred in 2008 when it formed a 50/50 joint venture agreement with privately held East Resource to test both the Marcellus and the Oriskany formations in northeast Pennsylvania.  (The Oriskany is a prolific sand formation directly beneath the Marcellus that has been produced in Pennsylvania for decades.)

Due to the success of early drilling in the Marcellus, UPL increased its acreage positions in and around Tioga and Potter counties to 320,000 gross or 170,000 net acres shortly after entering the Marcellus.  In 2009, the company purchased 80,000 net acres in northeastern Pennsylvania for $400 million or $5,000 per acre that brought the company’s total net acreage position to approximately 250,000 acres.   Similar to the purchase of Three Rivers, this acquisition was funded entirely with debt.   During 2012 the company drilled 27 net wells on its Marcellus acreage at a cost of over $200 million and in 2013 drilled another 20 net wells costing approximately $150 million.

By 2014, unable to produce consistent results on its acreage in northeast Pennsylvania and a very weak pricing natural gas in the Appalachian Basin, UPL significantly reduced its exposure to the Marcellus by swapping 155,000 net acres and $925 million in cash with Shell for Shell’s acreage in the Pinedale.  Once again, the cash portion of this transaction was funded entirely with debt.

Today, the company’s footprint in the Marcellus is a fraction of what it once was.  Below is a snapshot of UPL’s remaining acreage position in the Marcellus:

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Source: Company Presentation

Due to continued weak wellhead prices in the Marcellus, gas for delivery into the Leidy, PA hub on January 8th averaged $1.30 per MMBTU, and acreage that lies outside of the most prolific part of the play, a fair value for UPL’s remaining 130 bcf of proved reserves in the Marcellus would be approximately $.75 per mcf or $100 million.

Due to UPL’s propensity to fund property acquisitions with debt during a period very low natural gas prices, the company’s debt load has grown significantly in the past 7 years.  The below table display’s the company’s growth in year-end debt:

Year Total Debt on 12/31
2009 $795 million
2010 $1.6 billion
2011 $1.9 billion
2012 $1.8 billion
2013 $2.5 billion
2014 $3.4 billion
2015(est.) $3.4 billion

Source: Company 10K reports

UPL Valuation

While Ultra Petroleum has assets that can be valued at approximately $4.8 billion and debt of $3.4 billion, one could posit that the company’s shares should trade closer to their estimated net asset value of $8.50 per share ($1.3 billion in assets/153 million shares) rather than their current going rate of under $2.00 per share.

However, today’s commodity price bear market, dropping revenues, high decline rate project areas and Ultra’s large interest expense is choking the life out of the company.

For example, in Q3 2015 the company generated $222.5 million in revenue but had cash operating costs (which excludes depletion costs) of $102.5 million and interest expense of $43.1 million.  UPL’s interest expense alone consumed a whopping 19.3% of the company revenues for the quarter.

But it gets worse.  During Q3 2015, Ultra realized a gain of $45.3 million on its gas hedges which improved its average realized price to $3.33 per mcf from the otherwise $2.68 per mcf had the hedges not been in place.  However, Ultra’s natural gas hedges expired in October 2015.  Without a hedge book in place the company is likely to see its realized price for gas fall approximately 20% in Q4 2015 compared to Q3 2015.   Even weaker realizations can be expected Q1 2016.

Though UPL’s 2016 capex guidance will not be available until Q4 results come out next month, the company is likely to spend only enough to keep production flat in Wyoming.  According to the Q3 2015 company conference call, this would indicate about $300 million in spending in Wyoming this year.  Also, UPL is likely to spend only minimal amounts on its Uinta and Marcellus projects areas in 2016 due to the very poor current economics of both project areas.

It is quite clear that the strategy of UPL over the past six years of:

  1. continuing to drill hundreds of uneconomic/marginally economic gas wells
  2. overpaying for access to an oil project in Utah and
  3. for fringe acreage in the Marcellus

has severely damaged the company’s ability to weather today’s storm.

The outlook for Ultra Petroleum stands in stark contrast to that of Rice Energy.  Rice has a manageable debt load and concentrated, high-quality asset base that was acquired at reasonable prices which allows the company to grow production without grossly outspending cash flow.

Lastly, and most importantly, the inability of gas-focused companies such as UPL (Chesapeake Energy would be another) to survive the current market difficulties and increase drilling as prices improve, will make the next upturn in prices one for the ages. 

The searing downturn that is now in its final stages has so severely damaged the risk taking appetite and risk taking ability of the E&P industry that US natural gas production has now entered a decline that will last for years.  This situation will be great for the industry survivors such as Rice Energy (RICE-NYSE) and but may be of little value to companies like Ultra Petroleum.

Editors Note—This is a story about survivors.  This stock is a THRIVER—and it put my portfolio in 2015 into the black.  I now make $3500 a month in dividends from this stock.  Click HERE to get it working for you.

How to Connect With Success

By
Keith Schaefer
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Meet the Energy CEO’s—for FREE—in Toronto on Saturday, March 5
One of the most difficult jobs of the year is selecting the companies to present at the Subscriber Investment Summit (SIS).  It’s because we want the best companies possible there.

Companies like Canamax, which was bought out for a near double in December 2015.  And companies like Granite Oil, which increased dividends twice last year, and is likely the only junior producer trading at the same price now as it was in October at the Vancouver conference.  NexGen just announced one of the biggest uranium drill holes in history, and that stock has analyst targets at 3-5x its current price (and a great chart to boot!).

Meeting the CEOs, and other experienced investors, is how you Connect with Success at our Subscriber Investment Summit.

This year’s Toronto conference is Saturday, March 5th at the Toronto Hilton, downtown at the corner of Richmond and University. Click here to register today!

We have an incredible line up of energy CEOs attending. Here’s the list:

Michael Fallquist has grown Crius Energy Trust (KWH.UN-TSX; CRIUF-PINK) to almost 1 million customers from scratch in the last few years.  The company has NO DEBT, and pays a dividend. With only 17 million shares out, even a small increase in revenue can mean a big dividend increase.  All their revenue is in US dollars.  This energy retailer ticks all the boxes.

Ask Michael about his long-lasting residual payments on his solar sales, or how he benefits from declining energy prices.

Pat Ward’s Painted Pony Petroleum (PPY-TSX; PDPYF-PINK) will be the #1, fastest growing junior gas producer in Canada in the next two years, going from 16,000 boepd to 40,000 boepd in that time.  They’re well hedged, have no real development risk and give investors an incredible call on higher gas prices. Painted Pony has partnered with Altagas (ALA-TSX), whom I expect to be the first LNG project shipping natgas off Canada’s west coast.

Ask Pat and Jason about LNG and pricing, and breakeven levels.

Ian Telfer and Craig Steinke’s Renaissance Oil (ROE: TSX-V) was the only Canadian company to win any properties in the December 2015 Mexican auction.  They beat out the second place bids by only 2%!  They partnered with oil services giant Halliburton who does a lot of business in Mexico.

Ask Craig what he will be spending his $25 million in available capital on, and at what oil price he thinks he can get 1 year payback on wells.

Marc Murnaghan’s Polaris Infrastructure (PIF-TSX; RAMPF-PINK) is a most unusual energy producer because it knows exactly what price it will be paid for its energy for the next 10 years. The other interesting thing? They only have to drill a well every 2-3 years to keep production steady. Lowest decline rate in the world? Maybe. They produce 50 Megawatts of power from geothermal energy in Nicaragua.  PIF is having a big growth curve in 2016 with three new wells, and will be starting a dividend in Q3 this year.

Ask Marc and CFO Shane Downey how much they think they can increase their Free Cash Flow this year if these wells are successful.

You have many reasons to speak with Tamarack Valley (TVE-TSX; TNEYF-PINK) CEO, Brian Schmidt. You probably want to ask him how he gets such top performing wells out of Alberta’s giant Cardium play.  What does he do different?  How does he get such fast payback on wells with such a high percentage of natural gas?  Brian has been very active at CAPP—the Canadian Association of Petroleum Producers—for years.  He is very well connected, incredibly knowledgeable and willing to share.   He’s also one of the most disciplined operators in the patch.

There is a simple question for Richard Thompson, CEO of Marquee Energy (MQL-TSXv; MQLXF-PINK)—how did you assemble such a large, contiguous package of low-cost, highly productive oil production just outside of Calgary in a hyper-competitive environment? It’s a great story, and tells you about the patience, diligence and deal maker in whom you are investing.  His Michichi play is already one of the top payback plays in Canada, but you should ask him how he’s reducing costs even more.

We keep the presentations brief, and the one-on-one time long—at the coffee breaks and during lunch so you can ask them questions directly, face-to-face.

You get to ask them anything you want—and get a sense of them as people.  Being around winners helps you find winners.

Come meet them NOW—right here:

TORONTO SUBSCRIBER INVESTMENT SUMMIT 2016
Hilton Hotel – Downtown Toronto – 145 Richmond Street West
Saturday, March 5th, 2016 9 AM – 5 PM

Cocktail Reception to follow at the close

Connect with Success. Register today. Click here

(You have to pay $200 to enter the CAPP show in April to meet them, and here you get to do it for free.)

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