CDEV's Capital Structure & Reserves - a Case Study
“In God we trust. All others must use data” - W. Edwards Demming
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BACKGROUND.
Today’s newsletter is a one-off. A more comprehensive write-up (much too large for email) is saved here, the backup files (& a there’s pod for Unhedged users) -
Following the Ring Case Study, we’ve had questions & requests around the values of other E&P’s reserves
So we decided to take a closer look at another public E&P
We picked Centennial (CDEV)
OVERVIEW.
CDEV is a Permian E&P
With primary operations in Reeves County (TX) & Lea County (NM)
They produce ~72k boe/d, 58% of which is oil
The 30,000-foot view is straightforward:
Delaware acreage has - generally speaking - the best economics for shale oil plays
Mark Papa, the former CEO of industry leader EOG, helmed the ship, until March
In theory, a Good Management Track Record + Good Acreage should = Good Economics
Simple story…
Like Ring, the high-level takeaway for CDEV was that either:
CDEV would be flipped for a premium, or
it’d continue along its seemingly efficient growth strategy
Initially, we thought that Mark Papa & Co would get bought out -
HEDGING.
If you’ve ever played poker, then you’ve probably had a few good runs.
Sometimes they end well.
Sometimes, they don’t.
When it doesn’t, a common cause is “Winner’s Tilt”.
Strong - positive - emotions can be detrimental to a poker player.
In a game where you quickly amass half the chips, you tend to play more hands
Including hands that are likely to lose
Like 10/6, unsuited.
After giving back most of your stack, you find yourself still playing bad hands - like that 10/6, unsuited – but now, from a position of weakness.
The definition of Tilt is “a state of mental or emotional confusion or frustration in which a player adopts a less than optimal strategy”.
In the 2021 edition of the Oxford English Dictionary, CDEV’s hedging strategy will be the first example of “tilt”
On March 19th, on the 4th (consecutive) day that WTI closed below $30 in the last few years, CDEV put on WTI Fixed Price Swaps at a WA price of $26.79.
Not hedging, and then subsequently hedging WTI at $27 is a less than optimal strategy.
Running EOG for 14yrs (amassing chips)
Then running a smaller E&P w/o hedging (playing hands like 10/6 unsuited)
Hedging at a WA WTI Price of $27…
In poker, when you’re on Tilt, players are advised to leave the table & return once emotions calmed.
8 days after the hedge, Mark Papa accelerated his retirement – he left table on March 31st -
PRODUCTION.
The most commonly available tools to diligence assets (or the underlying assets of E&P securities) are publicly reported production data, supplemented with decline curve analyses.
Effectively, you can build your own production forecast:
We’ve found this to be much, much more predictive than E&P management forecasts
In fact, we’ve found this to almost always be more predictive
For this analysis, we ran a production forecast based on a third-party data provider, covering 370+ gross wells owned by CDEV.
CDEV report 72Mboepd
We found 65Mboepd in 3rd party data sets produced from public reports
Aside from our tool, Wildcax, we used:
ShaleProfile (DM Enno, or start a trial), for Data, Analytics & their Dashboards
FLOW (DM Tom, or start a demo), for their Decline Forecaster, Basin Evaluator & Type Curve Explorer
Relative / peer analyses produced interesting results…
From ShaleProfile - 48 Month, Normalized Well Productivity:
And from FLOW, Oil EUR / ‘000 ft:
Now - for shale - the Delaware is generally a better place to be than other plays…
… that said, the reality is that Centennial is - more or less - a middle-of-the-road Delaware operator -
BORROWING BASE / RESERVES.
Production forecasts from every horizontal PDP well they own
2020 guidance cost assumptions
Type curves for PUDs are presented in the table above
For the rest of the assumptions, check the full report here.
We believe CDEV’s borrowing base - empirically - should be $265MM.
We value their PDP at a 10% discount rate at $402MM:
CDEV’s latest Reserve Audit gave a PV10 of $2.2BN
Of note, CDEV’s 58% oil cut requires a high WTI price to make its economics viable:
For example, at $60 WTI, when adjusting for the % of liquids that are NGLs, CDEV realizes ~$48 / bbl for their liquids production
CAPITAL STRUCTURE.
Above, we’ve summarized CDEV’s Capital Structure, as it’s priced today.
Net, the market value of the debt & equity is ~$1.3BN.
At the current strip, we value their PDP at $400MM:
We clearly think CDEV’s PUDs are uneconomic to drill below $67 WTI
We have not included their hedges, which have a negative value (-$55MM)
Those hedges (@ a WA price of ~$26) get worse as prices increase
Fully baking in all costs (including G&A), we believe well-level break evens for PUDs are $67 WTI for their Reeves wells & $75 for Lea.
Also of note, at $60 flat WTI curve, we believe CDEV can pay back their debt from PDP cash flow.
The irony of WTI hitting $60, is that almost any shale operator will start drilling again, and drilling at $60 would be worse for creditors (at least until WTI hits $67) …
…this is the Creditor Catch-22 of Shale -
FINAL THOUGHTS.
We believe CDEV’s PDP to be worth <1/3 of the current market cap of its debt & equity.
That said, we recognize that cash flowing the PDP out isn’t the only option -
In the short history of shale, there’s been no shortage of parties that will overpay for PDP, acreage, or other assets that CDEV owns
However, if you’re underwriting this kind of investment, counting on a big-boy or a sucker (or both) to buy you out isn’t exactly value investing.
If they aren’t bought, you’re stuck owning these assets.
To be clear - we don’t hold any positions in CDEV’s securities – long or short – and we will not establish positions in them for the foreseeable future (by foreseeable, we mean months – realistically never).
We’re not short sellers.
We decided to throw this together on account demand, following the feedback from the Ring Case Study.
CDEV is discussed widely among analysts, as well as being a hot topic on the internet
And CDEV has, from our perspective, a manageable # of wells - at least for us to do as a side-project analysis
And there’re always the hopes that:
Natural resources prices can go up; &
Tech improvements can increase EURs / decrease costs
That said, hope is not a strategy.
Like with Ring, we’re here to say that if you’re going to take a position backed by production - do the work yourself. Or hire someone with the right incentives to do the proper diligence.
Finally – as always in A&D - there’s a winner & a loser.
Congrats DRW – selling those OneEnergy Partners assets turned out to be the right move -
That’s it for this week - we’ll be back to our regularly scheduled programming on Friday - catch y’all then -
Thanks for the writeup, will carefully read through it.