Friday, December 09, 2016

OPEC: Santa Claus to NatGas

Organization of Petroleum Exporting Countries (OPEC) has reached a historic agreement with several non-member oil producing countries to cut crude oil output in 2017.  OPEC members had reached a consensus a little more than a week earlier to curtail their own production for the first time in eight years.  Russia even agreed to reduce production by 300,000 barrels per day.  The OPEC agreements together involve countries producing nearly two thirds of the world’s crude oil.  The news sent the oil back up to a price near $55 per barrel as investors saw an end to the supply glut of the last three years.  Shares of major oil and gas producers followed the oil price. 
If the majors are seen as benefiting from the oil price increase, should not the small-cap oil and gas producers be as fortunate?  Or will it simply mean a new opportunity for U.S. natural gas producers?

With the cuts that OPEC has planned among its own membership as well as the pledges of its competitors, some have speculated that the barrel price of oil could rise above the $60 price level.  No one should lose sight of the fact that it was the rise in U.S. natural gas production that led to the supply glut in the first place.  Furthermore, oil producers in the U.S., Canada and Brazil are not included in the production cut pacts.  This puts them in a good position to boost production     
A price increase in crude oil could trigger a commensurate increase in natural gas selling prices.  Higher prices are as attractive to natural gas drillers as it is to the crude oil crowd, filtering through the profit and loss projections of producers and investors alike.  If natural gas producers had a chance to ‘eat OPEC’s lunch’ over the last two years, now could take a big bite out of dinner as well.
We have a decided preference for renewable energy sources.  Yet this chain of developments in the oil and gas market is enticing.  If we have to make a choice between oil producers or natural gas producers, it would seem the natural gas sector is the real beneficiary of the OPEC action.  Of course, ExxonMobile (XOM:  NYSE) and Chesapeake Energy (CHK:  NYSE) are top natural gas producers, but there are smaller companies involved in the sector. 
One of the smaller natural gas producers that could be especially interesting is PDC Energy, Inc. (PDCE:  Nasdaq).  The company has interests in the Ohio and Colorado gas fields and recently acquired property in the Delaware Basin in Texas.  With a low level of current debt PDC is in a particularly good position to move aggressively in its markets.  At the end of September 2016, the company had $1.0 billion in total debt, representing a debt-to-equity ratio of 52.6%.  PDC had $1.2 billion in cash at that time, some of which was used for the Texas transaction.  PDC can be generous its use of cash resources for strategic moves.  In the twelve months ending September 2016, PDC operations generated $490 million in cash.
The Texas deal brings total acreage to 215,000 acres.   Over the next year, PDC plans to invest as much as $235 million in the Texas property to tap an estimated potential 700 horizontal well locations.  That would bring the company’s 2017 capital budget to as much as $775 million, which could increase production to 33 million barrels of oil equivalent, representing a 40% annual increase.  Natural gas represents about 55% to 60% of total production. 
Oasis Petroleum (OAS:  NYSE) deserves honorable mention as a beneficiary of higher fossil fuel prices.  Oasis has interests in the gas fields of North Dakota and Montana.  Although the company reported a net loss in the twelve months ending September 2016, Oasis generated $203 million in operating cash flow on $613 million in total revenue.  The Oasis balance sheet has a debt-to-equity ratio of 89% and its current ratio is 0.80, suggesting Oasis has little flexibility in its balance sheet.  Nonetheless, its interests in the Bakkan fields make it possible for Oasis to keep costs low and the cash flowing.
There are certainly more natural gas producers in the small-cap sector.  OPEC may have just delivered a wonderful holiday surprise to these companies.  With very lean operating structures and uncluttered balance sheets, the gift in higher selling prices should be the size that fits all.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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