"The dog who caught the car"

Story time and who hasn't wondered what the dog is thinking as he chases the car - what's he going to do when he catches it? Stay with me and you will understand the title. Goes back to the Red Queen as well.

Like I've expressed in most posts, what I care about is the balance sheet, the bankers, and how the company's capital is being used to deliver continuing growth in earnings above the cost of equity capital. My posts are influenced by what oil company executives (real ones) opine, services companies, bankers and regulators and commentators with proven useful information. One company I hold in high regard (because I hold the stock) is ConocoPhillips which is the largest independent E&P company in the worldwide (i.e, not a NOC (such as say CNOOC) and not a vertical integrated  O&G company like Exxon). All ConocoPhillips does is Explore & Produce Hydrocarbons - lots of 'em.

Ryan Lance presented at the Sanford Bernstein Strategic Directions conference. Here are some things to think about. Anything in italics is quote from the transcript and anything bolded is my emphasis.

"We define that breakeven price as the price needed to generate enough cash flow from our operations to cover our capital and our dividend to our shareholders. This is not an aspirational goal. One of the reasons is we have a low breakeven price is we have the lowest capital intensities in the business today. This means we can keep our production flat for much lower portion of our cash flow than most of our peers."
--> Lots of different definitions for Breakeven Price - there's another


"Our captured resource base includes 14 billion barrels with an average cost of supply of less than $35 barrel Brent and that’s post the transactions that we have announced. That represents again over 30 years of production."

--> There is more detail on cost of supply - but what's important is it is fully loaded - none of this half cycle nonsense that ignores DD&A, land, seismic, infrastructure and so on.


" So I think that the bottom line is, you have to figure out in the E&P space not only thrive, but survive in that $40 to $50 world. We know what to do if it’s $60 or $70, that’s not a problem. You have to build the business plan that is resilient, that offers shareholders double digit returns, that is viable and competitive at that kind of a price deck. If you are waiting for $60 to bailout your business model, you might be willfully disappointed..."

---> The paragraph above is part of response to where Ryan thought oil prices would be short term. It's not about surviving $40-$50 oil but being able to thrive (grow) in this scenario


"It does feel a bit bimodal in terms of investors’ attitudes. If you are bullish on commodity price, there is a lot of growthy names that you can invest in. If you are maybe bearish and a lot more defensive, there is a few yield names you can go to today in the business. I guess what we are trying to describe to you is a unique value proposition for an E&P company. One that doesn’t chase the cycle up and spend every bit of their cash flow chasing capital and then when the market turns, your growth rate goes from your double-digit down to low single-digits because you are fighting decline."

--> So very relevant to SEA (and LNR). Most of their problems in a nutshell.


"certain categories of spend in certain geographic areas that are inflating today in pumping services, sand in the Delaware and Midland Basins is inflating a lot. And it’s starting to kind of move into Eagle Ford and up in the Bakken. Not as much as the Delaware Basin, but yes, absolutely if you are a pure-play player in one of those two basins, you have to figure out how to offset some pretty healthy inflation today in the service side of the business."

--> Yes, unfortunately one man's cost savings is the other's revenue. Expect to see D&C costs start to rise. Expect to see cost per lateral foot and cost of stimulated rock volume decrease from improvement in efficiency and from technology.


"... about 4 years, 5 years ago I was invited to the Vienna meeting. I was on the stage like this in front of all the big OPEC crowd with at the time, Ali Naimi, who is the Minister of Saudi Arabia, the Venezuelan oil minister, the Iranian and I got up and I told them that U.S. would surpass Saudi Arabia in production in 5 years. And I got laughed off the stage. And 3 years later, Naimi invited me back. He said, I will be damned, you are right. And we need to understand this a little bit more. And the message to him at the time was this isn’t going away in 3, 4, 5 years. .... Here is what’s happened, but I do think they have now woken up a little bit to the realization that it’s here, it’s here to stay, it’s competitive even at these kinds of these prices and it’s going to be a supply source in the world. So, now everybody is looking at demand side of the equation saying how much is demand going to grow over the course of the next few years and how much supply is needed to meet that demand and you better set aside a pretty significant supply coming from U.S. or North American tight oil."

--> Lots of things I've left out but the message from Ryan is very clear - there is a massive resource base held by the likes of COP, CVX, EOG, DVN, CHK, XOM, PXD, .... with low fully costed supply under $40 (Brent). I believe them and do not believe those that say shale is going away in 5 to 10 years. The market is presently over supplied and I believe it can stay that way for longer than most think at $40-$50 oil or $45-$55 range bound as it presently appears to be.


"I think as we look out, the access to capital of risk-free return with interest rates as quite low, so people are looking and they look at our cycle and say well, it feels like it’s the bottom of the cycle. So, I am a little bit bullish on prices and I can play that uptick and I can play that with some of these E&P space. I was surprised even through the downturn, many of these companies that should have went away, it didn’t. So, the debtholders became equityholders and they materialized out of the back end the same way they look like they came in the front end of it."

--> This is the problem now isn't it. These assets were not taken off the market


"So to your point, it’s – there needs to be consolidation. You all have many choices on the gross side, right. I mean, if you want to pick an E&P growthy company, you’ve got lots of choices, lots of options, you’ve just got to sort through that and there is frankly too many choices, too many options. We need consolidation in this business that at these low interest rates and the kind of private equity money that’s out there and the frothiness sort of in the market for some of these names just makes consolidation while it should be happening is difficult to take place."

--> This is my point as well. All very well to look to a recovery in oil price - but that's what all the E&P growth companies are hoping for - but not all can make it. These companies cannot survive on the "status quo" of their operations. This is why LONE did what it needed to do in this May acquisition. Basically doubled their Reserves, increased production, further increased drilling optionality, strengthened the balance sheet and lengthened their runway.

--> I would really urge anyone who holds SEA to review the material I put up on LONE acquisition. IT should help with "valuing" the present SEA asset, but just as important is probably a guide as to what SEA will need to do next. I signed off that post with "What's not to like, right". If you decrypt that, it means the capital came at a high cost. Preferred Shares pay a "dividend" but this is after tax whereas interest is tax deductible (so 9% Preferred Yield is roughly equivalent to 13% Debt). Not really much choice given they did large equity raising in Dec'16. So $60 oil makes LONE more attractive than most peers. SEA will need to do something - else it will get consolidated. They absolutely lack scale.


"...I think a lower for longer and lower mid-cycle prices make a difference. And if we do see that kind of environment work out, natural consolidation will start to occur with some of the players....I wonder what happens over the next couple of years as these guys have to scale up, because they need to deliver double-digit growth rates, right. That’s what they have built their business model around. It’s the dog who caught the car, now they have got to execute, now they have got to go deliver and it’s not trivial to go do that to hold your resources, recruit and train, develop and build and then hold those human resources to chase the rig."

--> So we come to the end of the story. LNR caught their car - and were forced to make a big equity raising (effectively 100% of existing equity - same as SEA) in Dec'16 and have been planning this for a while it seems. SEA is in the same boat - they made their raising about a year ago but have not followed through with anything transformational to bulk up their scale and efficiency (IMO).

Business as usual wont deliver shareholder returns.  Hope you all get something out of the post.

Here is a transcript
http://www.conocophillips.com/inves...cuments/Bernstein Transcript-FINAL 6-2-17.pdf

Here are the slides
http://www.conocophillips.com/inves.../Bernstein Conference Deck-FINAL 6-1-2017.pdf

Here is the audio of replay (with Q&A)
https://cc.talkpoint.com/bern001/053117a_as/?entity=48_3CD4RQD