Man it feels good to be a gangster…
But in oil and gas, we live and die by commodity prices so it’s like taking credit for the weather
Timing any market is extremely difficult. In my favorite movie of all time (The Big Short, which I shall be watching again this weekend to make sure that I retain my "loveable" brand of cynicism), the shorters were wrong for a long time before they were right because the market can stay irrational for longer than you can stay liquid. And thus risk management, a correct macro thesis, and patience, will be rewarded in the long term (as long as you don’t hold too long!)
The biggest business challenge to the oil and gas industry is that we are price takers. Huge amounts of capital are required up front- to pay for land, wells, facilities and infrastructure and the best day of a wells life? The first day. Every day thereafter is worse. Production declines, costs go up, pumps break, and well life happens. Scale. Spills. Leaks. Corrosion. It’s a heck of a lot easier drilling wells than it is producing them for the next 30 years. Private equity companies knew that, and thus the acquire and flip model was far preferred to the “drill your returns” model of today.
That said, many of these PE companies have successfully made the pivot. Birch Resources was one of the first. When I first heard their plan in 2019 to drill and complete 100% of their ~18,000 acres within 18 months with 5 rigs, I thought they were crazy. But like Felix and Double Point before, they just realized the game was about capturing the spread on “undeveloped” to “developed” acreage before anyone else. Flash forward to today and we see Tap Rock at 7 rigs, Ameredev headed to 6, and Colgate buying and building and kicking a$$ and taking names. But danger lurks.
When it comes to oil, currently trading above $93/bbl and trading north of $75/bbl in August of 2023, the backdrop is a far cry from the time when CDEV put hedges in place in Q2 of 2020 at $26/bbl, after famously rejecting the premise of hedging prior to. After General Soleimani was killed by missile January 3, 2020, I wrote a post when oil was $63 that anyone that wasn't hedging was crazy. HAD they hedged, 2020 would have been materially different. Many didn't. As a result, some companies were fire-saled. Others were smashco'd. And in hindsight, the Parsley and Concho boards of directors are likely kicking themselves.
Today, there is no doubt there is an energy crisis that has been exacerbated by “the energy transition narrative.” Those chickens are coming home to roost in their own. The U.K. just raised the power prices cap by 54%. The riots in Kazakhstan were another example of experiencing the reality of rising costs. But for oil and gas companies here, they aren’t immune to the panic. Supply chains are truly in disarray. Casing costs have doubled. 1000s of hard working field hands have left the industry, leaving a hole of experience. Sand is hard to come by. And OPEC+ discipline is materially at odds with their actions in March 2020.
So what to do? Hedge. Not all, of course, but certainly a lot. I would argue that a consistent hedging strategy over the last 4 years would have been a net positive, in particular helping avoid the 2020 black swan. Those that did it well, like Tap Rock, looks like an absolute genius for how well they managed their book through the cycle.
As the 10Ks from U.S. companies come out, we will revisit the SMOG exercise of late 2019 to dig into the true NAV and opportunity sets of many of these companies. But in the meantime, caution, concern and remembering the lessons of April 2020 might serve companies, management teams and their employees well. Don’t get too cocky, because being a gangster is good… until it isn’t.
When I first started in the Industry, HS Resources had a great trading group that on its own would make as much income annually as the entire operation. A great asset. But when we were acquired Kerr McGee, their management made it clear. We don't hedge. They bought us when landlocked gas in Colorado was selling for $13/MCF. 8 months later it was down to $3/MCF.
The fact is when you have a capital programming, hedging enough to cover your expenses and locking in prices when you can is simply prudent business sense. Do you lose some opportunity cost on the back end if prices are higher? Yes, but given the alternative, it can keep you out of bankruptcy too.
an inveterate self-kicker....held stock too long waiting for Good Dough....an epic Icarusque crash back to earth