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 -


LinkedIn Post

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:

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 -


Twitter Discussion

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:

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 DRWselling 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 -