Continental Resources (CLR) announced its 2016 guidance on January 26 (excerpts below). Essentially it confirms our theory of the new normal of seeking free cash flow (FCF) vs operation CF ex capex, commonly referred to as EBITDA. It also confirms the complete lunacy of the notion that oil prices can remain below $40 forever, as Goldman Sachs has suggested multiple times.
For CLR to remain a viable entity, it can just cover its cap ex via FCF at $40 oil. To earn an adequate return for its shareholders of about 20 percent would imply oil prices probably normalizing in the $50s, enough to sustain the industry at least.
2016 Guidance Detail
Looking to the current year, the Company expects first quarter 2016 production will be in a range of 210,000 and 220,000 Boe per day and expects to exit 2016 with fourth quarter production between 180,000 and 190,000 Boe per day, reflecting reduced drilling and a lower level of well completion activity.
Non-acquisition capital spending is expected to be approximately $300 million in first quarter 2016, down from an estimated $395 million in the fourth quarter of 2015. By fourth quarter 2016, capital expenditures are expected to decline to approximately $200 million.
The Company estimates its 2016 capital expenditures budget will be cash flow neutral at an average WTI price of $37 per barrel for the full year. At an average WTI price of $40, the Company estimates 2016 results would be cash flow positive in excess of $100 million.
A few takeaways from this insight. First, quarterly production will decline some 15 percent by 4Q16 vs 4Q15. As a reminder CLR remains essentially unhedged, as it liquidated its positions a while ago. As a result they are an excellent proxy to unhedged real-time metrics as all industry hedges roll off over next 18 months.
But since the rest of the industry is better hedged in 2016, they may not see such a dramatic drop off in production. However even if the industry is hedged at, say, 10 percent overall for the industry, that would imply some 900,000 per day to be removed in 2016.
Oil storage levels would begin drawing down as a result. Since storage levels, calculated in ‘days of supply,’ is only about 4-5 days over the long-term average, a 10 percent drop in production should rebalance the market closer to the 25 days’ worth of supply, a level that the U.S. saw for years (compared to the 29-30 days of supply that the U.S. has in storage right now).
Further I find it hard to believe that oil production can be sustained into 2017 when cap ex gets cut 50 percent, given that depletion by then will kick in, resulting in at least 30% drop in production from new wells in 2016. Barring a dramatic rebound in prices, the industry just won’t be able to compensate for falling output.
You notice also a change in the way senior management is managing the business, shifting from EBITDA vs FCF as it de-levers or at least avoids any additional debt to fund cap ex.
As I have previously stated: this is the new normal and will result in a much slower ramp up in production even if prices rise, as new investment must now be funded with CF vs external financing.
Eventually that will sow the seeds of a bull market as supply flat lines and demand, driven by better economic growth, starts to fuel price increases in 2017. Any production increases will be very gradual and will only follow prices, as capital will not readily be available as it was in the past.
CLR went on to say that every $5 rise in oil prices would add $150-$200M in revenue, implying that at $45, the company would generate about $275M, and at $50 oil, it would generate $450M annually. If its capital expenditures are normalized at $400M per quarter (vs about $250M per quarter in 2016) and the company needs to achieve 20 percent FCF returns, that implies oil prices need to be over $50 at least.
At $50 it would achieve $250M in FCF on $1.2 billion in cap ex. The so-called experts know this yet they continue to cloud the issue with ideologically based biased spin.
Thanks to a great post from John Kemp from Reuters we now know who is behind the magically higher imports starting in 2015 and that continues. This incremental 500,000 barrels per day of imports has been the primary reason for why the U.S. market remains imbalance (although not nearly as much as what is portrayed in media).
The motives for Saudi Arabia’s oil market strategies today – whether for vengeance, ego, politics or irrationality – cannot be known for sure. But it surely was not economics, given the price drop in 2015. A 50 percent drop in price on 9 million barrels per day (mb/d) was not made up by a 500,000 bpd increase.
I should also note that almost all of the Saudi production ramp up in 2015 went to fuel this surge. We should recall a U.S. State Department visit to Saudi Arabia in late summer 2014 when all of this started, as the dollar rose and Russia Ruble imploded. In light of the recent EPA methane crack down and tax levy on U.S. wells, one has to wonder how much of a coincidence all this is, as there is clearly a war on fossil energy as the global warming agenda ramps up.
The media bias throughout this downturn only adds to the suspicion. Whether or not it is indeed a conspiracy, the commodity bust has started to hollow out the U.S. economy.
(Click to enlarge)
You can find a video commentary with this post via Twitter @ lbrecken13.
By Leonard Brecken for Oilprice.com
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