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Betting On A Survivor


Around three years ago, in June of 2014, oil began a spectacular collapse. After rising to the point where WTI was fetching over $100 a barrel and holding that psychologically important level for a few months, the market turned. Six months after the rout began the price of a barrel of oil had halved, leaving a lot of companies in a lot of trouble. The hardest hit businesses in the industry were small exploration and production (E&P) companies. Even those that saw it as an anomaly rather than a new normal had worked on assumptions that seemed reasonable or even quite conservative at the time but proved disastrous very quickly. From that point, planning on a long-term average price of around $80 per barrel and borrowing and investing accordingly looked like a too conservative plan if anything.

As prices collapsed, however, even those companies faced a serious problem. Debt levels that looked manageable with oil at an average of $80 now became serious burdens. That situation was worsened by the fact that much of the borrowing had been done to finance land and mineral rights lease purchases that were now essentially worthless. There is no point having a right, and in many cases an obligation, to drill on land where the oil and gas cost more to get out of the ground than you can expect to get for it in the market.

I retell this history, as distressing as it is for most energy investors, to make a point about companies that have survived to this point. Many of them are still in existential danger. The big, multinational integrated firms, of course, have seen all this before and will ride it out. Many of the smaller E&P companies, however, face a daily fight to survive in the hope that oi and natural gas, or both, will recover soon. Each drop in prices such as that which came this week in response to another awful inventory number further delays that time and each one looks increasingly like another nail in some coffins.

There are, however, a few bright spots. Take Abraxas Petroleum (AXAS) for example. This is a company that faces exactly the problems outlined above, and around a year ago looked to be on the verge of bankruptcy. But their reaction to the problem has left them equipped to survive, and even to emerge out the other side of the changes as a leaner, more focused operation. The 3 Year chart of the stock shows that story.

(Click to enlarge)

Recently, however, as WTI has dropped back to the lower end of its recent roughly $45-$55 range, AXAS has lost ground again, dropping around 40% from the highs at the turn of the year. Given the history that makes sense in some ways but the restructuring and refocus have hugely reduced the existential risk to the company with oil at these levels, as demonstrated by the fact that they are making rather than losing money. I believe that light a 40% drop in reaction to a 20% decline in oil looks seriously overdone.

AXAS is better placed to withstand price fluctuations now that they are concentrating their efforts on their more profitable Permian Basin holdings. If, like me, you believe that oil is essentially range bound right now it looks cheap around here and is worth another chance.

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