Sweet 16 Update - Sept 21

[dan_s]

The Sweet 16 moved up 1.46% during the week ending September 20. After Monday's big spike in the price of oil it drifted lower. Oil prices will be "headline driven" and the risk for oil prices is definitely to the upside because the Persian Gulf "Drone War" has just started. Sweet 16 stock prices are trading as if WTI is stuck at $50/bbl and likely to go lower. My forecast is that WTI will average $60/bbl and move higher in 2020.

On Friday I spent several hours building a Pro Forma forecast valuation model for PDC Energy (PDCE). The company will be closing the merger with SRC Energy (SRCI) within a few months. PDCE will have production over 200,000 Boepd by year-end and should average 220,000 Boepd in 2020 making it the #2 upstream company in the DJ Basin.

PDCE closed at $30.40 on Sept 20. My Pro Forma valuation is $58.00/share and there is significant upside to that valuation when the midstream bottleneck issues in Colorado are resolves, which should be soon. See point #3 below.

Credit Suisse's special report on the DJ Basin dated September 18, 2019:

We recently completed a tour of the DJ Basin; here are three takeaways from our field trip:
1. The Basin potential is unappreciated and mired by headlines. We spoke to both midstream and upstream companies and the message was consistent across both groups - DJ growth is real and hasn’t been hindered by recent political noise (at least not in Weld County where the vast majority of PDC's activity is). That sentiment runs against a prevalent narrative among investors that the DJ has fallen out of favor and is less likely to be developed. SRC felt the returns in the DJ were competitive with the Permian; pushing back against the notion that politics are preventing development. The Energy sector’s relationship with Colorado governor Polis seems to be very constructive so far - this does not mean flare-ups with opposition groups won’t emerge from time to time, but management teams felt comfortable that a moderate consensus would continue to prevail.

2. Midstream companies appear to have an oligopoly. Ironically the negative headlines in the DJ may be working in midstream’s favor. As one management team put it: we like the fake news because it’s keeping competition out. E&Ps are short of midstream options in the DJ – it’s effectively dominated by DCP and WES, though NBLX is increasing its presence and attracting new third party business. NGL has a dominant foothold in the saltwater disposal business. A considerable portion of the acreage has been dedicated to them, which means these companies don’t run into competitive situations too often. The reason so few companies dominate the market is also partially due to E&P customers gravitating toward companies that can provide takeaway and downstream connectivity - DCP stands out here and NBLX is increasing its capabilities.

3. Midstream constraints from here should be short lived. The main constraint remains gas takeaway - processing constraints should abate as O’Connor II (DCP) and Latham (WES) come online. Line pressure should also decrease with more plants. That said, Cheyenne Connector (600mmcfd) is likely delayed into 1Q20 but should receive FERC approval soon. Until then, O’Connor II likely runs at half capacity due to the constraint. NGLs will see more headroom with the Front Range and White Cliffs expansion. Crude should benefit from the 100kbpd Saddlehorn expansion in 2H20. To the extent the market runs into constraints again, Big Horn could be brought online (permits in hand already) and Cheyenne Connector could potentially be expanded to 1bcf/d.

Henry Hub natural gas prices pulled back a bit after Thursday's storage report (Oct closed at $2.538/MMBtu), but Q4 and Q1 HH gas prices are 20 & 30 cents higher than what I'm assuming in my forecast/valuation models. AR and RRC are both trading at less than 2X operating cash flow per share.

Callon Petroleum (CPE) does face some resistance in getting their merger with Carrizo Oil & Gas (CRZO) approved by shareholders, but I expect it to close by year-end. On the day the merger closes CPE will have approximately 110,000 Boepd of production (71% crude oil, 19% natural gas and 10% NGLs). My Pro Forma forecast/valuation model for CPE+CRZO can be found on the EPG website.

Natural gas prices in the Permian Basin were terrible in Q2 (some companies had to pay to get rid of their gas) and will be bad in Q3. I expect gas prices to be about 50% of Henry Hub in Q4 as more pipeline takeaway capacity comes on-line.

The companies that will benefit the most from rising oil prices are Continental Resources (CLR) and EOG Resources (EOG) because none of their oil is hedged. I'd list OAS and TALO right behind them.

The Sweet 16 summary spreadsheet that shows my valuation and First Call's price target has been updated and it should be posted to the EPG website this afternoon.

I'm now working on the weekend podcast. Susan, our "Cruise Director" is working out some details for EPG Cruise 2020 (January 11-18, 2020 on RCL's largest ship, the "Symphony of the Seas"). Today we have 30 people that have booked the cruise.