Dan could you expand on wither for an oil company it is better to have free cash flow or just cash flow, and what is the difference.
Thanks
Dan cashflow question
Re: Dan cashflow question
It depends.
"Free Cash Flow" is cash flow from operations - capital expenditures. "Cash Flow from Operations" is Net Income +/- the non-cash items on the Income Statement. Public companies are required to file a "Cash Flow Statement" with their 10Q SEC filing each quarter.
In my opinion, the term "Free Cash Flow" has been overused. It implies that capital expenditures should be considered current period expenses, just like lease operating expenses. "Capital Expenditure" are just trading cash for fixed assets (i.e. drilling and completion costs that are capitalize to the balance sheet), which should generate a lot of future cash flow for the company.
So... If a capital program creates or enhances the value of existing assets more than they spent, then it is a good thing. For example, EOG Resources spent ~$5.8 Billion on capital expenditures in 2018 that IMO added fixed assets (primarily new wells) that will generate ~$20 Billion in future cash flow. I'd say that is a good capital expenditure program.
Our Sweet 16 and Small-Cap portfolio companies are "Growth Companies". They build shareholder value by drilling and completing wells that add a lot of proven reserves that will generate future cash flow.
Any upstream company can cease all capital expenditure and they will generate a lot of Free Cash Flow, but that would eventually cause them to go out of business. We don't want, that do we?
Mature companies, like EOG Resources, now generate much more cash flow from operations than the spend each year on capex. EOG generated over $2 Billion of "Free Cash Flow" in 2018 and their capex program increase production by 18.5 percent. EOG's 2018 capex program will pay out in less than a year; that is incredible.
"Free Cash Flow" is cash flow from operations - capital expenditures. "Cash Flow from Operations" is Net Income +/- the non-cash items on the Income Statement. Public companies are required to file a "Cash Flow Statement" with their 10Q SEC filing each quarter.
In my opinion, the term "Free Cash Flow" has been overused. It implies that capital expenditures should be considered current period expenses, just like lease operating expenses. "Capital Expenditure" are just trading cash for fixed assets (i.e. drilling and completion costs that are capitalize to the balance sheet), which should generate a lot of future cash flow for the company.
So... If a capital program creates or enhances the value of existing assets more than they spent, then it is a good thing. For example, EOG Resources spent ~$5.8 Billion on capital expenditures in 2018 that IMO added fixed assets (primarily new wells) that will generate ~$20 Billion in future cash flow. I'd say that is a good capital expenditure program.
Our Sweet 16 and Small-Cap portfolio companies are "Growth Companies". They build shareholder value by drilling and completing wells that add a lot of proven reserves that will generate future cash flow.
Any upstream company can cease all capital expenditure and they will generate a lot of Free Cash Flow, but that would eventually cause them to go out of business. We don't want, that do we?
Mature companies, like EOG Resources, now generate much more cash flow from operations than the spend each year on capex. EOG generated over $2 Billion of "Free Cash Flow" in 2018 and their capex program increase production by 18.5 percent. EOG's 2018 capex program will pay out in less than a year; that is incredible.
Dan Steffens
Energy Prospectus Group
Energy Prospectus Group
Re: Dan cashflow question
Here is an example using a company that in the early stage of life.
Parsley Energy (PE) is one of the "Aggressive Growth" companies in our Sweet 16 Growth Portfolio.
Based on my forecast model, Parsley should generate approximately $1.24 Billion in Cash Flow From Operations in 2018. They spent approximately $1.50 Billion on capital expenditures in 2018, so they had no Free Cash Flow in 2018. Is that "bad"? It depends.
Parsley increased production by 61% year-over-year (a VERY GOOD thing) and they probably increased their proven reserves ("P1") by more than 150 million barrel of oil equivalent ("BOE"). My guess is that the present value of their proven reserves increase by $2.5 Billion and a lot of their leasehold is now Held by Production ("HBP"), which increases its value.
So, Parsley outspent their Cash Flow From Operations, by $260 million to increase the value of their Fixed Assets by $1.0 to $1.5 Billion (net of depletion of assets heading into the year). That looks like a big increase in the value of their Equity to me.
Just remember, the real value of equity (common stock) for any company is the present value of its Net Assets. In other words, the present value of future cash flows - debt. If asset values are going up faster than debt, then the equity is worth more.
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Another thing to remember for companies in the Permian Basin, is that one horizontal well can hold a lot of valuable leasehold with "stacked pay zones". For example, from one drilling pad Parsley can drill a horizontal well with a two mile long lateral that will hold two sections (1,280 acres). If the rig drills another horizontal well in the other direction they now hold four sections. From that same pad, Parsley can end up drilling 24 to 40 horizontal development wells (four horizontal wells in each direction in 3 to 5 producing zones). That one pad could end up producing 20 to 50 million BOE of future production. If the wells cost $8 million each to drill and complete, 40 wells would cost $320 million. If 50 million BOE of reserves are added to the books, the Finding & Development costs ("F&D") are just $6.40/BOE. That is FANTASTIC. Double the F&D cost and it is still darn good.
Parsley Energy (PE) is one of the "Aggressive Growth" companies in our Sweet 16 Growth Portfolio.
Based on my forecast model, Parsley should generate approximately $1.24 Billion in Cash Flow From Operations in 2018. They spent approximately $1.50 Billion on capital expenditures in 2018, so they had no Free Cash Flow in 2018. Is that "bad"? It depends.
Parsley increased production by 61% year-over-year (a VERY GOOD thing) and they probably increased their proven reserves ("P1") by more than 150 million barrel of oil equivalent ("BOE"). My guess is that the present value of their proven reserves increase by $2.5 Billion and a lot of their leasehold is now Held by Production ("HBP"), which increases its value.
So, Parsley outspent their Cash Flow From Operations, by $260 million to increase the value of their Fixed Assets by $1.0 to $1.5 Billion (net of depletion of assets heading into the year). That looks like a big increase in the value of their Equity to me.
Just remember, the real value of equity (common stock) for any company is the present value of its Net Assets. In other words, the present value of future cash flows - debt. If asset values are going up faster than debt, then the equity is worth more.
---------------------------------
Another thing to remember for companies in the Permian Basin, is that one horizontal well can hold a lot of valuable leasehold with "stacked pay zones". For example, from one drilling pad Parsley can drill a horizontal well with a two mile long lateral that will hold two sections (1,280 acres). If the rig drills another horizontal well in the other direction they now hold four sections. From that same pad, Parsley can end up drilling 24 to 40 horizontal development wells (four horizontal wells in each direction in 3 to 5 producing zones). That one pad could end up producing 20 to 50 million BOE of future production. If the wells cost $8 million each to drill and complete, 40 wells would cost $320 million. If 50 million BOE of reserves are added to the books, the Finding & Development costs ("F&D") are just $6.40/BOE. That is FANTASTIC. Double the F&D cost and it is still darn good.
Dan Steffens
Energy Prospectus Group
Energy Prospectus Group