Sweet 16 Update - January 2

[dan_s]

I spent the last two days updating all of the Sweet 16 individual company forecast / valuation models. They will all be available on the EPG website by 1/3.

My valuations assume that WTI averages $40/bbl for the first half of 2016, then steadily increases to $60/bbl by year-end. I expect natural gas to average $2.50/mmbtu for the year. I do think there is near-term upside for natural gas as winter weather finally moves into the eastern half of the country. There are going to be several very big weekly draws from natural gas storage during the next 6-8 weeks that should get a market reaction. With U.S. natural gas production on steady decline and more gas consumed for power generation and export, the long-term outlook for gas is much better than most people think it is. Last week Baker Hughes reported that only 162 rigs are drilling for gas in the U.S. We need AT LEAST 300 rigs drilling for gas just to hold production flat.

In the individual forecast models I do adjust the oil, gas and NGL prices in future periods for hedges and regional price differentials. At the bottom of each forecast model you can find a table of each company's hedges or you can go directly to their Q3 10-Q report.

Only a few of the companies have given any 2016 production guidance, so I have tried to err on the side of being conservative. Since I have followed all of these companies for years, I have a fairly good "feeling" for their production.

First let me say that all of these 16 companies have more than enough cash flow from operations and liquidity to survive another year of low commodity prices. My HOPE is that we do not have to test that theory. All in cash costs of production are in the $10-$15 per boe range, so cash flow from operations is still decent even at today's low oil prices.

With upstream drilling budgets being slashed to the bone, non-OPEC production is on decline and the rate of decline will accelerate. Oil price cycles tend to "overshoot the mark" and I think this one is on a path that could overshoot by a wide margin. The chance of an oil shortage by the end of this decade is now very high. If you watched the video that I posted here yesterday, you now know that several analysts are now forecasting that oil demand will exceed supply as soon as the 3rd quarter of 2016. There is a large amount of oil in storage today, but this is a world that consumes close to 3 billion barrels of refined products per month. I also believe there is a HIGH chance of supply disruptions in the Middle East and North Africa that is not being properly priced into the futures market.

The Sweet 16 finished the year down 22.6%, with only three companies (FANG, NFX and PE) finishing the year higher. The "gassers" were a big drag on the portfolio.

For 2016, the "gassers" have a chance to lead the pack early. Weather forecasts are now for a major winter storm to move into the eastern third of the U.S. by mid-January. A spike in gas demand would be a welcome start to the year. Southwestern Energy (SWN) is trading at just 2.2 X my CFPS forecast for 2016. It is heavily weighted to gas. Compares to RRC, which is trading at 5.3 X my CFPS forecast for 2016.

Also helping natural gas and NGL prices in the Marcellus/Utica are several large midstream projects coming on-line that will improve area netbacks by $0.50 to $0.75 per mcfe.

For the most part, my individual stock valuations are very close to what First Call is now showing. Based on the December 31, 2015 closing prices, the Sweet 16 is ~70% below my estimated fair value. The Sweet 16 spreadsheet (which you can download from the EPG website) shows my valuation compared to First Call's price target for each company.

The two areas where well economics are still good (not great) are the Permian Basin and the SCOOP/STACK oil play in Oklahoma.
Permian companies: CXO, XEC, EOG, FANG, LPI MTDR, PE
SCOOP/STACK companies: XEC, CLR, DVN and NFX. My top pick for STACK is NFX.

To learn more about STACK, see the website of Chaparral Energy: http://www.chaparralenergy.com/

Devon Energy (DVN) now looks extremely oversold. IMO opinion the market's negative reaction to the Felix Energy acquisition has created an outstanding buying opportunity on this super high quality company. Devon has some of the best technical people in the industry and they think they got a billion barrels of recoverable oil in the Felix deal.

Two companies that are almost completely insulated from commodity prices for 2016 are Antero Resources (AR) and Laredo Petroleum (LPI).

CLR and EOG are now totally unhedged. They both have more than enough cash flow and liquidity to survive and they both hold extremely good acreage.

FANG and PE are trading at the highest multiples of CFPS, but they also have the most production and proven reserve growth locked in.