Sweet 16 Update - June 9

[dan_s]

The Sweet 16 moved 2.44% lower during the week ending June 8, 2018. It is now down 6.45% YTD. This is surprising since the price of oil is much higher YTD (WTI up 43% and Brent up 58% YOY) and ngas and NGL markets have firmed up nicely. Morgan Stanley and Wells Fargo have recently increased their oil price forecasts. The front month (Aug) NYMEX contract for natural gas closed at $2.905/MMBtu on Friday and the December - March NYMEX contracts are now firmly above $3.00. None of the "experts" predicted gas prices moving higher this year.

Only three stocks in the Sweet 16 moved higher last week: AR, CDEV and PXD.

The Permian Basin "Takeaway Capacity" issue is taking on a life of its own. This is more of a 2019 problem because as of today the pipelines serving the Permian Basin still have ~10% unfilled capacity. Based on current production forecasts the pipelines will be 100% full in Q2 2019.

There is a big oil price differential between Brent and WTI (over $10/bbl) and an additional regional price differential of more than $10/bbl between Midland and WTI. Keep in mind that the full impact of these differentials only applies to a few totally unhedged companies that don't have marketing agreements in place. PXD and CDEV have done a good job communicating with the analysts that they have a handle on the problem. PDCE also has a new agreement in place that covers most of their Permian production and should get them favorable pricing at least through 2018.

I took a hard look at Callon Petroleum (CPE) this morning. I have lowered production post-closing of the acquisition from Cimarex (XEC) and I built in more "cushion" for the unknown of regional discounts on their production. I am taking down my valuation by $1.00 to $16.00/share, which compares to First Call's price target of $17.29. My updated forecast model for CPE will be posted to the EPG website later today. The Credit Suisse report on the Permian Basin, which I mention under The View From Houston tab, has a $14.00 price target on CPE despite the fact that their cash flow per share forecasts for 2018 and 2019 are higher than what I now show.

I am not adjusting the other Permian company valuations because I think I have enough "cushion" built into my models to handle the impact for 2018 and I think these high quality companies have a better grip on the situation than what the Wall Street Gang is giving them credit for. PXD definitely calmed some nerves in their recent presentation.

Cimarex Energy (XEC) is the real "Head Scratcher" this year, down 29.85% YTD. This is a conservative company with a strong balance sheet that will be getting even stronger when they close the Permian Basin sale to Callon. Plus, Cimarex has a significant position in the STACK play. I can see them taking a rig or two out of the Permian Basin and moving it to Oklahoma if the takeaway issue becomes a big problem for them. XEC closed at $85.59 on Friday, which compares to First Call's price target of $126.94.

Personally, I find it hard to believe that trucking companies won't flock to West Texas to solve the takeway capacity problem. We are talking about Texas for God sakes!

One more thing: The First Call Price targets increased week-to-week on 12 of the Sweet 16. The "gassers" are still not getting much love from Wall Street, but stars are beginning to align for a nice run up in natural gas prices. Note that all three of the Sweet 16 gassers (AR, GPOR and RRC) do not produce from the Permian Basin. Permian Basin gas will be selling at a deep discount to HH this year and probably next year too.