Energy Prospectus

Mark Papa is a super smart guy, so he has figured out what I have been telling you in my podcasts for many months > U.S. oil production is not going up as fast as the "experts' think it is. Mark is the former Chairman and CEO of EOG Resources, a company that has been in our Sweet 16 since 2006. - Dan
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Mark G. Papa, Chairman & CEO, Centennial Resource Development, Inc. was the keynote speaker at the Bank of America Merrill Lynch Global Energy Conference held on November 16, 2017. He makes a bullish case for the price of oil, noting as follows:

· A major determinant of future oil prices is the rate of US oil growth, 2017 YOY US oil growth has been lower than expected ~330 MBD vs early predictions of ~600 MBD YOY
· US production has been essentially flat for the last 7 months
· Mark’s Perspective – 2018+ US Oil Growth is currently a minority opinion
· Even in a constructive oil price environment, US oil growth will be more tepid than most people are predicting

Reasons for tepid growth:
1. Lack of remaining Tier 1 geologic quality drilling locations in the Bakken and Eagle Ford
2. Net Gulf of Mexico year over year declines beginning in 2019
3. No new substantial resource plays to augment the Bakken and Eagle Ford (Scoop/Stack, Niobrara are localized combo plays)
4. Cash flow limitations and (perhaps) some degree of value over volume discipline among independents
· In a constructive oil price environment, total 2018+ US growth will be 600 – 750 MBD/yr. vs current predictions of 1.4 – 1.6 MMBD/yr. and demand growth of 1.2 – 1.4 MMBD/yr.
· Basis For This Prediction:

EIA monthly data is telling us something (i.e. - U.S. oil production has been flat since Feb.)
The GOM turndown is inevitable
A large portion of the Tier I Bakken and Eagle Ford acreage has already been drilled – approximately 70%
There’s a steep drop-off in oil output/well between Tier 1 and Tier 2 geologic quality
Completion technology improvements can’t cure bad rock Bakken and Eagle Ford will grow from present levels – but much less than expected
The GOM YOY growth will end in late 2018, then multi-year declines will begin
The Permian will be the only substantial US growth driver – and its growth won’t reach the high side predictions
· E&P’s Have Created The Illusion that All Shale is Equal Quality
Shale is like any other rock – the quality varies
An additional factor is the phase window
Much remaining inventory is Tier II or III geologic quality
Down spacing and multizone potential likely overstated
The Permian has the same rock quality and phase issues as the Bakken and Eagle Ford – it’s just less developed to date
Initial shale completion improvements were so rapid (and phenomenal) because the industry started from a zero knowledge base. Future improvements will be incremental
Big data will help only marginally

Conclusions
· US oil production will grow, but only at about half the rate currently predicted
Corollary: WTI will have to be very high to stimulate US growth of 1.2-1.4 MMBD/yr.
· Expect a very tight global oil S/D when the market concludes that US shale isn’t the “Big Bad Wolf” that it used to be
His slides are at the following link:
http://www.cdevinc.com/wp-content/uploa ... Final_.pdf

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Comments from one of the professors at SMU that supports EPG in the Dallas area:

Domestic crude oil production growth in 2018 will be much lower than analysts are estimating according to a presentation made by Mark Papa to the Merrill Lynch Global Energy Conference on Friday. Shale production has been essentially flat for the last seven months, a function of rock quality, lower rig counts and capital restraints, lack of new unconventional plays, slowing GOM growth, as well as slowing efficiency gains.

As a result Papa “expects a very tight global oil supply and demand balance when the market concludes that U.S. shale isn’t the “Big Bad Wolf””.
WTI pricing will have “to be very high to stimulate U.S. growth of 1.2 to 1.4 million barrels per day”.

I was speaking at an energy conference in Oklahoma on the same day and made a bullish case for energy prices based on recent trends. Papa’s slides are very interesting and tell the story, or his opinion, well: http://www.cdevinc.com/wp-content/uploa ... Final_.pdf

Papa has made this case in at least the last two quarterly conference calls. It’s the reason CDEV is unhedged on its oil production.

The FACT that U.S. production has been flat since February sure supports his comments. I still think EIA is over-estimating U.S. production each week.

What EIA reports as U.S. production each week is nothing but a wild ass guess on their part. They do not have gauges on any U.S. wells and even the operating companies do not know what their actual production is each week.

There is a lot of truth in his slides. You should all go through them carefully.

Just because an upstream company is outspending cash flow from operations does not mean it is not making money. As long as production and proven reserves are growing faster than debt, the value of the equity is growing. Most of the Sweet 16 are outspending operating cash flow this year because they are "Growth Companies". They are all going to report very large increases in their proven reserves this year.

For example, Parsley Energy (PE) has been outspending cash flow from operations since it was formed. Here is what annual production has been:

2015A: 21,985 BOE per day
2016A: 38,225 BOE per day < up 73.9% YOY
2017E: 67,761 BOE per day < up 77.3% YOY
2018E: 105,000 BOE per day < up 55% YOY based on my forecast

Per First Call, here is what operating cash flow is going to be:
2015A: $1.11
2016A: $1.58
2017E: $2.17 < This agrees with my forecast
2018E: $3.59 < My forecast is $3.94 using $50 WTI and $3.00 ngas
2019E: $5.46
2020E: $8.32

Note that First Call's cash flow forecasts are based on low commodity price decks.

99% of upstream oil & gas companies can generate "free cash flow" by stopping all drilling and completion operations. Any retail store can generate lots of "free cash flow" by liquidating all of their inventory.

I will be finishing work on the CXO and EOG profiles today. Anyone that says U.S. upstream companies cannot make money at $50/bbl oil price is not looking at companies like this (or any of our Sweet 16). CXO and EOG are funding all of their capex with cash flow from operations. CXO paid off $500 million of debt this year.

EOG has unlocked a new play (really and old play but with better completions designs): The Austin Chalk that sits on top of the Eagle Ford.

In the third quarter, EOG continued to delineate the South Texas Austin Chalk. EOG completed eight gross (eight net) wells in Karnes County with an average treated lateral length of 6,000 feet per well and average 30-day initial production rates per well of 4,440 Boed, or 3,195 Bopd, 630 Bpd of NGLs and 3.7 MMcfd of natural gas. Notably, EOG completed the Elbrus Unit 103H with a lateral length of 3,700 feet and 30-day initial production rate of 7,760 Boed, or 5,425 Bopd, 1,185 Bpd of NGLs and 6.9 MMcfd of natural gas.

EOG has over 8,000 undrilled horizontal drilling locations that will generate over 30% ROR if oil sells for just $40/bbl.

I expect all of our Sweet 16 to have very impressive year-end proven reserve reports. They've had successful drilling programs this year.