Energy Prospectus

We are going to publish the next edition of The View From Houston newsletter on January 22, so I am carefully reviewing my forecast/valuation models for all of our model portfolio companies today. I want to point out that there are a few things that will have a big impact on Q4 reported earnings (i.e. - GAAP results).

Keep in mind that "Adjusted Earnings" are what you need to compare to First Call EPS estimates and to my EPS forecasts. I know, this is very confusing to most of you but Generally Accepted Accounting Principles ("GAAP") rules for upstream oil & gas companies cause some very distortive earnings reports for individual quarters. Here are a few big ones that will impact Q4.

1. Mark-to-Mark Adjustments on Hedges: When commodity prices are a lot higher at the end of a quarter than they were at the end of the previous quarter, this will require a company with a lot of future production hedged to record a BIG non-cash adjustment to their hedges. This adjustment shows up as a loss on derivatives in the income statement.

2. The GOP Tax Bill: The much lower corporate tax rates will cause companies with big deferred tax liabilities (deferred assets in rare cases) to make a big adjustment. Again, this is a non-cash item and should be ignored. The lower tax rate goes into effect in 2018, so it will have a positive impact on future earnings and cash flows.

3. Year-end Reserve Reports: Upstream companies are required to have a 3rd party engineering firm review and report on their proven reserves at the end of each year. Details of the report must be included in the companies annual report (10K). Since the Sweet 16 are growth companies, they should all report nice increases in proven reserves. Higher commodity prices also increase proven reserves because they extend the economic life of producing assets, thus increasing EURs. Higher proven reserves lowers the DD&A rate since all of these companies calculate DD&A expense using the Units of Production Method. This can have a BIG IMPACT on Q4 and future Net Income.

4. Impairment: Companies that use the Full Cost accounting method should not have any impairment charges in Q4, but companies using the Successful Efforts method might have some. Ignore this non-cash expense.

I CANNOT STRESS ENOUGH THAT YOU ALL NEED TO FOCUS ON CASH FLOW FROM OPERATIONS WHEN COMPARING UPSTREAM COMPANIES. "Cash pays the bills, not reported income."

I have made minor adjustments to my forecast models for CLR, GPOR, RRC and RSPP. Updated forecast/valuation models will be posted to the EPG website later today. The only significant adjustment is to GPOR's valuation. I am lowering it to $25/share from $31/share because I have lowered the realized gas prices in my forecast and I am using a lower multiple of cash flow per share to value it. "Gassers" are in the Wall Street "penalty box" these days, but that can change quickly. The Sweet 16 is heavily weighted to oil and so should all of you be, but I want some exposure to high quality gassers in the portfolio.

CLR has a lot of upside if oil stays over $60 because it is unhedged. EOG is also unhedged.

First Call's forecasts for Revenues, EPS and CFPS have moved much closer to my forecasts since I last updated the forecast models. It is clear that Wall Street firms are raising the commodity prices used in their forecast models, but some firms are still using oil prices sub-$50/bbl.

Most of the Sweet 16 should report Q4 results above the current First Call EPS estimates. All of them are on-track to report much better Q1 2018 results than what First Call shows today.

I have been tracking and modelling all of the Sweet 16 for several years; some of them for over ten years. I have a very HIGH level of confidence in my forecast models for these companies.