QEP Resources, Inc. (QEP) is facing significant debt maturities in the next few years, at an inopportune time due to the industry downturn. Hedging is buffering them in 2020, and investor confidence will be gained if the company curtails production, cuts capital spending, and is transparent with NYSE listing requirements.
Watching QEP Resources, Inc.’s Q1 Report
QEP Resources, Inc. is set to release 1Q 2020 Earnings on the morning of Thursday, April 30th. Though results from 1Q are important to review, their outlook on the remainder of 2020 is of far more interest.
The end of Q1 and beginning of Q2 have seen an unprecedented collapse of oil prices, due to the double trouble of COVID-19 economic shutdowns and oil price wars between OPEC and non-OPEC entities. After their failed sale due to the last iteration of price collapses in 2019, QEP has had an enthusiasm gap and even embarked on exploring a sale of the company.
With a $382MM debt maturity coming up on 3/1/2021, the company has even more on its plate than before the most recent industry downturn:
source – February Presentation
Therefore, what QEP does going forward in 2020 will have a much greater impact than what the company accomplished in Q1.
Given that, here are three things to watch for in the Q1 Report and Conference Call.
Maximizing Hedge Value by Curtailing Production
QEP has hedged ~ 76% of their 2020 projected oil production at ~ $58/bbl:
source – February Presentation
Note that those hedges were for projected volumes as of February, before the double shock of COVID-19 and the oil price wars. At the time, QEP was projecting for 2020 volumes to have a midpoint of 21.9MM barrels, with 5.05MM estimated for Q1. Thus, the company was projecting that their Q2-Q4 production would average 5.62MM barrels per quarter, an increase on average of 11.3% in each quarter:
source – February Presentation
Note that in both the hedge table and guidance shown above, in order for QEP to get to the 76% of “2020” volumes, they are including their hedges in 2021 of 1.6MM barrels.
According to the tables above, QEP has actual 2020 hedges of 15.1MM barrels at an average price of $57.88/bbl. If we attribute those evenly throughout the year, that’s 3.775MM barrels per quarter, of which Q1 has already settled, leaving 11.325MM barrels remaining for 2020.
Looking back at Q1, the company brought on 21 net wells and produced 5.05MM barrels. If the company were to curtail production for the rest of the year, by shutting in those recently completed wells and deferring any further drilling and completion, then production would decline substantially from Q1. Indeed, simply allowing for natural production decline, say at 10% annual (7.5% prorated remaining 2020) would drop remaining 2020 production 1MM barrels.
However, there is considerable benefit to QEP if they were to curtail production not only to the level that they are hedged, so as to cut the losses on the non-hedged volumes, but were they to go even further than that, they’d realize more profit on the hedged volumes they aren’t producing than they would have had they been producing them. An example of this phenomena can be found here with Northern Oil and Gas (NOG). Indeed, in a perfect world, QEP would cut production as close to zero as possible while maintaining leasehold and any other obligations, such as midstream commitments.
At the base value, their swap hedges alone (ignoring basis hedges, which are also highly in the money currently) would net them $397.281MM, using the following data and calculations:
- 11.325MM barrels hedged at $57.88/bbl remaining
- 2020 remaining NYMEX futures average of $22.8/bbl (Nymex for barrels sold in April is currently at $16.67/bbl, with 2 trading days remaining before the front month (June contract) starts counting towards May sales):
source – CME Oil Futures
- $57.88 – 22.80 = $35.08/bbl x 11.325MM barrels = $397.281MM
However, with QEP’s operating cost and transportation and processing costs at midpoint of $5.5 and $3.45/bbl respectively per their 2020 Guidance tables above, as well as production taxes of 7.5%, near-term barrels could sell for negative prices and incur significant operating costs on top of that, especially in plays like the Bakken.
Indeed, the Clearbrook basis for Bakken crude for May blew out such that if the settlement price – which was -$13.07 – were the price for the entire month (it fluctuated below and above throughout the month, but that data is beyond my reach currently) and the current June 2020 contract shown above were to be the average price throughout the month of May, then QEP would net the following on Bakken crude produced and sold during may, per barrel:
- $13.93/bbl Nymex less $13.07 basis = $0.86/bbl
- $0.86/bbl less production taxes of 7.5% = $0.80/bbl
- $0.80/bbl less $3.45/bbl transportation/processing = -$2.65/bbl
- -$2.65/bbl less $5.5/bbl operating costs = -$8.15/bbl
Curtailing that production, though there would still be some fixed costs associated with it, would thus save QEP 678M barrels of oil operating and sold at a net loss of $8.15/bbl, or $5.53MM, just based off May Bakken production. Note that the 678M barrels for May is derived by taking the 12 MMboe for 2020 Williston Basin in the slide below, dividing by 12, and taking 67.8% of that as oil based off their oil makeup of BOE in their 2020 Guidance slide above:
source – February Presentation
That’s just for one month, in one part of their portfolio. Additional savings and value can likely be found in other areas and in additional months. In addition to that value, holding onto the reserves that would otherwise be produced without production curtailments will have considerable value if saved for a future date with higher prices.
Thus, the first thing to keep an eye and ear out for on Thursday is the extent of production curtailments they intend to engage in. The more, the better for the company.
Cash Build and Capital Spending
QEP’s plans for 2020 as of the February Presentation slides shown above show the following as it relates to QEP’s cash and spending plans:
- Ended Q4 2019 with $166.3MM cash on hand
- 1Q 2020 capital spending of $187.5MM at mid-point
- Planned midpoint 2020 capital spend of $570MM, thus $382.5MM remaining after Q1
Those numbers indicate that, absent of any free cash flow, QEP added to their debt in Q1 of 2020, and any remaining capital spending in 2020 will be debt financed. With the collapse in oil prices, there will be very little to no free cash flow in the near-term. Indeed, cash flow could be negative in the near term on non-hedged volumes.
Given the looming $382.4MM debt maturity on 3/1/2021, it is imperative that QEP curtails capital spending. Indeed, as shown above in the hedge analysis, the current book value of the hedges going forward is $397.281MM for 2020 swaps, with additional value in the basis swaps and smaller hedges in 2021. That, in and of itself, would be enough to fund the payment of the 2021 debt. However, this highlights the need to curtail production in order to prevent losses that would eat into those hedge gains, and the need to curtail production and capital spends.
Thus, the second thing to keep an eye and ear out for on Thursday is the cash on hand situation and the capital spend plans for the remainder of 2020, and even into Q1 2021.
NYSE Listing Requirements and Transparency
QEP announced on April 16th that they received a Continued Listing Notice from the NYSE on April 10th. With that, they have 6 months to bring the stock back into compliance, wherein the stock must trade above the minimum share price of $1.00/share.
This situation has become a common one for the E&P industry during this down turn, and companies are pursuing strategies to come back into compliance. Aside from the share price improving through trading, something that a company cannot rely on, many have resorted to doing reverse splits. While this can solve the problem initially, it comes with significant risks, as often traders may look to short the stock and more action results in a stock with a higher price point.
Fortunately for QEP, 6 months from April 10th is a lifetime away in regards to the potential supply/demand and price picture for the oil industry. There are numerous variables that will affect the market, of which QEP is for the most part along for the ride. Therefore, it is imperative that the company is transparent and honest about their strategy to tackle this issue. With plenty of transparency and lead time, shareholders and investors can make educated decisions.
Thus, the third thing to keep an eye and ear out for on Thursday is what QEP’s strategies are to deal with the continued listing notice.
QEP is faced with their greatest test yet, with a lack of investor enthusiasm from 2019’s failed Bakken sale carrying over into strategic alternative exploration, and followed by the largest shock to the industry in decades, if not of all time. Thankfully, they are well-hedged for 2020, and smart decisions as it comes to production and capital spending curtailments, as well as how to handle NYSE’s Continued Listing issue, may allow them to survive the worst, meet their 2021 debt obligations, and focus on continuing to meet future challenges. How they address these issues in their Q1 2020 Earnings on Thursday April 30th will be telling for current shareholders and potential investors, both shorts and longs. Should they relay wise decisions with significant production curtailment, significant or total reduction in capital spending plans, and transparent, confident strategies for dealing with the NYSE listing issue, they could be a contrarian pick for a rally through 2020.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As an owner in oil and gas wells and properties, I have a business relationship with multiple public oil and gas companies. This relationship is limited solely as a minor, 3rd party owner in the wells, wherein my only authorities are to make elections on participating in proposed wells, and subsequent operations on those wells. While I am able to discuss operations with operators, I have to make my own elections and decisions, and the operators control the process. I have minor interests in a handful of QEP and COP operated Bakken wells.
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