27-Nov-08 11:00 AM  CST  

Tudor Pickering Holt Energy Thoughts (11-28-08, Friday) CHK, CPE, rigcount, TPH reader energy thoughts 

CHK equity issuance and implications, Callon stops deepwater project, Rigcount falling, Thoughts from our readers

·          Energy stocks (OSX $139, E&P $420, XOI $980, XNG $420) – Post-Thanksgiving, slowest market day of year and interesting stuff busting out all over late Wednesday.  Turned our non-note into fair amount of dialog.  Energy stock rally now 20-40% off bottom..and today probably has good vibes from 1) stronger foreign markets, 2) trend following, 3) ability for hedgies to jam stocks to help end of Nov performance numbers.  Word of caution – outlook/world remains shaky.  Profit-taking TRADING call approaches.


·          CHK $1B best efforts equity offering ($20.24 - H) – Ugh.  CHK files to raise up to $1.8B equity in normal shelf and best efforts basis (ongoing open market sales by hired ibanks).  Read-though: Shelf filed evening before holiday says CHK may need cash NOW, confirms debt market still closed (to CHK anyway), bought deals unavailable (ibanks have no money) and asset sale market very weak (low South TX bids).  Drip equity creates stock overhang until deal done ($1B is 3-5 trading days) and CHK has no plans for 2008 offering.

·          CHK cutting rating to Hold ($20.24 - H) – 3P asset value trapped by capital structure that may require last resort equity financing.  Why should investors pay for 3P potential if CHK has to fund with more equity?  1P NAV was $21 at $6/$60, drops to $18 with 10+% share dilution ($1B at $15/sh).  CHK says no plans for equity in ’08, but Q4 lack of liquidity could be worse than expected as CHK just received $1.25B from Statoil (11/25) and expects $450mm Arkoma/Anadarko VPP (failed S TX asset sale, bid economics lower than possible S. TX VPP).

·          CHK stock implications ($20.24 – H) – Goes from doghouse to tunnel in basement of doghouse.  Assets say buy CHK, but reality is virtually impossible for stock to outperform peers with drip equity overhang, uncertainty about how much more cash will be needed to survive (threat of more equity) and another big blow to management credibility that had indicated no equity needed.  Hard to tell how low stock will go as this is last straw for some diehard CHK owners and shorts will swarm. 

·          CHK cash situation ($20.24 - H) – We THINK drip equity and asset sales will cover Q4 needs, but current $6.5-7.4B '09 capex still outspending cash flow by $1.2B at $8/mcf gas and $2.3B at $6/mcf gas.  Without big credit market improvement (unknown) or more equity (anathema), next step will be laying down more rigs and cutting '09 capex.  Solving '09 capex/production feels like we've got two equations and three unknowns, but we take stab below.

·          CHK leasing plans ($20.24 – H) – S-4 filed, but not effective yet - had some interesting tidbits.  Details show potential to close acquisitions or leasehold with stock instead of cash.  CHK clearly playing hardball on any non-closed lease transaction.  Not only will they push for lower lease terms, but they likely pay for leases with stock instead of cash.  Will be interesting to see how many shares issued for leasing. 

·          CHK '09 capex, where to cut? ($20.24 - H) – Economics say 1-2 rig drop in multiple areas - Panhandle, West TX, and West OK get cut. CHK lowered production 3% with first cut (16% growth), next cut into producing muscle likely drops another 2-3%.  CHK's Haynesville, Fayetteville, and Marcellus partnerships/drilling carry keep ~$2.5B capex flowing to shales ($700mm from CHK).  Next layer, long term rig contracts  and leasehold drill-to-hold/earn acreage keeps rigs running in Haynesville, Fayetteville, Barnett, but CHK deferring Barnett completions (up to 60% of well cost). 


·          Callon suspends Entrada deepwater GOM development (CPE - $7.23 - NR) –  Projects getting cancelled = sign of times….and we’ll see more, offshore and onshore.  Cost overruns combined with much lower commodity prices force cash-strapped Callon to stop development they’d just started mid-2008.  Say they won’t resume project under current economic conditions.  CPE operates with 50% wi, CIECO Energy (ITOCHU subsidiary) bought 50% in field for $155mm in April 2008.

·          Commodity rationality ($6.80/mcf, $54/bbl) – We love efficient markets.  Oil prices low and we’re swimming in gas, driving many individual occurrences to begin bringing markets back toward equilibrium (long way/time to go, but it’s a start).  Examples:  CHK issuing equity at stock lows, CPE cancelling major deepwater project, REXX deferring ASP capex, OXY laying down West TX workover rigs, Middle East markets slowing reopening, newbuild rig projects that can’t get funded.  More are coming.

·          Rig count heads-up (OSX $139) – Rigs falling right-and-left.  Most widely followed BHI U.S. count now 1,866…-75 rigs (-4%) vs. prior week, gas -68, vertical -51.  Steepest weekly decline in BHI count since Spring 1987.  Only two caveats – low revenue/rig Appalachia drove downtick (-42 rigs) and data gathered during holiday week.  However, Smith Bits and M-I SWACO corroborate directionally…-28 rigs and -63 rigs respectively.  More color (and our Weekly Rig Roundup report) on Monday.

·          You write the Friday note – reader thoughts (OSX $139, E&P $420, XOI $980, XNG $420) – And we thought it would be slow today – HA!  Many responses to our invitation to tell us something 1) misunderstood by market  2) overlooked by market  3) most important to making money in 2009.  4) Exciting.  5) Scary.  Find them down below and thanks to those who participated.  Only consistency was that nobody understands what “brief” means.  So we’ve trimmed, culled, edited in some/many cases.  More below.

Interesting articles

OPEC to weigh further cuts – WSJ, http://online.wsj.com/article/SB122782329512462271.html

You write the Friday note! – reader thoughts (OSX $139, E&P $420, XOI $980, XNG $420) 

Key disclaimer – we didn’t write, we didn’t censor them.  We put them in here just like they were sent to us.  Any stock discussion below (long, short or otherwise) is not endorsed or dismissed by TPH – in other words, it could be right, it could be wrong – caveat emptor!  Some interesting stuff to chew on, that’s for sure. 

·          Most important issue in this market – Whether the equity markets will work before the debt markets are repaired and the marginal cost of capital is reduced. Today, the average high yield corporate bond is trading around 18%.  Accordingly, with a historical equity risk premium of 5% (which seems conservative in this market), your pretax cost of equity for a new capital project is 23% with a 50/50 WACC of 20.5%.How many companies will generate a ROACE of 20% at these commodity prices?  Not many, moreover, utilizing a 20% discount rate into your DCF implies that many E&P equities are overvalued even at these levels.  Market neutral hedge fund investor

·          The Freight Train is Coming – Consumer spending = 71% of GDP; the U.S. consumer is over-levered and shopped-out having spent well above its means for the last few years;  U.S. personal savings rate is at all time low (-1.0% '08YTD vs 7.3% Post-WWII); if savings rate reverts to historical mean, GDP declines directly by over $1.3 trillion (9%) and indirectly by more (>10%) including a further collapse in residential and corporate capex spending;  What does this mean for energy??  Expect significantly lower U.S. GDP = lower demand for oil and natural gas = commodity price recovery (particularly natural gas given current glut) will take a long time (see 11/25 TPH note for early indicators).  Better batten down the hatches.  Private equity investor

·          Scariest thought during Thanksgiving food coma – Is E&P where the banking sector was six months ago - recognizing the fundamentals have deteriorated but not yet seeing the cliff we're headed for?  Will it take a large independent or two going Chapter 11 to bring capex budgets down enough?  And where is that federal bailout package for oil and gas producers?  E&P company exec

·          Misunderstood – Velocity of money down 39% year over year…..fiscal stimulus package now over $7 trillion committed…..what happens if/when all this committed capital comes back to the marketplace and the velocity of money picks up???  Answer…not deflation.  Energy specific long-only mutual fund portfolio manager.

·          Misunderstood – Once oil starts moving in the same direction as the stock market, the stocks no longer have their diversification value in a long-only portfolio, and historical multiples lose their relevance, and get out of the way.  Betas to the market are usually low for energy, it’s the volatility that is high...when the correlation to the SPX starts getting higher, then get out of the way. This was beginning to happen late in summer. Basically people don't understand the difference between volatility and beta.  Energy hedge fund analyst/PM.

·          Misunderstood – The true value of long-lived assets when using NPV valuation.  Long lived assets will still be generating cash flow relatively near the level of current generation 10+ years out.  The more bullish you are on commodities long term, the more you should be looking to long lived assets; and they are even more attractive during recessionary dips.  (This is a non-biased opinion, I swear!) Long only portfolio manager

·          Most overlooked stock:  Range Resources  E&P exec (not from Range)

·          Centered In The Best U.S. Gas Price Market Appalachian Basin gets premium pricing to NYMEX

·          Uses the K.I.S.S. Strategy

1. Will increase cash flow by redirecting limited budget to higher percentage development wells.

2. Successfully reducing costs by developing cheaper completion techniques. 

3. Focusing resources to just one basin.

4. Has extensive Marcellus acreage that provides hundreds, if not thousands, of future drill locations.

·          Possible Ultimate Dream - Eventually gets bought out by a major.

·          Only Negative - Not diversified at all ... married to the gas market and Marcellus Shale play

·          McMansion?  From penthouse to outhouse?   With electricity demand weak, what happened to the theory (pressed over the past 5+ years) that the ever-increasing size of new-build homes was structurally increasing electricity/natural gas consumption?  Are foreclosures/lack of occupancy in recent months adding to the sluggish demand?  Inquiring minds want to know.   E&P exec.

·          Scary to think that the world is counting on China to bail out the global economy.  Hedge fund energy analyst

·          Overlooked by the Market.  Urbanization and industrialization of India and China are unlikely to be reversed.  Even if GDP in the OECD goes down by 10% before resuming growth, that means 3 years at 3% growth to get back to where we were.  And "where we were" was very rapid oil demand growth in China and India.  China and India EACH have as many people as the OECD, but COMBINED they consume only ~20% as much oil as the OECD; <50 cars per 1000 people compared to ~700 in USA.  Deepwater Oil and Oil sands (subject to risk of carbon craziness) deserve long looks at current prices.  Industry consultant.

·          Category, all of “misunderstood, overlooked, most important, exciting and scary” – I gathered the data above and did a quick plot to see if I could get any correlation between Fed Funds Rate and Oil Price, with the Fed Funds rate a predictor/cause to future oil price.  Not really appropriate to put in your Friday note (so please do not include) but I (as well as everybody else out there) am always looking for some forward indicator to oil price.  A 3 ½ year lead for the Fed Funds rate to oil price might be too much, but it does take the Fed some time to work its way through to the U.S. economy (which in turn affects the global economy) and then the economy to oil price.  This plot would indicate a soft oil market until late 2010 – early 2011, which I think we are all hoping against.  Energy private equity

·          Misunderstood: U.S. Energy Independence … to many, this politico-favorite means drilling up every square inch of pristine wilderness to cut the country’s umbilical to the Middle East.  Reality – the U.S. is about to transition from 900-lb gorilla that can scare major resource holders into pant-wetting obsequiousness into second-tier consumer of diminishing influence.  China, India and other developing nations will call the shots with fatter wallets and larger, energy-starved populations.  Energy independence will come to mean having a domestic supply to turn to when the ships are sailing away from the U.S. and not toward it (much like the view from the developing nations’ beachhead today).  Oilfield service exec.

·          Exciting – Driven by low commodity price and onshore shales, Majors and NOC's to build US E&P positions. Early moves have already begun (BP deals with CHK in Woodford and Fayetteville, Shell JV with EnCana in Haynesville, StatoilHydro JV with CHK in Marcellus. Expect to see deals of all type; joint ventures (to take both operated and non-operated positions), asset acquisitions, and corporate (stock) deals. Challenge will be what types of assets/structures can these companies effectively manage and will cause other transactions to occur as the food chain heats up. Energy investment banking.

·          Idea – Arbs are scary but one is done and financed (HSBC,RBC,TD,DB), they are already integrating systems and the arb is 90 cents on a 5.80 cent stock which closes in ten days. that is a fat percentage return.  Hedge fund analyst/PM.

·          Scary – What's scary is the unwillingness to value and address banks' bad assets, leading to the critical loss of trust. Trust is the engine driving all financial relationships and business. One result harmful to global economy, including energy, is the lack of demand for fresh credit, industry's lifeblood.  Oil industry exec.

·          Exciting – While not a stock – your members should know about YPE (www.ypenergy.org <http://www.ypenergy.org/> ) – with chapters in Houston, New York, and 18 other cities and over 5,000 members, it’s the most exciting non-profit organization for young leaders in the oil patch.  Private equity

·          Idea – The best value story in energy appears to be natural gas related midstream MLPs. They went down with financial stocks from midyear 2007 to mid June and then declined with commodity prices since then. I assume they will come to life as the credit markets thaw. You can eat while you wait with the high yields and adequate coverage ratios.  Long only money manager.

·          Overlooked/Misunderstood – ACGY.  Overlooked and possibly misunderstood.  Who the heck knows where it’s going this month or this year.  Buy now, go to the beach and come back in 6 years.  Below book value, <2x current year EBITDA, muted financial risk (as its essentially net debt free).  Who cares that it’s disappointed everyone since 1993 (yes, I remember predecessor tickers: SCSWF and later SCSAY), it’s the Transocean of the deepwater subsea market! (Ok, maybe that’s a little bit of a stretch).  Energy private equity.

·          Overlooked (4 short ideas): Royalty owner.

One. - Oil Prices during a OPEC supply dominated era never reached above 48 per bbl as I recall. Jan 2004 is when Campbell’s Study (similar to hubbert's peak) started the peak oil scare. We now have 2.5 mm bbls of OPEC cushion per day. That is 3 years or normal global growth with high consumer confidence.

Or……It is the combination of the underlying base productions, current rig count, and current decline rate that matches demand that counts.

Or……Rig count corrects all supply and demand under or over pricing. And within 9 months in today’s just in time market.

Or…….Prior to the false over levered economy we averaged 65.75 per bbl for 2 years with above average  consumer confidence and slow growth in demand, neither of which is present today. Obviously that should be the ceiling if things turn better for oil demand. Traders had good reason for those 2 years.

·          Fits categories 1, 2 and 3 (misunderstood, overlooked, important) –  MLP's (those without an immediate capital need and those that are not producing entities) are the most underrated investments in the market.  They generate most of their income from throughput.  With prices declining, their throughput volumes should stabilize and then rise.  Even Obama wants to assist infrastructure growth (that is what most of them are-infrastructure entities).  Their yields are at all-time highs and for good MLP's the payouts are expected to rise further in 2009.  Compared to equivalent investments, they are very cheap.  Older investors will have less money to create "retirement income" with in 2009 than they did earlier in 2008.  This is the best way for them increase that "income".  Oh yes, the payout is mostly tax deferred and there is a tax benefit at death.  Oil service exec.

·          Idea – volatility of the US gas market (amplitude and period) as related to swings in resource play funding.  High declines + big capex swings = Chaos or opportunity?  E&P exec.

·          Overlooked – Heads Up!!  In low commodity price environment “drilling within cash flow” is oxymoron.  When the banks run your borrowing base on new lower price deck, 25% of your cash flow goes to the banks to get you back into a “conforming status” or alternatively a “shotgun marriage”.  Gentlemen, recheck your models!!!!!!!!  E&P exec.

·          Misunderstood – CHK and how their exotic hedging program works in their favor, or what market dynamics could cause them to blow up.  With all of the knock-outs, etc are they really defusing risk or just putting a mask on it?  If there is no free lunch in the markets (including derivative markets) then have they paid too much for risk management products when they could have followed "Keep it simple stupid!"(?).  Investment banker.

·          Idea – Pinnacle Gas Resources Company reiterates seeing production growth from 14mmcf/d currently to 20mmcf/d by March/April 2009.  Company working on pipeline sales agreement with large public company, which would bring cash and additional pipeline development (lowering company future costs).  Bid on straight CBM comparable company would value Pinnacle at $4/share.  Hedge fund manager.

·          It is SCARY that CLB has a much higher P/B and EV/IC than Microsoft.  Hedge fund manager.

·          Misunderstood – Holly Energy Partners (HEP).  It is an MLP currently trading below $20/unit due to technical issues in the MLP market.  The biggest technical issue is that the MLP market has traditionally been made up of retail investors, but over the past 5 years, institutions, hedge funds, and  closed end funds have gotten into this very illiquid market.  Big sellers over the past two months have included Lehman, Goldman, and hedge funds.  Retail investors are on the sidelines and there is no bid for small MLPs.  Back to HEP, HEP has contracted revenue primarily from Holly Corp (its GP which has excellent management and no debt) and from Alon USA (a local refiner with strong backing from its parent Alon Israel).  HEP has no commodity price exposure (they ship for a fee and have take or pay type contracts) and has a $3.02/unit tax deferred distribution.  Growth may be muted by the current environment, but I am good with a 10% yield on this MLP, which translates into a $30 unit price.  This MLP was constructed for the retail investor and was IPOed at a time when bankers made sure that their investors were protected.  Energy private equity.

·          Scary –  Beyond the huge bailout underway for mis-managers whose contributions include the current havoc with U.S. energy markets, U.S. political leadership is about to "invest" $150 billion taxpayer dollars over the next 5 years to create "green collar" jobs and renewable energy resource economics, based upon the questionable premise of anthropogenic (man-caused) global warming, which no one in the media appears willing to question.  While the earth may be warming (the earth has been always either warming or cooling over the last 4 billion years...much warmer for much longer in the past), peeling away a few layers of the onion, eminent climatologists and earth scientists (Dr. John Christy, Dr. Lee Gerhard, as 2 good examples among many) document that anthropogenic CO2 in the atmosphere...less than 3% of the total... is a 4th order event, with much more fundamental planetary dynamics at work, far beyond mankind's ability to stop, reverse, or influence.  Kind of like trying to control the weather, keep New Orleans from flooding, or predict the price of oil tomorrow...  Industry consultant.

·          Scary that 20% of US energy companies will go bankrupt in the next 2 years.  This will be the worst recession for the world since the Great Depression.  Global GDP contraction reduced demand for metals used in cars, coal used to heat metals, and oil to run cars.  Lack of financing popped the housing bubble.  So, there will be less demand for US electricity.  Much lower industrial production in the US also reduces electricity demand.  Thus, we will have more natural gas supply in the US than demand.  Rising inventories will crush the prices down to marginal costs.  Like prior cycles, numerous energy companies will lack fiscal conservatism.  They will drill until the bank takes the keys away.  This will hit during 2009.  Individual wishing to remain completely anonymous.

·          Overlooked—again!  “Surplus” oil and nat gas plus the slow economy sets up the next shortage and bull run in prices—Can you say $6.00/gal?  The economies of the world will recover—perhaps not the synchronized global boom with EZ money next time--but the cycle will return to expansion.  Add in cap and trade and no nukes from the new pres and congress and we’ll be speaking $.25/kwh in addition. BTW, using nat gas for a higher purpose than electric generation--e.g. transportation, makes a lot of sense--but what will it take to make it work?  Backing it out with wind per T Boone?  Nukes? Clean coal?  Solar? Geothermal?  Conservation?  Tax credits for fleet conversion?  Busses, taxis?   Get the car companies on board? Big job.  Shouldn’t we finally stick a fork in ethanol?  Wouldn’t it be better to pay the framers NOT to grow corn.  At least Butanol and DME can go in a pipeline. How about OCS drilling?  Fat chance.   ANWR?  Alaskan Gas PL? LNG?  Mexico?  How else could we foul it up?  How about a windfall profits tax?  It worked so well last time….Financial advisor.

·          Energy Futures Speculators, “Don’t forgive them, for we might know what they do” –  Throughout commodity futures history great bull and bear markets come and go. World Sugar from 4 to 60 cents plus in the mid 70s and then to 2.3 cents in late 80s. In-between times are characterized as clunky, minor moves are met with hedgers and producers actions, the market helps supply get allocated. Now and then the wild move comes and “regular “specs who have done well in range bound  markets, meet something that takes them out. Often hedgers see credit lines limited or get fearful themselves and are forced to cover hedges, often adding to the demand that creates the final leg. Efficient market? I will let other debate that.


A few years back along comes indexing. Most vets of the commodity world know that through time commodities rise less than the CPI in real terms. Economically it is intuitive, production becomes more efficient (IE seed science!) man advances, tangibles become less and less of whet we consume and produce. What was the highest price for crude in history? Pre Drake, 1958, Titusville PA, $20/barrel, in real terms that is $400. $150 was nothing. That 20$ would he a part of the equation that sprung the Drake well and the petroleum world into action. In 1999 crude was $9 briefly, it amazing what a good job the industry has done.  But along comes indexers, they somehow think owning perishables and things that are consumed can make $$$. Indexing grows, masses of funds join in, Joe and Jane Mutual Fund tires of stocks that go down, oh my!, join in big. Indexers don’t consume and they don’t sell just because the market hits levels that will incite demand and conservation, they sit long,,,,,,,,,,,,until price really drops and then in discouragement, liquidate.

Excess length in commodities doesn’t create value, it incites supply. Commodities are not capital assets, they are to mine, grow, recover. Indexing has added to upside excess in price and now as they learn these base lessons, the downside as well.

$100+ crude was unsustainable and as the huge run was in excess, liquidation by indexers will or is taking energy to “depressed”, levels that will be also be unsustainable.  So many are discouraged, those who care about their capital and wish to place it when and where it is truly needed, should be thrilled to be living at this time.  Industry observer.


·          Most Important – Fear drove this market down and the short rode along.  This is best expressed with the following sage words of wisdom which should be enshrined in investment textbooks:  "Hey, we're losing all our damn money, and Christmas is around the corner, and I ain't gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain't gonna f... my wife ain't gonna make love to me if I got no money!" So they're panicking right now, they're screaming "SELL! SELL!" to get out before the price keeps dropping. They're panicking out there right now, I can feel it.  Energy hedge fund analyst/PM

·          Issue/Idea: For the good of the country, it is time for Wall St to get a real bailout:

•          Reimburse all shareholders who have lost money in the market;

•          Guarantee our investments against any future losses;

•          Institute an "uptick" rule to prevent a down market --- no selling of stock unless it is above the previous trade's price.

•          If there are no natural buyers, the Federal Government will buy the shares being offered (on an uptick) in order to assure properly functioning markets.

This proposal would:

·          Unlock Wall Street and encourage investment; who cares whether it is productive or not!

·          Keep inflation low due to the over-investment it would spur, thereby increasing competition and lowering pricing power;

·          Be profitable for the government because of increased tax receipts resulting from increased Capital Gains taxes and a stronger economy;

·          Be a better use of our government's $ than giving it to the auto companies;

·          Save GM, Ford, and Chrysler by creating a stock market bubble that will enrich everyone!

·          Restore Pension Plans that became underfunded due to the Market decline, enabling them to become fully funded;

·          Reduce the potential strain on the Pension Benefit Guarantee Board, and potentially make it unnecessary.

·          Strengthen the dollar as investment money seeks out the ultimate safe haven.

·          Confirm Sen. McCain’s claim that Obama is a Socialist, since all equity would be owned by the Federal Government once natural buyers have been satiated and liquidity dries up.  Long only portfolio manager

·          Scary in these trying times for "financial" types.   Given that investment banking is the "art of stating the obvious with an air of discovery", hard to know what the "obvious" is today.  Fortunately Maynard Holt has found side work as Bozo the clown.  Portfolio manager

·          Scary:  40% to 50% of us hedge fund guys won't be employed in '09.  Hedge fund energy analyst

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