Why Resolute Energy Should Run Three Rigs – Resolute Energy Corporation (NYSE:REN)

Resolute Energy (REN) is a company that I’ve covered in-depth for my Marketplace offering. However, for this article, I’d like to particularly focus on its cash burn and leverage. Forge River Research mentioned in December that Resolute would burn cash with a three rig drilling program even at $65 oil. This is true for 2018, but I will show below that its situation markedly improves in 2019. At high-$50s oil it should be able to grow exit rate production by approximately 38% while reaching breakeven cash flow. At lower oil prices such as $50, it can reach breakeven cash flow while growing exit rate production by around 12%.

I’d argue that given Resolute’s relatively productive acreage and its upcoming $525 million 2020 debt maturity, it is best served in the current favorable oil pricing environment by continuing with a three rig drilling program in both 2018 and 2019.

2018 Capital Expenditures Affect 2019 Production

If Resolute proceeds with a three rig drilling program in 2018, it is going to see more production benefit from that spend in 2019 compared to 2018. I estimate that total 2019 production from wells completed in 2018 will exceed total 2018 production from those wells by around 15% to 20%. Part of the reason for that is that the average 2018 well will probably have less than six months of production in 2018 compared to a full year of production in 2019.

As well, a decent amount of Resolute’s 2018 capital spend is going towards wells that aren’t even going to start producing in 2018. Resolute’s three rig development program calls for it to spud 45 wells in 2018 and complete 42 wells in 2018. However, only 35 of those wells are expected to be producing by the end of 2018. Around $65+ million of Resolute’s 2018 capital expenditures may be going towards wells that contribute nothing to 2018 production.



Source: Resolute Energy – December 2017 Presentation

Two Rigs In 2018

To set the stage for the 2019 calculations, I will first look at 2018 expectations with both a two rig and a three rig drilling program.



Source: Resolute Energy – September 2017 Supplemental Presentation

With a two rig program, Resolute expects to average 29,000 BOEPD in 2018. In this case I will use a production split of 50% oil, 22% NGLs and 28% natural gas. At $58 WTI oil during 2018 and around $2.80 NYMEX natural gas, Resolute should generate around $362 million in oil and natural gas revenue. Earnout payments (from its Aneth sale and Caprock Midstream) and net hedge value add another $20 million combined, bringing total revenue to $382 million.

Type

Units

$/Unit

$ Million

Oil (Barrels)

5,292,500

$55.00

$291

NGLs (Barrels)

2,328,700

$12.50

$29

Natural Gas Tradebuddy.onlineMCF]

17,782,800

$2.35

$42

Aneth Earnout

$10

Midstream Earnout

$25

Hedge Value

-$15

Total Revenue

$382

Offsetting this is around $430 million in total cash expenses, including $265 million in capital expenditures with this two rig program. Lease operating expense is estimated at $5.50 per BOE, while production and ad valorem taxes are estimated at 8.5% of oil and gas revenues.

$ Million

Lease Operating Expense

$58

Production and Ad Valorem Taxes

$31

Cash G&A

$25

Cash Interest

$46

Preferred Dividend

$5

Capital Expenditures

$265

Total Expenses

$430

Thus, Resolute is expected to have around $48 million in cash burn at $58 WTI oil in 2018 along with a two rig drilling program. This brings its year end 2018 credit facility debt up to around $68 million.

Three Rigs In 2018

With a three rig drilling program in 2018, total revenue increases to $432 million and production increases to 33,000 BOEPD. This uses the same assumptions around production splits and prices as the two rig scenario above.

Type

Units

$/Unit

$ Million

Oil (Barrels)

6,022,500

$55.00

$331

NGLs (Barrels)

2,649,900

$12.50

$33

Natural Gas Tradebuddy.onlineMCF]

20,235,600

$2.35

$48

Aneth Earnout

$10

Midstream Earnout

$25

Hedge Value

-$15

Total Revenue

$432

Total cash expenditures are estimated at $570 million with this three rig scenario, resulting in $138 million in cash burn in 2018 at $58 WTI oil. Resolute’s credit facility debt is estimated at $158 million at the end of 2018.

$ Million

Lease Operating Expense

$66

Production and Ad Valorem Taxes

$35

Cash G&A

$26

Cash Interest

$48

Preferred Dividend

$5

Capital Expenditures

$390

Total Expenses

$570

Effect On 2019

Resolute’s 2019 average production is dependent both on its 2018 rig count and its 2019 rig count. With a two rig program in 2018 and a one rig program in 2019, Resolute’s average production is estimated at 31,625 BOEPD in 2019, with a 2019 exit rate that is down around 4% from 2018’s exit rate. With a three rig program in 2018 and a three rig program in 2019, Resolute’s average production is estimated at 51,000 BOEPD in 2019, with a 2019 exit rate that is up around 38% from 2018’s exit rate.

2018 Rigs

2019 Rigs

2019 Production (BOEPD)

Estimated Exit Rate Growth

2

1

31,625

-4%

2

2

38,250

27%

3

2

44,000

12%

3

3

51,000

38%

This results in the following estimates for 2019 revenue under the various rig combination scenarios and various 2019 WTI oil prices. There is an assumption of no midstream earnout, but the Aneth sale earnout payments are included as revenue for this calculations.



Estimated 2019 cash flow is shown below. The two rigs in 2018 and one rig in 2019 scenario is cash flow positive at around $45+ WTI oil. The two rigs in both 2018 and 2019 scenario is cash flow positive at above $55 WTI oil, while the three rigs in 2018 and two rigs in 2019 scenario is cash flow positive around $50 WTI oil. The three rigs in both 2018 and 2019 scenario is cash flow positive around $57 to $58 WTI oil.



The estimated year-end 2019 net debt is shown below for the various scenarios. The net debt calculation includes credit facility debt and Resolute’s 2020 notes and also includes Resolute’s preferred shares as debt. Reducing the number of rigs can reduce Resolute’s year-end 2019 net debt by around $196 million at $50 oil or $141 million at $65 oil.



Next, we will look at 2019 EBITDA for the various scenarios. The highest production scenario results in EBITDA rising to $377 million at $50 oil and $530 million at $65 oil. EBITDA is close to 40% lower at all listed oil prices for the lowest production scenario.



The boost in EBITDA caused by the increased production more than offsets the higher net debt when calculating 2019 leverage. The more aggressive growth scenarios will result in lower leverage levels at all the different oil price scenarios. For example, at $55 oil in 2019, Resolute’s year-end leverage would be around 2.3x with the two rigs in 2018 and one rig in 2019 scenario, but would be approximately 1.8x with the three rigs in both 2018 and 2019 scenario.



My conclusion is that Resolute would be best served by strongly growing its production in the current oil price environment. It needs to refinance its 2020 notes at a lower interest rate than the current 8.5% rate. Moody’s previously rated Resolute’s proposed note offering (that was subsequently withdrawn) as Caa1 due to Resolute’s relatively significant leverage and low production at the time. Moody’s also noted that an upgrade could occur if Resolute increased production to above 30,000 BOEPD.

Under the strong three rig growth scenario, Resolute’s 2019 production is expected to reach 51,000 BOEPD while its retained cash flow to debt ratio would be around 48% at $55 oil. This should result in Resolute’s debt getting upgraded by a couple notches. If a new proposed note offering is then rated as B2, that would probably knock a couple percent off of Resolute’s interest rate.

Growth Benefits Tradebuddy.onlineholders

Strong production growth also has a positive impact on the value remaining for Resolute’s shareholders. There is a $168 million difference in estimated 2019 EBITDA at $55 oil between the two rigs in 2018 and one rig in 2019 scenario and the three rigs in both 2018 and 2019 scenario. At a 6x EBITDA multiple, this results in $1.008 billion additional value under the high growth scenario. Debt is expected to be $179 million higher in the high growth scenario, while the cost of replacing 45 additional gross locations in inventory is estimated at around $54 million. This results in an estimate that shareholders will see $775 million in additional value if Resolute goes with the strong growth scenario instead of the other extreme of reducing rigs.

$ Million
6x EBITDA Difference $1,008
Less: Debt Difference -$179
Less: Location Difference -$54
Total $775

Conclusion

In the current oil pricing environment, Resolute should push for strong growth and go with a three rig drilling program. This should result in Resolute growing production to over 50,000 BOEPD in 2019 and allow Resolute to refinance its 2020 notes at a noticeably lower interest rate. Being overly cautious and reducing its rig count would result in higher leverage for Resolute, probably higher interest costs and also less value for shareholders. As shown below, Resolute achieves pretty good payback on its wells in a $55+ oil environment.



Source: Resolute Energy – December 2017 Presentation

If oil prices were much lower (such as $40), it would make sense for Resolute to preserve its inventory for the time being. However, with futures prices above $55 until mid-2020, Resolute’s best strategy is to push for growth.

Unlock The Latest Research

If you found this article useful, I invite you to join our premium service for the latest and best research.  There is currently a free trial to check it out, but this free trial will only be available until January 17th. 

We are also planning a rate increase after that time. Any current subscribers plus anyone who joins by January 17th will also be grandfathered in at the current rate ($39 per month or $299 per year).  On January 18th, our price will increase to $49 per month or $379 per year).

This is a great opportunity to check out our premium research offerings for free, and to lock-in a lower rate if you like it.

Disclosure: I am/we are long REN.

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.

Disclaimer Tradebuddy.online would like to remind you that all opinions expressed at Tradebuddy.online are those of the individual authors and do not necessarily represent the opinion of Tradebuddy.online or its management. Tradebuddy.online has not verified the accuracy or basis-in-fact of any claim or statement made by any independent author: errors and Omissions may occur.Any opinions, news, research, analyses, prices or other information contained on this website, by Tradebuddy.online, its employees, partners or contributors, is provided as general market commentary and does not constitute investment advice. Tradebuddy.online will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

Leave A Reply

Your email address will not be published.