EP - Empire Petroleum: Liquidity May Get Tighter During 2023

2023-04-04 16:47:34 ET

Summary

• Empire is projected to end up with a modest amount of cash burn in 2023 at current strip if it attempts to grow production.
• I've modeled a scenario where it has $4 million in cash burn along with 2,500 BOEPD in 2023 production.
• Empire is also required to pay down its credit facility by $2 million during 2023.
• This could leave it with $6 million in liquidity at the end of 2023.
• Liquidity constraints may hamper Empire's ability to improve its cost structure through production growth.

Empire Petroleum ( EP ) is projected to have a slight amount of cash burn in 2023 at current strip prices. It is also required to make $2 million in credit facility repayments during the year and could potentially end 2023 with only $6 million in liquidity.

The limited liquidity may prevent Empire from growing production to the levels it needs to get its per BOE costs down to more competitive levels. Some of my previous assumptions about Empire's ability to grow production within cash flow appear to be a bit optimistic based on its Q4 2022 report. Thus I now estimate Empire's value at $6 per share in a long-term $75 WTI oil environment. This price is probably already above its PDP PV-10 at $75 oil, as Empire's PDP PV-10 is under $9 per share at $93.67 oil.

Change In CEO

Thomas Pritchard resigned as Empire's CEO a couple of weeks ago to pursue other opportunities. Empire's President and Principal Financial Officer Michael Morrisett has taken over as Empire's CEO, adding to his duties.

Pritchard is receiving $0.361 million in severance benefits in recognition of his past service to the company. Morrisett is not receiving any additional compensation for taking on the role of CEO, so Empire may save a bit of money over time if this continues.

However, Pritchard's decision to pursue other opportunities may be a reflection of the challenging position Empire is in at current strip prices. Empire needs to grow production to help reduce its per BOE costs, but also has a limited amount of liquidity.

Q4 2022 Results

Empire's Q4 2022 production ended up declining slightly from Q3 2022 levels . Empire's total production declined by 4%, while its oil production went down by 2%. Empire attributed the sequential decline to the impact of severe winter storms and shut-in production while it completed its Starbuck Program.

Empire's Q4 2022 results also show that its results are pretty marginal at $80 oil due to its cost structure. Empire reported adjusted EBITDA of only $1.3 million in Q4 2022 in a quarter where WTI oil averaged roughly $83. This result was not significantly affected by Empire's hedges either, as it reported paying $0.015 million for net derivative settlements during Q4 2022.

One thing to note is that Empire changed its reporting of gathering and processing costs with this earnings report. Gathering and processing costs were previously included in lease operating expenses, but are now treated as a deduction from oil and gas revenues, reducing the realized price for commodities.

As a result, Empire's lease operating expense has been reduced by several dollars per BOE and was at $33.40 per BOE in Q4 2022. Empire's realized prices (particularly for NGLs) have also been reduced, and it only realized $11.69 per barrel for its NGLs in Q4 2022. The benchmark price for NGLs also was relatively low in Q4 2022 compared to recent quarters.

Potential 2023 Outlook

Empire's production should rebound a bit in 2023 as it placed on production three wells at its Starbuck Field in Q1 2023 and should place a fourth well on production soon. Empire noted that Starbuck Field production has increased from 3,000 barrels of oil per month to 7,000 barrels of oil per month, with further production increases expected in 2023.

If we assume that Empire can average around 2,500 BOEPD production (66% oil) during 2023, then it may be able to generate around $8 million in adjusted EBITDA at current strip (high-$70s WTI oil). This also assumes that the increased production helps Empire keep its lease operating expense to around $30 per BOE.

Empire's 2022 non-acquisition capex ended up at $11 million. A similar budget in 2023 (resulting in that production growth) would leave Empire with around $4 million in cash burn after interest expense.

Empire's credit facility (now maturing May 2024) has an existing commitment amount of $6.18 million as of February 2023, and this amount is reduced by $0.5 million per calendar quarter during 2023.

Thus Empire's cash position may decrease from $12 million at the end of 2022 to $6 million at the end of 2023 due to the combination of cash burn plus credit facility repayments. Empire's ability to grow its production is limited by its relatively modest amount of liquidity. I have already made relatively generous assumptions about its ability to grow production in 2023 with an $11 million capex budget. It does not appear to have much ability to grow production further without additional sources of liquidity.

Estimated Value

I've reduced Empire's estimated value to $6 per share (based on long-term $75 WTI oil) due to its liquidity constraints and projected challenges with further increasing production (beyond around 2,500 BOEPD) at current strip.

Empire had around $2 million in debt (net of working capital) at the end of 2022. This may increase to $6 million in net debt at the end of 2023 based on current projections.

Empire's PDP reserves at the end of 2022 had a PV-10 of approximately $8.60 per share after subtracting its year-end 2022 net debt. This does not include the impact of future income taxes on PV-10. This was based on SEC prices including $93.67 WTI oil and $6.358 Henry Hub natural gas.

Thus a $6 per share value for Empire would probably already be higher than its PDP PV-10 at $75 WTI oil.

Conclusion

Empire Petroleum's production in Q4 2022 declined a bit due to weather issues and downtime associated with its Starbuck development program. Empire's production should be stronger in 2023 with recent completions. However, if one models its 2023 production at 2,500 BOEPD (a significant 16% increase from 2022 levels), it looks likely to still end up with a bit of cash burn in 2023 at current strip.

The cash burn combined with required credit facility payments will reduce Empire's liquidity and at current strip prices it would likely need to raise additional funds to be able to grow production and reduce its per BOE cost structure.

I now value Empire at approximately $6 per share in a long-term $75 WTI oil environment, which is probably a generous valuation given that it appears to be more than PDP PV-10 at that oil price.

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