REPX - Riley Exploration Permian: Low-Cost Production And CO2 Projects Will Support The Growth

Summary

• Riley Exploration Permian has a P1 reserve addition cost of $6/boe.
• In 2023, fewer volumes are hedged freeing up FCFs.
• Leverage is very low.
• The CO2-EOR and CCUS projects have strong potential.

In the first three weeks of the year, there was an energy stock that got my attention due to its strong upward rally: I'm talking about Riley Exploration Permian (REPX), an Oklahoma City-based oil and gas company, that recorded a +17% year-to-date. In this article, I will provide an overview of the company and I will explain why I believe that the company might be worth a BUY recommendation.

About Riley Exploration Permian

The current Riley Exploration Permian, also known as Riley Permian, was created in 2021 after the merger between Riley Permian and Tengasco. The company is focused on the exploration and production of oil, gas and NGLs in the Wasson field complex in the Permian Basin, an area that spans across Texas and New Mexico.

Within the Wasson field, Riley Permian is focused on a 26k acres area - called "Champions" - where it is developing its production with horizontal wells. Production mostly targets the San Andres formation (5,200 feet depth), a reservoir that has been producing for more than 100 years and that is characterized by high porosity and permeability resulting in limited drilling and completion costs.

As of September 2022, Riley Permian is producing from 77 active horizontal wells with an average age of 3.8 years.

The average daily production was 12.7 Mboe/d in the first nine months of 2022, with 75% of the production (9.4 Mboe/d) being oil. The total net proved reserves are 82 MMboe (9/30/22) with 61% oil, 19% natural gas and 20% NGLs.

The cost to add new P1 developed reserves is about $6/boe, lower than in other oil and gas fields due to the specific characteristics of the San Andres formation that, being highly permeable, allows keep costs low and also limits production decline.

In addition to its core upstream business, Riley Permian is carrying out two CO2 synergistic projects that could have a relevant potential upside. The first initiative is the CO2 Enhanced Oil Recovery ((EOR)): this project is based on a widely used and proven technology that injects CO2 into the reservoir to increase the overall reservoir pressure leveraging the miscibility principle. In addition, CO2 will blend with oil creating an oil mix that will flow more easily toward production wells. As a result, production increases in the short as well as in the long term with overall recoverable volumes that increase. The company started the CO2 injection in November 2022 and it expects to see the first results on production volume in about 6-9 months.

The second project is based on Carbon Capture Utilization and Storage ((CCUS)) technology. The idea is that the same CO2 infrastructure developed for the EOR could be used for the permanent storage of CO2 in depleted reservoirs. These two projects have a high potential upside because the Wasson field lies in an area with a high concentration of companies and plants with high CO2 emissions. In a business environment where stakeholders are paying more and more attention to sustainability, these companies need to find a way to reduce their CO2 emissions and, providing it to Riley for its EOR and CCUS initiatives could be one way to lower their net emissions. As highlighted in the presentation of the Q3-2022 results , Riley Permian has already started a FEED study for the CO2 permanent storage and has started negotiations with potential commercial partners.

Financial results

In the first nine months of 2022, Riley Permian reported revenues of $243MM, up 90% year-on-year. Almost 93% of revenues are generated by oil sales ($225MM) with natural gas and NGLs that account for just a small percentage. The large year-on-year increase is explained by two effects: on one side, oil production increased by 28%, from 1.7 MMbbl in 9M-2021 to 2.3 MMbbl in 9M-2022, on the other side the realized oil price after hedging increased by 42% from $52/bbl to $73/bbl. The realized price was much lower than the actual average oil price because Riley Permian was heavily hedged during 2022 with almost 50% of the volumes hedged at an average price of $57/bbl. It was a strategy that generated much lower free cash flows than what could have been possible, but it clearly was a protective position opened in a period where prices were lower and the future was uncertain. For 2023, the company has less strict credit requirements and it will be more flexible with the hedging strategy: only 22% of 2023 volumes are currently hedged, for an average price of $57/bbl.

Total costs increased by 8%, from $75MM to $81MM with lease operating expenses increasing by $5MM and exploration costs significantly decreasing from $9MM to $1.5MM. Net income for the first nine months of the year was positive at $91M.

Cash flow from operations was $130MM, up 86% year-on-year mostly due to a higher net income. Cash flow from investing activities was negative at -$82MM due to additions to oil and gas properties. Cash flow from financing was negative at -$37MM due to debt repayments ($21MM) and payment of dividends ($18MM).

As of September 30, 2022, the company has a debt of $48MM and cash of $18MM, resulting in a net debt of $30MM.

Dividends raised

On January 11th, 2023, Riley Permian announced the quarterly dividend of $0.34/share, to be paid on February 8th. The annualized dividend will be $1.36/share.

Risks

One of the main risks that I see is that Riley Permian has production and revenues that are heavily skewed towards oil and this could be perceived as less sustainable if compared with peers who have more gassy portfolios. The company is aware of this and has already carried out some initiatives to reduce emissions such as the elimination of trucking in favor of pipeline transportation for all oil volumes.

A second potential risk could be the drop in oil prices with a consequent reduction in revenues and free cash flows. However, Riley Permian has lower production costs than peers and, despite 2023 volumes being less hedged, the company will constantly monitor the commodity prices to evaluate whether to open new defensive hedging positions.

Finally, Riley Permian is currently trading close to its 52-week maximum (3% discount), which might represent a psychological threshold investors do not want to pass.

Investment rationale

Overall, I believe that Riley Permian is a solid company with low leverage and free cash flows that will improve due to a better hedging strategy. The fact that it operates in the San Andres foundation creates a competitive advantage over other players since development costs are lower. A further upside is represented by the CO2-related projects that I believe could have a high potential. On one side, EOR can help to increase production volumes leading to higher recoverable volumes and FCFs. On the other side, CCUS could represent a new source of revenue stream, particularly if we consider the CO2-intensive area where the company operates and the increasing need for companies to decarbonize their business. Overall, I believe that, in the long run, Riley Permian is a BUY.

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