2023-10-12 13:03:55 ET
Summary
- Crescent Energy Company, a combination of KKR and John Goff, aims to capitalize on the seller's market in the oil and gas industry. Rarely can the public invest alongside such professionals.
- The Eagle Ford, with its low well breakeven points, premium pricing, and lack of takeaway issues for oil production, often outperforms the Permian basin.
- Bargain prices for Eagle Ford acreage lower the location cost of wells and prevent overpayments that may only be revealed during a downturn.
- Growth will likely continue to be from acquisitions. The Eagle Ford acreage now adds the prospect of organic growth as well.
- A return of capital priority will be low.
Crescent Energy Company ( CRGY ) is the very public combination of KKR & Co. Inc. (KKR) and John Goff. These are two very well-known entities that have very attractive records separately. They have combined forces to go after the seller's market that has prevailed for some time in the oil and gas industry. Rarely does the public have a seat next to some of the better investors known throughout the industry.
Interestingly, this management has grown an Eagle Ford presence to an impressive amount. The Eagle Ford often has profitability comparable to the better-known Permian. But many times, the takeaway capacity issues that plague the Permian during the boom times (that lead to price discounting and very expensive transportation issues) do not plague the Eagle Ford. The result of this is that the Eagle Ford often performs as well or better than the Permian basin.
Eagle Ford Acquisitions
Management made two Eagle Ford acquisitions. Previously this was a company that acquired established production with an emphasis on cheap reserves. Drilling for more production was not a priority, as the production acquired often had low decline rates, and any cash generated could acquire more cheap production from distressed sellers.
Now management is acquiring acreage where profitable growth through drilling is a far more reasonable proposition. The Eagle Ford basin is some of the lowest breakeven acreage in North America. The Permian gets a lot of attention. But oftentimes, takeaway capacity has become an issue in the Permian leading to high transportation costs and discounts. The Eagle Ford has not had that issue and often receives a premium for its production.
When it comes to actual execution of business strategy, the Eagle Ford has come out ahead for those reasons in the past. That makes the recent expansion by this company in the Eagle Ford very interesting.
The "mad rush" to get a stake in the Permian created rapid growth with a whole lot of logistical issues. Anytime that happens, the actual execution involves extra costs that were generally not mentioned by competitors who rushed to buy the premium acreage.
The Eagle Ford, on the other hand, has really been no one's idea of premium acreage. The result is that there are sellers willing to accept bargain prices for some acreage that performs surprisingly well. More importantly, those bargains lower the location cost of wells.
Many times, investors cannot "see" the effects of paying too much for each drilling location. It is rarely, if ever, shown to investors on well breakeven calculation, and land does not depreciate. Generally, the only way overpayments show up is during the next cyclical downturn when management announces a massive write-off due to industry conditions.
Low Decline Rate
The company achieves a low decline rate by purchasing established production. Since the production is "older" the operating costs are higher, and the production is not worth as much. Oftentimes, this is shown by a low acreage cost to make up for the higher production cost.
In theory, when costs get too high, one either moves onto some sort of EOR (secondary recovery) or plugs and abandons the well. In practice, technology keeps advancing that often allows for reworks to keep that well producing long after the original "due date."
Many times, the decline rate is a function of growth in the recent past. That means that the purchase of established production often means there has been no growth for a while. Therefore, the decline rate will be low.
Investors should expect that more Unita and Eagle Ford type acquisitions could increase the corporate decline rate in the future. Those two areas have the ability to grow corporate production but have relatively steep first year decline rates.
However, the corporate breakeven rate can remain low through the bargain purchase price that often "punishes" the acreage price for the lower, higher cost production. By purchasing older production from distressed or unnatural sellers, the higher production cost is effectively offset by lower well and acreage cost (through the purchase allocation process).
Management can often retain considerable upside for any parts of the undeveloped acreage. As technology continues to advance, that often makes these bargains into outright "steals" because more intervals become commercial over time than was ever part of the original bargaining. That technology advance puts management in a "win or win more" position. The same goes for shareholders.
Unita
The Unita Basin has its own interesting history. This was a basin where decline rates were a real pain. Therefore, the ability to get older production that establishes a base cash flow turns out to be a huge competitive advantage because it was a real challenge for newcomers to establish that base cash flow.
Crescent had the advantage of purchasing established production after "somebody" sold out as a distressed seller to the current holder. That means that no one drilled for a while (or at least not much anyway). So, the feared rapid initial decline was over with. That means that less wells are needed to maintain production.
Management, therefore, based the bid on this acreage upon established production. Now, supposedly, management is able to replace that declining production with one rig.
What is interesting is there have never been plans to grow this production. Given the history of this basin, that is not at all surprising as growth here has been very capital intensive in the past.
As a cash flow machine, this production is probably a decent idea.
Debt
Debt levels throughout the industry are heading into some interesting territory. This is probably caused by the fading of fiscal year 2020 and its challenges into the distant past.
This company is fairly conservative when it comes to handling debt. Unlike many KKR projects, the debt levels here are uncharacteristically low. The cash flow is protected by hedging so that a conservative cash flow structure is assured.
Supposedly, the latest Eagle Ford acquisition will be accretive. It will raise the debt ratio and we will likely be updated with a lot more specifics when the company reports the third quarter.
The two Eagle Ford acquisitions in May and September will seriously alter the company characteristics from established production fields that usually do not grow to Eagle Ford production that will grow at competitive costs while providing for an attractive return.
Before this acquisition, the strategy was to acquire cash generating production and produce it (period). The Eagle Ford will now have material production to at least partially change the company strategy.
Debt ratings keep rising as shown above as the company gains a public history of operations. The credit line is kept open for potential bargains as management finds them.
Key Takeaways
This company management is engaging in a build and sell the company strategy. Therefore, investors can expect that return of capital will have a relatively low priority. The growth will likely come mostly from continued acquisitions. However, some acreage, like the Eagle Ford, can be managed for profitable growth.
There is upside potential in several locations like the Eagle Ford from multiple intervals that are not yet commercially viable. But these areas are likely to become commercially viable as technology continues to advance.
Production costs are likely to remain on the "slightly higher" side as a result of the strategy of purchasing established production from "unhappy sellers." The lack of recent drilling activity in a lot of these purchases means that the high decline rates of newer production are already a thing of the past. Therefore, maintaining production has a low capital requirement.
The strategy of purchasing distressed properties means that overall corporate costs are likely to be very low even if production costs are a little on the high side.
Rarely do investors get to invest alongside entities with the stature of KKR and John Golf. This is one of those rare times. The lower financial leverage and the experience of management mitigate a lot of the perceived upstream risks. Similarly, the conservative balance sheet minimizes the financial risk. This equity is probably a strong buy consideration for a wide variety of investors as a result.
For further details see:
Crescent Energy: Let's Make A Deal