Can Hess Have Its Cake and Eat It Too?

Sometimes it's best to focus on what you already do well. By shedding assets around the world, Hess Corp (NYSE: HES  ) is moving closer to becoming a pure-play exploration and production company. Over the past year, the company divested $7.8 billion worth of assets, allowing it to grow its share buyback program and boost its dividend while reducing debt.

However, Hess has also reduced its exploration capex by 30% since 2012 and plans on continuing to do so in 2014. The big question is: How is Hess going to grow while cutting spending?

I understand the need to shore up the balance sheet, but I would rather see more invested back in the business than being dolled out to share buybacks. Hess is trying to have its cake and eat it to; so how does it plan on going about doing so?

Growing output while spending less
One of Hess' core plays is an American favorite, the Bakken. Everyone knows about this play, but few know that Hess has been pumping out crude from the area since 1951.

So how is Hess going to utilize its acreage in the Bakken? Since the end of 2012, Hess has been able to lower well completion costs to $7.8 million (third quarter 2013) from $9 million. Part of this is due to Hess' ability to bring wells online four days faster (now 24 days) in that same time frame. As Bakken operators are able to bring wells online faster while reducing costs through downspacing and better infrastructure, reduced capex can still result in more wells being brought online.

In Hess' upcoming earnings call look to see if management sees well completion costs still trending lower, because this would easily justify spending less on the area to bring down the debt load. 

The Utica shale will also provide onshore gains for Hess. By joining hands with CONSOL Energy, Hess plans on further developing the wet gas window of the Utica which offers plenty of upside over the next few years due to a relatively small base to grow off of.

Eventually a midstream MLP?
Don't just look at the upstream assets, Hess plans on adding significantly to its midstream operations as well. Hess has the ability to expand the capacity of its Tioga gas plant from 100 MMcf/d to 250 MMcf/d, which processes NGL. Part of the expansion plan could also include expanding Tioga rail capacity to 120,000 bpd from 54,000 bpd.

Investors should care about how Hess decides to move forward with its midstream assets because by 2015, Hess wants to monetize these assets some way or another. Whether it's an IPO or a sale to another company, by expanding its midstream assets Hess will be able to generate more cash through whatever monetization method it chooses.

Offshore developments
1. Start up of the Tubular Bells by mid-2014 in the Gulf of Mexico to keep output flat through 2017

2. Exploration efforts in the Paleogene and Miocene parts of the Gulf

3. North Malay Basin assets coming online, which plans to quadruple output through 2017

4. North Sea expansion through 2017 though the non-operated Valhall complex and the operated South Arne platform, potential for exploration upside

5. Exploration efforts in Ghana

6. Declining overall production from Equatorial Guinea as base output plummets

Exploration efforts are what will drive future value creation as its offshore assets paint a mixed growth picture. But how will Hess be able to find additional reserves while reducing its exploration budget. Unless 4-D seismic imaging can fill in the gap, it will be quite a struggle.

Foolish conclusion
Watch the Bakken shale to see if Hess will be able to find additional cost savings to boost output while spending less. If Hess can keep lowering well completion costs and drilling times then it could complete more wells with less. The Utica shale is an emerging asset that offers plenty of liquid potential if the proper window is tapped into, so look toward the production mix from the region. Lack of additional efficiency improvements will force Hess to consider revising either its guidance or capex going forward.

The offshore picture is mixed, with some regions producing growth and some not. Upside will come from new deposits being tapped into and by using 4-D seismic imaging Hess is trying to compensate for the capex reductions.

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9/19/2014 4:05 PM
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Hess Corp. CAPS Rating: ****

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