The deep dive in the price of oil over the past year was expected to push small shale drillers into bankruptcy. But while some are on that brink, others like Laredo Petroleum (LPI -0.74%) are more than just surviving the downturn. That was clear on the company's third-quarter conference call after the management team detailed its solid performance.
1. We're focused on drilling better wells
CEO Randy Foutch noted that the company's solid performance during the downturn is the direct result of investments it made during the boom years. He said:
We continue to focus on enhancing well economics using the advantages afforded us by our contiguous acreage position and prior infrastructure and data investments...In the foreseeable future, as a result of careful planning in prior years that emphasized drilling to hold acreage, we expect to be able to drill the majority of our horizontal wells with 10,000 foot laterals along production corridors targeting the Upper and Middle Wolfcamp zones and utilizing the Earth Model.
Over the past few years, Laredo invested heavily to gather a contiguous acreage position, build infrastructure, and gather data, all of which is paying off during the downturn. That is now allowing it to drill longer wells into targeted areas of the reservoir, which is leading to returns that are just as good as those it was earning when oil was much higher.
Data source: Laredo Petroleum investor presentation.
2. We're operating at breakeven
Despite very weak oil prices during the quarter, which were down more than 20% from just the prior quarter, CFO Rick Buterbaugh pointed out:
During the third quarter, the Company operated approximately within cash flow, exiting the quarter with more than $940 million in liquidity, up slightly from the second quarter level.
It is worth pointing out that the company did sell some non-core properties during the quarter, which boosted its cash flow. However, it also invested nearly $50 million into its midstream pipeline system during the quarter so the company's oil business really is operating near breakeven, which is a remarkable accomplishment given the current oil price. Laredo is in a very elite group of small drillers thriving during the downturn, joining the likes of Oasis Petroleum (OAS), which is also running a breakeven or better oil business, while its midstream business is consuming a bit of cash.
3. We're on solid financial ground
To explain how the company is unlike a lot of its peers, Foutch said:
I'm pleased with the company's financial position. The recent redetermination of our senior secured credit facility resulted in a borrowing base of $1.15 billion and supports our $1 billion elected commitment. Our strong hedge position and operating approximately within cash flow during the third quarter enabled the Company to exit the third quarter with more than $940 million in liquidity.
Going into the fall, analysts were worried that banks would cut deeply into the borrowing bases of smaller shale drillers like Laredo and Oasis Petroleum, but that just didn't happen. Because of this, both companies have robust liquidity for at least the next six months. Even in six months' time, Laredo and Oasis Petroleum are less likely to see borrowing base reductions by banks because both have solid balance sheets, are running at breakeven, and have little borrowed on those credit facilities compared to weaker peers.
4. We're really benefiting from our oil hedges
One thing that Foutch noted being as key to its financial strength was the company's strong hedge position. CFO Rick Buterbaugh went into more detail on its hedging practices, saying:
A vital component of protecting our cash flows is our ongoing core strategy of hedging to reduce the variability of our anticipated cash flows due to commodity price fluctuations. In the third quarter, we received more than $66 million of cash settlements on maturing derivatives. Our oil hedges provided an uplift of almost $34 per barrel to our realized price which equates to an increase of approximately 80%. In combination with our gas hedges, this results in more than a 60% uplift to our realized price on a BOE basis.
The company has been able to stay around breakeven because of its conservative decision to hedge a large percentage of its production when prices were higher, which paid off last quarter. Laredo was able to capture a $34 per barrel higher sale price for its oil, which provided a big boost to cash flow. Oasis Petroleum likewise benefited from a strong hedge position, though it only captured another roughly $20 per barrel via its hedges.
Looking ahead, Laredo plans to remain well hedged in 2016, with Foutch noting:
[...] We added additional hedges for 2016 and now have hedged approximately 85% of anticipated oil production in 2016 at a weighted average floor price of more than $70 per barrel...
5. Our long-term approach is paying off
Foutch summed up the company's ability to deliver solid performance during the downturn by saying:
Laredo is benefiting today from long-term strategic decisions made almost 10 years ago at the Company's inception. Core principles such as investment in data, infrastructures that reduce costs and build value and hedging production to protect cash flows are adding significant value to our shareholders today and we believe will continue to do so in the future.
While a lot of oil companies build infrastructure such as pipelines and hedge production, what really sets Laredo apart are its investments in data. A key outcome of this investment is the Earth Model, which it uses to target its wells so that it can hit the most hydrocarbon saturated rocks beneath its acreage. That is leading to better production as well as better well returns.
Investor takeaway
Unlike a lot of its wildcatting peers, Laredo Petroleum has taken a conservative, data-driven approach to building the company, one that is paying big dividends during the downturn as evidenced by the fact that its financials are on solid ground and operations are performing well.
