Why Pioneer Natural Resources Investors Should Be Wary of Slumping Crude Prices

The shale driller is banking on $55 oil to fuel its ambitious growth plan.

Matthew DiLallo
Matthew DiLallo
Jun 28, 2017 at 12:15PM
Energy, Materials, and Utilities

Late last year, Pioneer Natural Resources (NYSE:PXD) unveiled its "1 million in 10" plan, which laid out its vision to grow production up to 1 million barrels of oil equivalent per day (BOE/d) by 2026. For a company that only produced at a quarter of that rate last quarter, it's an ambitious goal, though one it can achieve by increasing output at a 15% compound annual rate for the next decade. For perspective, that's the rate that it grew production last year and about what it expects this year.

As long as oil prices cooperate, the company shouldn't have any problem achieving that plan because it can fully fund that growth within capex at a relatively low oil price. That said, the pivot point for delivering that growth within cash flow is $55 oil, which at the moment seems a bit optimistic given that crude has slumped into the low $40s in recent weeks. That steep decline in oil prices is something that should make investors a little nervous because it might force the company to reevaluate its long-term growth plans.

Drilling rig among agricultural fields.

Image source: Getty Images.

Staying on pace, for now

When Pioneer Natural Resources reported its first-quarter results early last month, it noted that production grew 3% sequentially, which was at the top end of its guidance range, keeping it on pace to meet its full-year growth expectations. With no changes in its plan to invest $2.8 billion this year on new wells and related infrastructure, the company remained confident that it would hit its target and increase production by 15% to 18% this year.

Further supporting that outlook is that Pioneer has ample financial flexibility to fund that spending level. That's because it hedged about 85% of its oil production for the remainder of 2017, which will enable it to generate between $1.5 billion to $2.2 billion of cash flow as long as oil remains in the range of $40-$55 a barrel. Meanwhile, with $2.4 billion of cash and other liquid investments on its balance sheet, and non-core assets sales in the works, Pioneer clearly has the capital resources to finance its 2017 plan.

That said, if crude continues its downward trajectory, Pioneer Natural Resources' financial firepower will slowly start to erode over the next year. That's because the company only has 20% of its oil output hedged in 2018 and it's on pace to burn through more than a $1 billion of its cash cushion this year if oil stays in the low $40s. Because of that, the company might need to cut back spending next year, which could cause it to go off track of its 10-year plan. Its other option would be to raise capital and bridge the gap between cash flow and capex, which could include selling assets, issuing new equity, or borrowing money. In fact, with a fortress-like balance sheet thanks to an ultra-low leverage ratio, the company would have no problem borrowing to finance growth if needed.

An oil pump at sunrise.

Image source: Getty Images.

It's a matter of market need, not ability

While Pioneer Natural Resources could continue to grow production at a mid-teens rate for at least the next couple of years even if oil remains low, the question is whether it should keep pursuing that growth given what's driving down oil prices. On one side of the equation, rising shale output from Pioneer and other Permian Basin peers like Diamondback Energy (NASDAQ:FANG) are offsetting OPEC's efforts to drain the market's excess inventory. In Diamondback Energy's case, it ratcheted up spending, which has already unleashed a gusher of new production, with it delivering 13% quarterly organic production growth last quarter. This spike in output from Diamondback and other drillers is coming even as OPEC is trying to get rid of excess stockpiles by reducing its production, causing oil inventories to remain in the upper half of the average range for this time of year.

Meanwhile, on the other side of the equation is demand, which just isn't as robust as hoped. For example, the International Energy Agency expects oil demand growth to slow again this year, marking the second straight slowdown. Overall, it expects demand to increase by 1.3 million barrels per day, though it warned that its outlook could "prove optimistic." That has been the case thus far given that oil demand has only grown by 900,000 barrels per day due to weakness in India.

In other words, if oil supplies from shale continue rising unabatedly while demand growth remains tepid, it could cause oil prices to fall further in the future. Some analysts are already predicting that oil could slump into the low $30s at some point in the next year. At that price point, few oil companies can make decent returns, even on wells drilled in the heart of the Permian since oil breakeven levels are in the high-$20-a-barrel range in the areas where Pioneer drills.

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Investor takeaway

Pioneer Natural Resources is banking on crude remaining in the mid-$50s for the next decade, which would give it the cash flow it needs to fuel its ambitious growth plan. That said, with crude dropping into the low $40s recently, its making that target look less achievable, especially considering that oil is falling because the market doesn't need any more at the moment. It's why investors should be wary of low oil prices, because if crude keeps falling, it makes it less likely that Pioneer can grow as fast as hoped.