Independent E&P operator Cimarex (XEC) just announced a massive cut to production for 2020, shutting down all but one producing rig starting in May. How much revenue can it make off of one oil rig? Thanks to management's hedging, quite a bit.
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The scramble to react to shakier times
Most energy firms have reacted to plummeting oil prices so far by pulling the first of many levers within management's reach: curtailing capital spending for the fiscal year.
When an energy company's management sees profitability fall, it generally reacts first by lowering forecasts for capital expenditures -- in short, planning to spend less on the company's maintenance and expansion. CAPEX spending is most companies' growth engine, and especially so for energy companies. Once CAPEX is completely cut, a company can, at best, forecast profits that are flat year-over-year. At worst, the company can succumb to its debt burden and collapse if it doesn't grow enough to cover its bills.
On April 15, Cimarex announced that it's essentially pulling the CAPEX lever 60% of the way down. It still has room to cut CAPEX spending, but it probably shouldn't, since some of that money keeps its equipment operating safely and up to environmental codes.
Knowing that Cimarex hasn't fully yanked back on the CAPEX spending lever might reassure investors, especially when they think about the other levers they may not want the company to use: operating expenditures, dividends, and debt payments. Once a company starts cutting these, it's vulnerable to layoffs, stock value deterioration, and/or bankruptcy.
Cimarex once predicted capital spending between $1.25 billion and $1.35 billion this year. It has now pared that to $500 million to $800 million.
What this means for production
When Cimarex issued its initial prediction for this year's capital spending, it aimed simply to maintain 2020's production at 2019 levels.
Cimarex produces oil, natural gas, and NGLs from its assets, but by far it makes the most revenue off of its oil production. It brought in $1.66 billion from the 31.5 million barrels of oil produced in 2019 -- roughly $52.77 per barrel. That wasn't great performance by last year's standards; rival ExxonMobil (XOM 0.02%), for instance, managed to command roughly $61 per barrel produced. However, Exxon gets a lot of its advantage from being an integrated producer -- it can sell some of the oil it produces from its upstream operations to the processors and refiners in its downstream operations. Cimarex, all upstream, can't match that.
Nevertheless, producing oil for $52.77 per barrel is profitable for the company if you take out the non-cash charges the company records when the value of its wells drops. The company realized $618 million of impairments to oil and gas properties in 2019, but cash from operations of more than $1.3 billion in the same year.
In its most recent earnings call, Cimarex forecast a lower-end production of oil about flat year over year, meaning management was prepared to produce about 32 million barrels of oil for the year 2020 . If management hadn't hedged production through 2021 -- signing contracts in advance to deliver oil at an agreed-upon price -- the company might have to resort to selling its oil for the current market price around $20 per barrel, capping its revenue in oil for the year at about $640 million.
The glimmer of hope in all this
Fortunately, Cimarex did hedge production. In announcing its capital spending cuts, Cimarex's management emphasized just how much of the production of oil had been hedged, and how far out into the future the company those hedges extended. For the rest of 2020, the company has hedged its daily production to ensure that nearly half of the oil it produces won't sell for less than roughly $44 per barrel. Thanks to these hedges, the company will make at least $600 million of revenue from its oil production in 2020. Beyond that, Cimarex will be forced to sell what it produces at the prices governed by its contracts, which fluctuate according to spot prices of oil.
I'd still say that's a pretty good return for a $16.7 million hedge. Beyond 2021, the company holds no hedges, and even the ones in 2021 don't come close to covering even half of the company's historical production. So things might get rough for Cimarex investors in 2021, but for now, the company's derivative holdings are more than enough to pay its bills. Still, investors should hold off on buying Cimarex unless the oil market starts to head toward $50 a barrel going into 2021.
