So far, 2020 hasn't been a good year for oil producers. And it's been an absolutely lousy year for U.S. shale oil producers. So, what should investors think about the top producer in North Dakota's Bakken Shale, Hess Corporation (NYSE:HES)?
On the one hand, Hess' stock is down 26.8% so far this year, and its dividend yield is now about 2%. On the other hand, oil prices have collapsed and demand has evaporated. Let's dig deeper to see if Hess looks like a buy at its current prices.
Hess has been a North Dakota driller for more than a half-century, discovering oil in the Bakken formation of North Dakota in 1951. And although it now has stakes in offshore drilling operations around the world, it's still primarily a Bakken Shale driller. In fourth-quarter 2019, 51.5% of Hess' production came from the Bakken Shale, compared to 49.6% of production for full-year 2019.
But shale drilling is comparatively expensive; most shale drillers require an oil price of at least $50/barrel to break even. Right now, U.S. benchmark WTI Crude is trading for less than one-third of that, at about $15/barrel at the time of this writing. North Dakota Williston Sweet Crude -- the Bakken Shale is part of the larger Williston Basin -- is trading for about half of that, at $7.50/barrel.
So it's a small wonder that Hess is cutting its rig count in the Bakken Shale from six to just one. However, the company seems to think that this won't have much of an impact on production, adjusting its projected 2020 daily Bakken production downward by less than 3%, to 175,000 barrel of oil equivalents per day (BOE/d). However, if it can't make money on its Bakken operations, it doesn't matter how much production it can maintain.
Filled to the brim
Those Bakken numbers aren't good for Hess. Meanwhile, just over 20% of its 2019 production came from the Gulf of Mexico, meaning more than 70% of Hess' production is dependent on U.S. oil prices -- and U.S. oil storage.
That storage is at a premium right now. Fuel demand is low due to coronavirus-related travel restrictions, and companies (including Hess) haven't cut production by anything close to a similar amount. Lack of available storage was the primary cause of WTI Crude prices' drop to negative $37.63/barrel on April 20: sellers had to pay "buyers" to take the oil off their hands because they had nowhere to put it.
The supply glut is likely to persist, even if travel restrictions are lifted and demand returns to 2019 levels. It will take time for the current oversupply to work its way through the system, and countries like Saudi Arabia and Russia have shown they're willing to flood the market with even more cheap oil if they believe it's in their interests to do so.
That adds up to low U.S. oil prices for months, if not years, and Hess has already been unprofitable for nearly five straight years at higher oil prices. How long can it last if 70% of its production is selling at a loss?
Hanging on vs. thriving
In a statement on March 17, Hess tried to reassure shareholders that it was poised for long-term success.
Hess announced the Bakken rig cuts, and an end to "most discretionary exploration and offshore drilling activities," excluding its promising collaboration with ExxonMobil (NYSE:XOM) offshore Guyana. But Guyana is just ramping up, accounting for merely 0.3% of the company's fourth quarter 2019 production. It's unlikely to meaningfully contribute to Hess' bottom line for years.
CEO John Hess pointed to the company's hedge positions, stating that 80% of the company's 2020 production is hedged, or committed for sale at an artificially high cost. But hedges -- essentially, oil and gas futures contracts -- cost money to buy, and aren't a long-term substitute for a profitable operation.
Hess also announced a new $1 billion three-year loan on top of an existing $3.5 billion undrawn revolving credit facility. Coupled with the company's $1.5 billion cash hoard, that gives Hess $6 billion in liquidity, and "no material debt maturities until 2027."
That may sound reassuring, but Hess already has more than $7 billion in long-term debt on its books: 2.5 times its trailing EBITDA. Kicking the can down the road a few years will only delay the day of reckoning -- just from an even worse financial position.
So, yes, Hess is likely to be able to hang on for at least a few years by maxing out its credit cards, relying extensively on hedges, and investing heavily in a region that currently contributes next to nothing to its top line. Not a compelling investment thesis.
Huge red flags
The oil industry is an absolute mess right now, and the U.S. oil industry -- which accounts for about 70% of Hess' production -- is in dire straits. Tumbling prices, storage issues, and the poor economics of shale are challenging for even the strongest of oil companies -- and Hess is not a strong company.
Hess' plan is to load up on debt and cross its fingers for a speedy recovery in U.S. oil prices, which may never happen. That's not much of a plan. It's coming off of nearly five straight years of unprofitability. About the only thing it has going for it is its investment in Guyana, which is like a juicy cherry on top of a sludge sundae.
Investors should avoid Hess. If you want to invest in Guyanan oil production, a better bet is Hess' partner ExxonMobil, which not only offers more stability, but a much higher (and safer) dividend yield.