As shale has taken the lead for exploration, it's no wonder companies with negative free cash flow might sell themselves short.
With pipeline assets up for grabs, the big name taking over is Enterprise Products Partners (NYSE:EPD), buying $2.15 billion worth of assets from Pioneer Natural Resources (NYSE:PXD). But what will Pioneer actually be giving up, by giving in?
A full transcript follows the video.
Sean O'Reilly: Oil companies are getting creative with raising cash on this energy edition of Industry Focus.
Greetings Fools! I am Sean O'Reilly joining you here form Fool headquarters in Alexandria, Virginia. I am joined by our energy experts Tyler Crowe and Taylor Muckerman. How's it going, guys?
Taylor Muckerman: Being awfully generous with that expert word.
Tyler Crowe: Yeah. I really get nervous when you say 'expert' because then people are going to trust us.
O'Reilly: I didn't want to say it, but you guys are our second stringers.
Crowe: Yeah. It's fine.
O'Reilly: Oh, well.
Muckerman: Who's first string?
O'Reilly: You don't want to know. Obviously the analysts outside our door here.
Crowe: Must be.
O'Reilly: Yeah. Stock Advisor analyst.
Muckerman: Beating down the door.
O'Reilly: So, if you're just joining us, folks; today we're going to be talking about how all these oil companies are keeping the lights on, basically. First up, we've got a deal where Pioneer Natural Resources is selling a pipeline asset to Enterprise Product Partners for $2.15 billion. Tyler, what did you think when you first saw this?
Crowe: He's kind of leading me because I told him about this earlier. But, the first image that came to my mind is -- has anybody seen those 'cash for gold' commercials where it's like "Need cash now!" Or it's like someone's grandma says "I turned in my scrap gold for cash."
Crowe: For some reason, this deal just -- to me -- screamed "I need cash now!" And what ended up happening was -- and Pioneer Products has these pipeline assets they had built out to get their production started in the Eagle Ford Shalearea. They couldn't get it to work.
O'Reilly: So, this thing isn't even working...
Crowe: Well, I'm sorry. Let me clarify. It wasn't generating revenue, and it wasn't a way to monetize for them because there's basically a way for them to gather everything they have and bring it to market. It's nice to have, it can reduce your cost a little bit and when you're getting started it can be hard to get a partner to develop all your gathering pipeline. So, they were doing it themselves, but then they had all this pipeline that didn't have as much.
So, it was like "We have all this pipeline, but I need cash now." So, they headed down to Enterprise Products pipeline emporium and turned in that pipeline for cash.
O'Reilly: I noticed that Pioneer -- which was cash flow negative last year, of $1.2 billion, and the year before that was $900 million -- happened to sell something to Enterprise Products which had positive free cash for the last year of $1.2 billion. So, this definitely seems to be a case of 'somebody's got a bunch of money lying around, they'd totally buy it'. And they bought the gold.
Muckerman: What caught me off-guard was that everyone always talks about Pioneer being one of the top producers in the country, and here they are...
O'Reilly: Negative free cash flow.
Muckerman: Negative free cash flows. Selling pipelines.
O'Reilly: Even when oil was at $100 -- in fiscal year 2014.
Muckerman: Yes. That was -- granted five months of that year were pretty -- it was on the downturn. So, they weren't living at low prices the whole time.
O'Reilly: Even in 2013 it was $900 million.
Muckerman: Yeah. People, I think, look at Pioneer and everyone keeps saying they're one of the top producers, but maybe it's just asset based. They have great assets. If oil prices rise they could be one of the great producers because if you look at EOG (NYSE:EOG) they have their own rail lines, they have their own pipelines, they have their own sand mines. They're doing all right.
Crowe: Yeah. One of the things I think -- when I look at Pioneer Natural Resources people say it's a top producer. I think a lot of people get very starry eyed at the size of their reserves. If you look at what they have...
O'Reilly: Are they mostly in Texas?
Crowe: They're mostly in Texas.
Muckerman: Yeah, Permian Basin.
O'Reilly: That's at least a win, right?
Crowe: Yeah. The amount that they estimate they have in the Permian based on the multiple layers of shale that are available, once the technology catches up and the costs come down we're talking about -- what they believe -- is better than 75 billion barrels of oil. This thing is massive and Pioneer has a pretty good acreage position in it. So, everyone gets a little starry eyed.
It's like "Oh my God! Look at all this oil they could drill." But they have to do it economically and they haven't quite figured out how to do that yet.
O'Reilly: Are they not as efficient as an EOG? Because I did this deep dive and I compared them to Devon (NYSE:DVN) and Chesapeake (NYSE:CHK), I think, and they all compete in the Eagle Ford and all this stuff and EOG somehow manages to be free cash flow positive last year, and grow production more than those other guys. If, in a magical world, Pioneer were as efficient as EOG they would be a little bit better off?
Muckerman: Yeah. In a magical world. Maybe that's how EOG's doing it. Maybe it's magic. If no one else can replicate it, right?
O'Reilly: Clearly. They have Harry Potter on it.
Muckerman: They've been around for a while and every year they get better and better at it.
O'Reilly: Which is what -- that was the story. It was staggering. These people are really, really good at this.
Crowe: It also makes it -- something slightly ironic about one of the greatest failures in energy was Enron.
O'Reilly: They were just this castaway.
Crowe: A castaway of Enron. Two castaways of Enron are now two of the biggest players in the American oil and gas space. You have EOG Resources, and Kinder Morgan (NYSE:KMI). Which, technically, it wasn't part of the portfolio, but Richard Kinder was the heir apparent to Enron and said "Nah, I'm going to go run pipelines."
Muckerman: Well, then he -- I guess he used the money that they gave him to go buy the pipelines. I guess he didn't -- well, I thought he bought them from Enron.
O'Reilly: Enron had spawn because you also had that hedge fund guy -- John Arnold -- that was a trader for Enron, and he made an $8 million bonus just trading natural gas for them and he just left when it was collapsing. He's worth billions now and he's traded natural gas for the last 10 years and he just retired.
There's all these castaways from Enron that were all great bets, just Enron wasn't.
Muckerman: Nobody writes a book about that. It's only the smartest guys in the room.
O'Reilly: It is a really entertaining story.
Muckerman: Nobody writes a book about all that.
O'Reilly: So, bringing it back around to our 'cash for gold' scenario; these energy companies are having to get creative with keeping the lights on and everything. Pioneer's obviously selling this for a reason, and actually, it sounds like a good deal because they aren't making the best use of the asset. Arguably it should go to somebody that can.
Crowe: It works out to a pretty good deal overall. Pioneer is basically going to net about $1 billion because they owned half of it. The other one was a private holding. So, they'll get half of it, the other half will get their billion share, and the nice thing for Enterprise is they don't have to pay for it all up front. I believe they pay half now -- $1.15 billion now, and then one year after the closing is when they have to make the final payment.
So, it actually gives Enterprise a nice buffer period to gain a little cash from operations that they can throw at it and not have to go out today and raise $2 billion in cash.
Muckerman: Do you think that's a sign of a buyer's market?
Crowe: It sounds pretty good to me.
Muckerman: Dictating terms? "I don't have to give you all my cash just yet. You can take this and like it."
Crowe: They even threw a little kicker in. They were like "You can even use our system at a slight discount."
Muckerman: That's right.
Crowe: "You'll save $200 million over 20 years." So, throw a little kicker in and say "We don't feel like paying you all of it now. We don't think you're responsible enough. We'll give you $500 now, $500 later."
O'Reilly: So, how does this relate to what other energy names like Linn (NASDAQOTH:LINEQ), or a Breitburn (NASDAQOTH:BBEPQ) where they're slashing their dividends, they're issuing a few units? Is this where we are now? Are they just trying to survive as long as possible before having to sell something?
Muckerman: I don't know. What's that song? "The first cut is the deepest"?
O'Reilly: Yeah. That's a little Sheryl Crow there. I know what you were listening to this morning.
Crowe: Where did that come from?
Muckerman: I think a lot of these companies are just taking that first stab at -- they don't think this is going to be that long of a period, so let's just go ahead and get a dividend cut out of the way, let's get a massive sale out of the way. Rather than taking bits and pieces at a time, planning for a five year downturn. I think these companies are expecting this to turn around.
But the ones that are in trouble need quick infusions of cash, or quick reduction in cash outflows, like a dividend. And a lot of those companies are paying dividends that were right on the fringe of being sustainable even at $100 a barrel. So, I think that was the gut reaction. They had to do it and now, most likely, if this turns around in the next fiscal year, I think they'll -- most of them will be all right.
Crowe: It kind of gets into the next thing we were going to talk about after this.
O'Reilly: Yeah, who here is surprised at how shale's not died?
Muckerman: Yeah. Nobody's getting bought, nobody's going bankrupt. I mean, not 'nobody'.
Crowe: There's been a couple small bankruptcies, but these companies were teetering on bankruptcy at $100 a barrel. There was a couple...
O'Reilly: So, what did you think happened at $50?
Crowe: Yeah. So, at $50 they're like "Come on, obviously." But they've been a lot better. It's been surprising to see how resilient they have been to that. A couple things I think have been -- that can attest for the resiliency is, number one: shale costs. The actual cost of drilling shale -- it's still a relatively new process. We haven't mastered it like we have conventional drilling.
So, costs are coming down at a rate that, what was profitable at $90 a barrel two or three years ago is now profitable at $75 or $70.
O'Reilly: Yeah. What was it in that EOG presentation? They're making more money at $65 per barrel than they did at $93 or something? I can't remember.
Crowe: Yeah. From bringing costs down through a lot of the things you were saying. Rail, sand, logistics; things like that. They've been able to bring down their cash costs enough that they could make profits at these lower levels. Like you said, EOG...
Muckerman: Those are things that only they're doing right now. Other companies that are all doing the same thing, or they have multiple wells being drilled in the same pad, they have deeper wells, longer laterals; they're able to extract more oil from the same well, or from the same pad, which is where they have the multiple wells being drilled in the same area. That reduces cost and it reduces the time to drill.
O'Reilly: So, these shale companies are getting really efficient and they're making more money at lower oil prices. Is this somehow bearish for oil prices, but bullish for the companies themselves? I don't want to get too macro-y here.
Muckerman: That's the $1 trillion question.
Crowe: Yeah. That is the $1 trillion question. One of the things when I look at it -- the fascinating thing about shale in contrast to a lot of other oil development is: shale development is a much shorter cycle then everything else.
O'Reilly: Yeah. What does it last? Six months and your well's half gone, or something?
Crowe: Not only that, but actually ramping up as well. For an offshore oil well out in the Gulf of Mexico we're talking three to five years of development for procurement and getting all the subsea infrastructure in place to actually make it to work. Which also means that you have to bring on a lot at the same time 70, 80, 100 thousand barrels per day.
Whereas with shale, I'll go out, I'll drill a well in 7 days, have that thing running in 10 and...
O'Reilly: We're going to go out to the ...
Muckerman: Wham, bam, thank you ma'am!
Crowe: Yeah, exactly. 1000 barrels a day right back up on schedule. What I think it -- this is the possibility that I see that could actually see a significant change. With that quick turnaround you don't have to be as consistent of a capital allocator. From year to year you don't have to be that steady hand. You can be that one that shifts with the market a little bit more and being able to do that with such a short development cycle -- I'm making a bold speculation guess here -- but I think it could shorten commodity cycles. With the ability to react...
O'Reilly: Especially with the U.S. as the world's "swing producer" now.
Crowe: Yeah. With so many different companies within the United States -- Wall Street Journal actually had a good factoid today. I think it's more than 50 companies in the U.S. produce 75% of the oil, versus -- so, it's so fragmented that you can't control it. It's like herding cats. So, when you have that, all these people are going to be able to move quickly, change what they want to do, pivot, and that can shorten the commodity cycle because if you can react that quickly...
O'Reilly: As opposed to five years with this offshore stuff.
Crowe: Yeah. Exactly.
Muckerman: And there's really no other country that's started to do it yet. And so many other countries have shale that could turn this on if they get their act together in the government side by allowing companies to come in, companies aren't worried about their assets being seized, if they can get their resources as far as water and then they get pipelines built.
China, Argentina, you've got Poland sitting there on tons of natural gas, Russia; all these countries just haven't even tapped the shale resource yet. Then if that takes place, then you're going to see supreme flexibility.
O'Reilly: We have a lot of advantages though with the capital markets and the ability to drill.
Muckerman: Yeah. We have a lot of advantages which is why all of these countries...
Crowe: It started here.
Muckerman: Then these other countries aren't going to have to take all this time to figure it out because you're going to have the Halliburtons (NYSE:HAL), the Schlumbergers (NYSE:SLB) -- now the Halliburton and Baker Hughes' (NYSE:BHI), and a couple other smaller companies -- Weatherfords (NYSE:WFT) -- that are going to know how to do this already, they're going to go over there, and then you're going to have the big E&Ps, the Exxons (NYSE:XOM), the Statoils (NYSE:EQNR), the Shells (NYSE:RDS-A) (NYSE:RDS-B); all these guys that have been doing it that aren't just U.S. producers.
They've already got the work for us abroad, and they're going to know how to do it, they're going to get in there, and they're going to get it done and these countries are going to be the beneficiaries of that. If they allow it and if they allow these companies to do it as safely as we've been doing it.
O'Reilly: Very good. Well, thanks for your thoughts, guys. Have a good one. If you've found this show informative and are looking for more Foolish stock ideas, Stock Advisor may be the service for you. It is our flagship newsletter started more than 10 years ago by Motley Fool co-founders Tom and David Gardner. We're offering the lowest price out there for all of our Industry Focus listeners. It is $98 for two a two year subscription to Stock Advisor.
You will get two stock recommendations every month with insight from our team of analysts. Just go to focus.fool.com to take advantage of that deal. Once again that is focus.fool.com. As always, people on this program may have interests in the stocks that they talk about, and the Motley Fool may have formal recommendations for or against those stocks. So, don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, I am Sean O'Reilly. Thanks for listening, and Fool on!