Photo credit: Flickr user Lindsey G.
Halcon Resources' (HK +0.00%) recent third-quarter report was good, but certainly not great. That was clear when taking a closer look at three key numbers, two of which showed progress while the third showed a new headwind the company will face starting next year.
1. This critical cost is coming down
Halcon Resources is doing a great job reducing its costs, which helps lessen some of the pressure from lower oil prices. In commenting on the company's progress, CEO Floyd Wilson noted in the earnings release that, "Our operational staff continues to exceed expectations. Efficiency gains combined with lower costs are driving results." One area where this was evident was in the Bakken where the company, for example, modified its well clean out process, which has reduced the number of days from the start of completing a well to production by 32% to 19 days.
However, the most important cost reduction number was the decline in operating costs per unit, which are down 27% to $17.04 per barrel of oil equivalent, or BOE. That reduction is really helping to offset some of the weakness in oil prices, enabling the company to maintain better margins on each barrel produced.
2. Cash flow gap is shrinking
Another number that has vastly improved is the gap between cash flow and cash outflows, especially from capex spending. Through the first nine months of last year Halcon Resources generated $582 million in cash from operations, however, it spent more than $927 million on investing activities, which included capex. That forced the company to borrow around $350 million to cover the difference. That outspend has narrowed this year, with the company generating $332 million in operating cash flow while spending $539 million on investment activities through the first nine months of this year, or a roughly $200 million shortfall.
However, the shortfall during the third-quarter was actually fairly minimal. The company produced roughly $115 million in cash flow and while outflows were less than $127 million. That put its cash flow shortfall at a mere $12 million, which is a huge improvement. This is a number to keep watching, with the ideal situation seeing it switch from a shortfall to an excess.
3. Hedging won't help as much in 2016
Unfortunately, Halcon Resources is going to have a tough time generating excess cash flow given how much it currently depends on its oil hedges for cash flow. During the third quarter the company noted that while it generated revenues of $129.9 million from oil and gas production, it also benefited from a realized net gain on commodity price hedges totaling $114.9 million, which almost doubled its revenue. Because of these hedging gains, Halcon's average realized price for each barrel of oil was $78.44 during the quarter, instead of the $40.71 it would have realized without hedges.
The importance of hedging gains on its cash flow last quarter can't be stressed enough and investors can't overlook the fact that these gains won't be as strong next year because the company's hedging is less robust. For example, during the fourth-quarter of this year 30,500 barrels of oil per day are hedged -- which is a large portion of its approximately 32,000 barrels of oil production per day -- at an average price of $90.21 per barrel. However, next year its oil hedges drop to just $80.59 per barrel on only 25,497 barrels per day. This suggests its cash flow will fall next year, unless oil prices vastly improve.
Hedging gains were quietly one of the key stories driving results during the third quarter for the industry. Another company that really benefited from hedging was Chesapeake Energy's (CHK +0.00%) after its realized sales prices for oil and gas were almost 50% higher during the third-quarter thanks to hedge gains. Without hedging Chesapeake Energy would have only realized $41.25 per barrel of oil, and just $10.63 per barrel of oil equivalent, last quarter. However, once hedge gains are added to the mix it boosted Chesapeake Energy's realized sales price to $62.68 per barrel of oil and to $15.45 per barrel of oil equivalent. Overall, hedging boosted Chesapeake Energy's income by $227 million, which provided a lift to overall cash flow given that its operating cash flow was just $476 million during the quarter. The problem with Chesapeake, as with Halcon, is that hedge gains at these levels aren't sustainable the longer oil prices stay lower because most of these contracts were initiated when prices were much higher.
Investor takeaway
Three numbers really stood out from Halcon Resources third-quarter report. First, it reduced operating expenses by 27% to just $17.04 per BOE helping take away some of the sting from low oil prices. Second, its cash flow gap is sinking thanks to those cost reduction as well as reduced capital expenses and hedging gains. Finally, hedging gains nearly doubled the amount of money the company brought in during the quarter, however, that isn't sustainable given the fact that it has less volumes hedged next year and those volumes are hedged at a lower average price. Because of this Halcon Resources still has more work to do before its operations can be considered sustainable should oil continue to remain weak.
