For a lot of oil companies, $30 oil is the tipping point after which they can no longer afford to grow production. In fact, most can't even afford to maintain it at that price. Then there's Pioneer Natural Resources (PXD 0.74%), which is still growing strong despite oil in the low $30s. Here's the secret to its success.
Location, location, location
When Pioneer Natural Resources unveiled its 2016 plan, it was somewhat surprising to see that the company was planning to grow its production by more than 10% over last year's rate. That's because very few North American oil companies are even planning to invest what it would take to keep their production steady this year, let alone investing to grow it. For example, Devon Energy (DVN 0.86%), which grew its production 7% last year, is projecting that its production will decline by about 6% in 2016. Meanwhile, even steeper production declines are expected from Whiting Petroleum (WLL), which sees its production slumping 18.5% in 2016 after running it up a stunning 42.5% last year, partially because of its acquisition of Kodiak Oil and Gas. Even the ultra-conservative EOG Resources (EOG -0.73%) is expecting its production to decline in 2016, with the company expecting its oil production to drop 5% after it held it flat last year.
One of the main reasons Pioneer Natural Resources continues to invest to grow its production is that it can still earn very lucrative returns. The company estimates that at a $36 oil price in 2016, wells drilled in the Spraberry/Wolfcamp will earn an internal rate of return up to 30%. That's a bit better than the returns EOG Resources can earn from its premium drilling inventory, which are as low as 10% at a $30 oil price to as much as 30% at a $40 oil price. Meanwhile, returns in the Bakken, where Whiting focuses, are pretty much negligible right now, which is why the company is winding down its operations in that play. For Pioneer, its location is simply better because, among other things, there's more oil and gas saturating the rocks underneath its acreage than is found in other locations, enabling it to earn higher returns per well.
Cash is king
The other big factor driving Pioneer Natural Resources' ability to continue to mint money in the current environment is that it has the cash to do so. The oil industry is one in which the old saying "it takes money to make money" is the standard it lives by, because it costs a lot of money to drill oil and gas wells. That cost is a problem for most other producers, because their cash flow is drying up. Not only are oil prices low, but their oil hedges have also evaporated, fully exposing them to the current oil price. For example, last quarter, Devon Energy captured an extra $24.36 per barrel of oil thanks to its oil hedges, which pushed its realized price to $53.67 per barrel. Those hedges, however, have dried up in 2016, which is a big reason the company had to cut its capex budget and dividend by 75% in an effort to balance cash flow with outflows. Whiting Petroleum, likewise, captured big oil hedging gains last year but won't see quite the same gains this year, forcing it to cut its capex budget by 80%.
Pioneer Natural Resources, on the other hand, has 85% of its oil production hedged in 2016, which locks in a decent amount of cash flow. Further, it has minimal debt and a lot of cash, which gives it the flexibility to invest while its rivals must hold back. In fact, after selling assets and equity in recent months,the company has roughly $2.5 billion in cash either in the bank or on the way, which is more than enough to cover the company's $2 billion capex plan. Further, thanks to its oil hedges, it projects to bring in another $1.3 billion in operating cash flow this year at current oil prices. That puts the company in the position to fully fund its capex plan through 2017 without needing to tap the capital markets. Add to that a minimal amount of debt, especially compared with the likes of Whiting Petroleum, and it has tremendous financial flexibility right now.
Pioneer Natural Resources has two things going for it right now. First, it controls a premier location in the Permian Basin that's still profitable to drill at $30 oil. In addition, it has a cash-rich, debt-light balance sheet that gives it the financial flexibility to continue to invest above its projected cash flow. That's why the company is thriving while many of its peers are just working on surviving.