Christmas Stocking

A Snakebite For the Oil Rally

It shows shale E&P firms can raise capital to keep pumping.
DIAMONDBACK ENERGY INC
-4.64
At Closing, May 25th
120.35 USD

Diamondback Energy Inc. moves fast. No sooner had OPEC and 11 other countries boosted oil prices with a pledge to cut production than the U.S. oil and gas firm was out doing deals and raising cash. Late on Wednesday, it announced the $2.4 billion acquisition of Brigham Resources LLC and a simultaneous stock sale worth about $1 billion.

Diamondback exemplifies the problem shale poses for another big rise in oil prices. Why? Because it has access to two things: oil resources the size of an elephant and a capital market as big as a whale but with the memory of a goldfish.

The history of Diamondback as a public company is characterized by repeated trips back to the equity market:

Diamondback For More

Including its latest stock offer, Diamondback will have raised about $4.1 billion in 13 separate equity sales in the past 4 years or so. Current market cap: $7.9 billion

Source: Bloomberg, the company

Note: Figures show offer size rounded to nearest $ million (MM). All dates as per pricing of offer, except latest announced

When you consider this period encompasses both some of the highest and lowest oil prices of the past 30 years, that ability to keep coming back to the stock market is remarkable.

Here's a rough summary of how much money Diamondback has used since the start of 2012 versus where that money can from:

The Big Issue

Diamondback's funding model has relied heavily on selling stock

Source: Bloomberg

Note: Sources and uses of cash from 2012 through 3Q 2016. Does not include nominal other sources of cash from financing.

Equity is the most expensive form of capital, yet it dominates, accounting for about two-thirds of the sources there. Usually, you would load up on more debt before resorting to equity. Still, Diamondback may have had its eye on this chart:

Best Avoided

It's been a rough couple of years in the energy bond market

Source: Bloomberg

Leverage has been the death of at least 105 E&P firms (as in, filed for chapter 11) since the start of 2015, according to law firm Haynes and Boone, LLP. While equity is more expensive, it is also safer -- and that has a value of its own for investors in rough times such as these. Despite Diamondback's share count having risen by more than a third since the oil market turned sour at the end of 2014, its stock has trounced the sector.

Diamondback Keeps Selling, They Keep Buying

Despite the drip-feed of dilution, Diamondback's stock has thrived during the oil crash

Source: Bloomberg

Note: Performance indexed to 100.

Besides a safe balance sheet, Diamondback's focus on the prolific Permian basin has also been a major selling point. Indeed, for an E&P company, it looks like a Silicon Valley start-up in this respect -- promising high growth and technological progress in the form of faster, cheaper fracking, and using that to tap investors for more capital as its ambitions expand (odd echoes of Tesla Motors Inc. there). This happens to also be the exact opposite of the model of the oil majors, where free cash flow and buybacks are the ideal.

Looking ahead, if oil prices rise further due to supply cuts elsewhere, then the extra cash from operations should give Diamondback the option to add more debt to the financing mix, according to Dan Pickering, President of Tudor, Pickering. Holt & Co., an energy-focused investment bank (disclosure: Pickering owns Diamondback stock). This would reduce the company's overall cost of capital.

Flexible funding, courtesy of accommodating investors, has been a key element in shale's resilience. It isn't foolproof, and 2017 will bring further tests.

Still, it should worry OPEC & Co. that Diamondback can do this -- and isn't alone, either.

The Permian ATM

U.S. E&P companies have sold more stock so far this year than in the prior 2 years combined

Source: Bloomberg

 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

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