A Snakebite For the Oil Rally
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:
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:
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:
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.
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.
To contact the author of this story:
Liam Denning in New York at firstname.lastname@example.org
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Mark Gongloff at email@example.com