Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Diamondback Energy Inc. epitomizes the problem shale poses for traditional oil majors and oil-reliant economies such as many of OPEC's members.

The E&P company reported results late Tuesday that blew away earnings expectations, marking the eighth such quarter in a row, according to figures compiled by Bloomberg. Diamondback's stock duly popped by as much as 4.5 percent on Wednesday morning, staying in the green even after another weak set of inventory data from the Energy Information Administration pushed down oil prices.

Indeed, remarkably, Diamondback's stock has held pretty steady this year as oil prices have dropped, taking down E&P stocks and even weighing on the relative darlings of the sector, its fellow Permian-shale-focused companies:

Snake On A Plane
Diamondback Energy's stock is flat so far this year even as oil prices and peers have tumbled
Source: Bloomberg, Bloomberg Gadfly analysis
Note: Performance indexed to 100. "Permian E&P index" is a market-cap weighted index of 13 E&P companies with significant exposure to the Permian shale basin.

This matters because, as I wrote here, Diamondback is a practiced user of the force that really propels the shale boom: U.S. capital markets. It has raised about $4.1 billion from a series of stock sales, the most recent one in December. Its share count is now 2.7 times what it was at the end of 2012. That's a lot of dilution to absorb unless you see results.

Fortunately for Diamondback, it is delivering what E&P investors want; namely, growth and efficiency gains.

Production in the first quarter was up 61 percent from a year earlier, to 62,000 barrels of oil equivalent per day. Three quarters of that was higher-value crude oil versus natural gas and natural-gas liquids. On a trailing four-quarter basis, Diamondback's average production of 49,000 barrels a day was up 150 percent since 2014. Importantly, production per share, despite the rapid increase in the share count, is 43 percent higher over the same time frame.

Meanwhile, Diamondback's unit costs keep dropping. This chart shows cash costs per barrel before income taxes:

Snakebite
Diamondback's cash costs per barrel have dropped 58 percent since 2012, with four fifths of that reflecting production and overhead efficiencies
Source: Company filings, Bloomberg Gadfly analysis
Note: Production costs include gathering and transportation costs. 'LTM' refers to the last 12 months as of March 31st, 2017.

Squeezing costs has been a consistent theme across the sector since oil prices crashed, for the E&P companies that have survived it, anyway. In Diamondback's case, it kept annual cash margins on its production above $20 a barrel even as markets tanked (and before hedging gains):

Snakepit
Diamondback's productivity gains blunted the impact of the oil-price crash
Source: Company filings, Bloomberg Gadfly analysis
Note: Realized price reflects blended price for oil, gas and liquids received by Diamondback before hedging effects. Cash margin is realized price less costs of production, gathering and transportation, G&A, non-income taxes and interest. 'LTM' refers to last 12 months as of March 31st, 2017.

OPEC's efforts to juice prices have helped, too, of course. Diamondback's realized price of almost $42 per barrel of oil equivalent in the first quarter was up almost $17 versus the same period in 2016, when oil prices crashed below $30.

However, Diamondback's cash margin was up even more, by almost $19 a barrel. And its guidance, reaffirmed with the results, suggests further gains to come. While production and transportation costs in the first quarter were already at the low end of the company's guidance range for the year, both G&A and interest costs, $2.48 and $2.21 per barrel of oil equivalent, respectively, were above or toward the top end of their ranges.

Indeed, at the mid-point of Diamondback's guidance, and assuming the same production mix as the past 12 months, it should earn a cash margin per barrel of almost $30 this year, up almost 50 percent from 2016. That assumes an average realized oil price of $50, $3 for natural gas and $20 for natural-gas liquids.

And, of course, this higher margin would be earned on 69 percent more barrels, at the mid-point of guidance, implying a cash margin of $780 million, not far short of expected capital expenditure of $900 million. Diamondback's credit facility, just raised by $250 million, is more than enough to cover that, even allowing for some cash taxes in the mix. The company's nearest bond maturity isn't until 2024.

In other words, Diamondback is coming close to self-funding very high double-digit growth at $50 oil, meaning it could slow the pace of stock sales. This very fact, though, means it probably will keep acquiring more acreage, coming back to the market to fund that -- and finding the market quite willing to do so.

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