The Era of Quality Questions

As we start to see Q2 reporting across the energy space, we expect many companies to directly address their product quality – either proactively, or in response to questions from the investment community. This marks a recent phenomenon, as stakeholders start to investigate how product quality is driving cash flows. Product quality drives revenues as certain barrels are a better fit for refineries. It also drives costs due to items such as treatment costs, blending costs, and spec penalties. These details are especially relevant when the market discovers the product quality in new locations. 

Why is this happening now? 

In the past, the industry has focused on production growth, with a preference for high-value liquids growth. In that environment, investors rewarded liquids growth without time to focus on the cash flow implications. As growth slows, and capital becomes more restrained, the quality items that drive cash flows are now becoming a focus. 

How much of an impact does quality have?

Realized pricing can vary significantly between peers within the same basin based on the qualities they produce. In the Montney, the discounts on condensate can range from a couple of percent off benchmark pricing to a little over ten percent. This discount balloons if the condensate is heavy enough that it’s classified as crude. The Permian, which is also often thought of as a uniform resource play, is seeing a similar trend. Approximately 70% of new production volumes have >50 API. Lighter Permian crudes can qualify as West Texas Light and explicit API deductions are also making their way into contracts. The net result is deductions that amount to a few dollars a barrel. The impacts of these deductions are significant when applied to the development NAV for a company and/or asset. As a result, the investment community has doubled-down on understanding the quality of volumes that companies bring on stream. They are increasingly expecting a well thought-out plan on how to manage that quality. 

How are companies changing their reporting?

Many companies have recently started taking a proactive approach to these questions. 

  • Montney names are starting to walk their investors through their realized pricing compared to their peers. 
  • Permian names are actually detailing the API they expect by county. 
  • Diamondback provides API estimates in their corporate presentation across their assets. 
  • Parsley highlights their API gravity range of 40-42 which they expect to translate to better pricing versus peers. 
  • Callon highlights their API by basin with the Delaware averaging 42 degrees and Midland averaging 39 degrees.

It makes sense the companies with preferable qualities are leading quality disclosures, but they have begun warming up the investor community to the new trend. We expect this trend to stay and accelerate rapidly from here.

 

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Mark Le Dain

Mark Le Dain currently runs strategy for Validere and previously worked as an energy investment banker. Mark has significant experience advising energy and infrastructure companies, successfully completing over $18 billion of M&A transactions and $5 billion of capital markets transactions.
Mark Le Dain

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