This week, Durig Capital takes a look at a unique oil and gas producer. California Resources Corporation (CRC) produces oil, natural gas and natural gas liquids (NGL) strictly within the state of California. Most people know that California is one of the largest states (physically) in the U.S. But most probably don’t know that it represents the world’s 5th largest economy. Against this backdrop, CRC produces oil, natural gas and NGLs and sells all of it in the state of California. This looks to be a great situation for CRC – a local buyer for all of its product and a huge appetite for more. CRC, a spinoff of Occidental Petroleum in 2014, has spent the past few years recovering from the oil doldrums of 2016 and it looks to be on the upswing. Some of the highlights from its most recent quarterly results include:
- Increased daily production by 8% over last year.
- A 20.4% increase in adjusted EBITDAX.
- Revenues were up 13.3% over first quarter 2018.
- Adjusted net income jumped from $8 million a year ago to $31 million.
- Interest coverage of 1.8x.
Debt reduction has been a focus for CRC over the past few years, and the company has succeeded in eliminating $378 million in bonds (face value). The company’s borrowing base was just recently reaffirmed, an external validation of the company’s commitment to improving its balance sheet. CRC’s 2021 bonds currently have an outstanding yield-to-maturity of nearly 17.5%. Considering CRC’s unique position, its excellent Q1 results, as well as its debt reduction efforts, these short-term maturity (28 month) bonds are ideal for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, the aggregated performance of which is shown below.
California Resources Corporation First Quarter 2019 Results
CRC has done a fantastic job of responding to market fluctuations in order to maximize its revenues while limiting its operational losses. Such was the case in late 2018 when oil prices retreated suddenly and unexpectedly (oil makes up the lion’s share of CRC’s revenues). The company was able to quickly adapt its current and planned capital expenses to respond to the sudden shift in commodity prices. As a result of this shift, the company reported solid first quarter results which included increases in daily production, adjusted EBITDAX, revenues and adjusted net income.
- First quarter total daily production volumes increased by 8% year-over-year from 123,000 BOE per day for Q1 2018 to 133,000 BOE for Q1 2019.
- Adjusted EBITDAX for the first quarter registered $301 million, as compared to $250 million in the prior year period. This represents an increase of 20.4%.
- Total revenues in the first quarter were $690 million as compared to $609 million a year ago, an increase of 13.3%
- Adjusted net income for Q1 was $31 million, compared to $8 million in Q1 2018.
California Resource Corporation is the largest energy producer in California, which is the world’s 5th largest economy. California needs all the energy that CRC can produce. In turn, CRC provides California with affordable, reliable energy. The company continues to improve its operational efficiencies – including continued joint ventures with selected partners, improve its balance sheet and strengthen its portfolio of producing properties. Its competitive advantage lies in its long-life, low risk, high quality resource base operated by an excellent team.
(Source: CRC Goldman Sachs Leveraged Finance Conference, May 7, 2019)
About the Issuer
California Resources Corporation (CRC) is an oil and natural gas exploration and production company focused on high-growth, high-return conventional and unconventional assets exclusively in California. Formed in 2014 as a spin-off from Occidental Petroleum, CRC explores for, produces, gathers, processes and markets crude oil, natural gas and natural gas liquids.
CRC is the largest oil and natural gas producer in California on a gross-operated basis. The company has one of the largest privately-held mineral acreage positions in the state, consisting of approximately 2.3 million net acres spanning the state’s four major oil and gas basins, including the lucrative San Joaquin Basin.
Continuing to Improve the Balance Sheet
One of CRC’s continuing goals is to improve its balance sheet. Over the past few years, the company has worked diligently to accomplish this task in part by repurchasing its notes on the open market at a discount. Some of these transactions include:
- For 2018, the company repurchased $183 million in face value of its Second Lien Notes for $159 million in cash.
- Also in 2018, the company repurchased $49 million in face value of its 2024 Notes for $40 million in cash.
- In 2017, CRC repurchased $128 million in face value of tis 2020 and 2021 Notes for $116 million in cash.
- In its most recent quarter (Q1 2019), CRC repurchased $18 million in principal amount of its 8% 2022 notes for $14 million cash.
These transactions have helped to shore up CRC’s balance sheet and the company remains committed to reducing its debt even further. CRC’s debt reduction (including the recent Lost Hills transaction) appears to have pleased its creditors as its bank group recently reaffirmed its borrowing base at $2.3 billion. This is an encouraging sign as the company looks toward refinancing notes in the next few years.
(Source: CRC Goldman Sachs Leveraged Finance Conference, May 7, 2019)
Lost Hills Transaction
In a very recent news, CRC closed a deal on the sale of 50% of its interest and operatorship of certain shallow zones at its Lost Hills field. The deal, made between CRC and a private oil and gas E&P company was completed for a total consideration in excess of $200 million. These proceeds were used toward additional debt reduction. The company continues to consider which assets it might monetize to strengthen its financial position.
An Update on Oil
As most of CRC’s revenues are derived from the sale of oil, the company is exposed and affected by world events that influence the price of oil. The most recent news affecting oil prices showed recent unexpected gains in the U.S. crude supply which has eased prices of both Brent crude futures as well as U.S. West Texas Intermediate (WTI) crude futures. However, recent news from Saudi Arabia, where reports of drone strikes against two of its oil pumping stations just two days after the sabotage of oil tankers near the United Arab Emirates, has had the opposite effect. In addition, tensions are rising between the U.S. and Iran this month following Washington’s decision to try to cut Iran’s oil exports to zero. OPEC remains on the sidelines for now, but that could change if the attacks on oil in the Middle East continue.
Interest Coverage and Liquidity
Bondholders invest in bonds primarily for the income from interest payments. As such, interest coverage communicates the level at which the issuer / company is able to service its existing debt. For its latest quarter, California Resources Corporation had operating income (without the effects of non-cash depreciation expense) of $175 million and interest expense of $100 million. This translates to an interest coverage ratio of about 1.8x.
Liquidity is also critically important as it provides the company with reserves to pay operating expenses when cash flow is not sufficient, as well as cash for capital expenditures. As of March 31, 2019, CRC had $256 million available from its revolving credit facility as well as $43 million in cash for a total liquidity of $299 million.
The risk for bondholders is whether CRC can continue to grow production and revenues after a period of limited capital investment, as well as improve its balance sheet enough to position itself for debt refinancing opportunities within the next few years. The company has proven to be very nimble in its response to oil’s ups and downs. The key to success will be in its ability to derive more production from its current asset base. In regards to debt reduction, the most recent Lost Hills sale provided much needed cash to pay down the company’s current revolver and may have influenced the banking group’s most recent reaffirmation of CRC’s borrowing base. In any case, the outstanding yield-to-maturity of nearly 17.5% on CRC’s 2021 notes does appear to outweigh the risks identified.
Recently, there has been a bill proposed in the California legislature that would essentially shut down all of California’s in-state oil production. Assembly Bill AB-345 would require, beginning in 2020, that all new oil and gas development that is not on federal land, to be located at least 2,500 feet from a residence, school, childcare facility, playground, hospital, or health clinic. For these purposes, the bill would define re-drilling of a previously plugged and abandoned oil or gas well or other rework operations, to be considered new oil and gas development.
The effect of this 2,500 feet of clear space around production wells would virtually destroy California’s in-state oil production. If passed, this bill would likely put CRC out of business as the vast majority of its revenues come from its production and sale of oil. However, opponents of this bill argue that shutting down in-state production would further threaten California’s economy by increasing its dependence on foreign oil and eliminating 368,000 high-paying blue collar jobs. Legislation like this has been proposed in the past, each time falling short of becoming law.
CRC’s revenues are derived from the sale of oil and, to a lesser extent, natural gas, so price fluctuations of these commodities is also a risk. Oil prices, which react to both market forces as well as national and international politics, have been recovering since the unexpected decline in late 2018. However, predicting the movement of commodity prices is difficult at best. A drop in prices could affect CRC’s ability to increase its production through increased capital spending.
In general, bond prices rise when interest rates fall and vice versa. This effect tends to be more pronounced for lower couponed, longer-term debt instruments. Any fixed income security sold or redeemed prior to maturity may be subject to a gain or loss. Higher yielding bonds typically have lower credit ratings, if any, and therefore involve higher degrees of risk and may not be suitable for all investors.
Summary and Conclusion
CRC is unique in that it sells 100% of its oil production within the same state where it sources the oil. The upside is that the state of California is very energy intense – it consumes more gasoline than countries that are four times larger. CRC has been vigilant in its efforts to operate a lean organization when oil prices are low, increasing production through various joint ventures. It has made a commitment to reduce debt, which it has routinely done over the past few years. The company’s 2021 notes offer investors the opportunity to invest in a unique E&P oil and gas company and make an ideal candidate for additional weighting in Durig Capital’s Fixed Income 2 (FX2) High Yield Managed Income Portfolio, shown above.
Issuer: California Resources Corporation
Ticker: NYSE: CRC
Bond Coupon: 5.50%
Rating: Caa3 / CCC-
Yield to Maturity: ~ 17.42%
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Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services. Most of our client accounts are custodied in their own name at TD Ameritrade Institutional, a large discount service provider that is SPIC insured, or at Interactive Brokers. We have now started offering our highly successful FX2 service to clients of other Registered Investment Advisors through segregated accounts at TD Ameritrade. Please ask us to learn how this might work for you and your current advisor.
Disclosure: Durig Capital and certain clients may hold positions in CRC’s September 2021 bonds.
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