This week, Durig Capital looks at an independent energy company primarily focused in the exploration, development and production of natural gas. PetroQuest Energy (PQ) had a banner year in 2017, hitting its major financial and operational goals for the year.
- 62% increase in oil and gas sales over 2016 levels.
- 17.5% increase in daily production over 2016.
- 216% increase in adjusted EBITDA over 2016.
In addition to these outstanding metrics, PQ also significantly reduced its leverage during 2017 thanks to additional cash flow. PetroQuest has recently invested in the Austin Chalk formation, which has seen increasing interest and activity from some of the larger oil and gas companies. PQ is betting on adding significant oil production to its portfolio once its drilling program is up and running. The company’s 2021 bonds, couponed at 10%, currently have a yield-to-maturity of over 21%. It is important to note that these bonds carry more risk than some of the other bonds we have reviewed, and whose potential benefits should only be considered for investment by those able to withstand the potentially higher risks. Given the company’s outstanding 2017 performance as well as the prospect of significant oil production being added from its newly acquired acreage, Durig Capital has marked these 2021 bonds for addition to its Fixed Income 2 (FX2) Managed Income Portfolio, the most recent performance of which is displayed below.
Fantastic Fourth Quarter and Full Year 2017 Results
PetroQuest recorded fantastic results for both its fourth quarter and full year 2017. PQ had robust increases in revenues, production and adjusted EBITDA.
- Oil and gas sales more than doubled during fourth quarter–$35.1 million as compared to $16.4 million in Q4 2016.
- Daily production for Q4 2017 was 93.3 MMcfe as compared to 50.4 MMcfe in Q4 2016.
- Adjusted EBITDA for Q4 was $18.4 million, an increase from Q4 2016 of $10.6 million.
PQ’s full year results were just as impressive, highlighting the company’s success in meeting its 2017 financial and operational goals.
- For the full year 2017, oil and gas sales increased 62% to $108.3 million, up from $66.7 million in 2016.
- 2017 daily production increased to 75.7 MMcfe, from 64.4 MMcfe in 2016.
- Full year adjusted EBITDA was $57.0 million, increasing from $18.0 million in 2016.
About the Issuer
PetroQuest Energy (PQ) is an independent energy company engaged in the exploration, development, acquisition and production of oil and natural gas reserves in Texas and Louisiana. PetroQuest was founded in 1985 as a Gulf Coast oil and gas company. From 1985 to 2002 PetroQuest grew its reserves located principally onshore in Louisiana and offshore in the Gulf of Mexico. In 2003, PetroQuest implemented an asset diversification strategy to balance its Gulf Coast and Gulf of Mexico operations with longer lived, lower risk onshore properties. Using the cash flow generated from its Gulf Coast Basin assets, PetroQuest has expanded into the Cotton Valley trend in East Texas, where it currently has approximately 52,000 gross acres in the Carthage Field. PQ is primarily a natural gas producer– for 2017, 87% of the company’s production was in natural gas and natural gas liquids.
Adding Production from Austin Chalk Formation
In late 2017, PetroQuest acquired acreage in Louisiana’s oil-heavy Austin Chalk formation. PetroQuest believes “that applying modern hydraulic fracturing methods to this formation provides the opportunity to achieve a substantial uplift in recoveries versus vintage unfracked horizontal wells. Based on a comparative analysis between 22 fracked and hundreds of unfracked Austin Chalk wells drilled in Karnes County, Texas, fracked horizontal wells achieved an approximate 500% increase in resource recoveries as compared to unfracked horizontal wells. The average per well recovery for these fracked wells was in excess of 600,000 barrels of oil equivalent. PQ intends to drill its first horizontal test well in Q2 2018. If production from this region is as the company projects, this would add a significant boost to PQ’s oil revenues.
The U.S. – Becoming a Global Natural Gas Supplier
Just as fracking has allowed oil producers to to extract increasing amounts of oil from shale formations around the country, natural gas production has followed a similar curve. With natural gas supplies booming from shale production, the U.S. has now become a net exporter of natural gas, and with global demand increasing (up 11% in 2017), there will continue to be a market for U.S. natural gas.
Every few days, a 900-foot long tanker departs from the Sabine Pass LNG (liquid natural gas) terminal on the Gulf Coast of Louisiana bound for destinations around the globe. In the month of January 2018 alone, there were 21 tankers that departed from the Gulf Coast terminal. The massive Sabine Pass terminal was the first of its kind in the United States. Cheniere Energy, the Houston-based company that built Sabine Pass is currently in the process of expanding its operations at Sabine Pass by adding at least two additional “trains” (“trains” are actually liquefied natural gas processing units) to the Sabine Pass complex. Cheniere is also in the process of building another LNG shipping terminal in Corpus Christi with at least three trains slated to come online at terminal completion. These two ports, along with the newest operational LNG terminal at Cove Point Maryland, as well as the LNG export projects currently in process, are predicted to quadruple U.S. LNG export capacity in the next two years, reaching an estimated 9.6 Bcf/d (billion cubic feet per day) by the end of 2019. The current global LNG market is now about 45 Bcf/d and represents $100 billion annually. With the growth in export capacity, the U.S. would become one of the top three LNG exporters. Lastly, a recent report from the American Petroleum Institute estimates that U.S. natural gas exports will add up to $73 billion to the U.S. economy by 2040, as well as provide up to 450,000 jobs.
Saudi Arabia – Investing in U.S. Natural Gas
The United States cheap and abundant natural gas supply has also caught the attention of Saudi Arabia. Saudi Aramco, the world’s largest oil company, recently signed agreements with oil-equipment makers TechnipFMC and Honeywell UOP to study their production technologies as it relates to products manufactured from petrochemicals (plastics, etc). Aramco is keen to take advantage of cheap natural gas feedstocks from the West Texas shale fields. Based on the results of these studies, Aramco may potentially build a manufacturing complex on the Gulf Coast, investing between $8 billion and $10 billion in the project.
PQ’s increased cash flow in 2017 allowed the company to improve its balance sheet, significantly reducing its leverage. From Q4 2016 to Q4 2017, PQ reduced its debt / EBITDA ratio from 13.4x to 4.2x.
(Source: PetroQuest Presentation, April 2018)
Interest Coverage and Liquidity
Interest coverage is of paramount importance to bondholders as it indicates a company’s ability to service its existing debt. For its latest quarter (Q4 2017), PetroQuest had operating income of $10.5 million (without the effects of non-cash depreciation charge) and interest expense of $7.1 million. This gives PQ an interest coverage of 1.5x. As of December 31, 2017, PetroQuest had cash and cash equivalents of 15.7 million. In addition, the company has $20 million available from its multi-draw term loan, for a total liquidity of $35.7 million.
The risk for bondholders is whether PetroQuest can continue to increase its production and revenues while continuing to improve its balance sheet. The company does appear to have landed on a lucrative oil formation in the Austin Chalk region in central Louisiana. Interest in the area has been picking up, with several other major oil producers recently acquiring acreage in the area with the intent to begin drilling. Also, the growing demand for natural gas, not only in the U.S. but globally, should bode well for PetroQuest. With increased exports of natural gas projected in the years to come, the 21.0% yield-to-maturity on the company’s 2021 bonds appears to outweigh the risks identified. While the yield to maturity on these bonds is outstanding, it does come with substantial risk over and above that of our typical bond review. However, for investors who can take the added risk, the potential returns could offer a significant boost. We feel the risks are acceptable and have marked these bonds for addition to our FX2 managed income portfolio.
PetroQuest’s revenues are tied to the price of natural gas and to a lesser extent, the price of oil. Commodity prices can be volatile based on supply and demand. Natural gas prices have somewhat mirrored those of oil over the past few years, with significant decreases followed by a somewhat steady increase over the past 18 months. If commodity prices were to decrease significantly again, this would affect the company’s ability to meet its operating and financing expenses.
Summary and Conclusion
As demand for natural gas increases, companies like PetroQuest stand to benefit handsomely. The company showed robust increases in many areas in 2017 over its 2016 performance. With its recent acquisition in the Austin Chalk formation, PQ stands a good chance of adding significant, additional oil production to its portfolio. The company is more than covering its interest and coverage should increase as new projects come online. With their outstanding yield-to-maturity in excess of 21%, PQ’s 2021 bonds make an excellent addition to Durig Capital’s FX2 managed income portfolio.
Issuer: Petroquest Energy Inc.
Ratings: — / CCC
Yield to Maturity: ~ 21.42%
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Disclosure: Durig Capital and certain clients may hold positions in PQ’s 2021 bonds.
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