This week, we review an oil producer that was formerly a part of Occidental Petroleum. California Resources Corporation (CRC) is an independent oil and gas exploration and production company whose assets are all located exclusively within the state of California, and is California’s largest oil and natural gas producer. Utilizing its inherited asset wealth from Occidental, CRC management is at work to unleash these assets to position the company for long-term viability and profitability.
In Q1 2016, the company managed to produce the same amount of operating cash flow as it did in Q1 2015, despite the lowest quarterly commodity prices realized by CRC to date.
CRC generated $87 million in free cash flow in Q1.
CRC has effectively been reducing costs, with an 11% reduction in 2015 production costs over 2014 levels, and Q1 2016 production costs coming in 24% lower year-over-year.
CRC’s current low cost production translates to healthy margins even at low oil prices.
In December 2015, CRC reduced debt by $563 million through a 2.8 billion bond swap.
The company had its borrowing base reconfirmed in May with its levels unchanged at $2.3 billion.
Oil prices have recovered from their lows earlier this year, and the oil industry is cautiously optimistic about sustained higher prices moving forward. With its effective cost reductions, CRC is strategically poised to increase profits as oil prices move higher. After its recent bond swap, the company’s remaining original bonds may prove to be difficult to procure at the discounted price of under 60. However, Durig Capital is targeting these incredibly attractive, but sparsely traded, 22% yielding bonds from California Resources Corp for its clients at better prices than what might be currently indicated with the wide spread between buyers and sellers. As a result, we plan to opportunistically be adding them to both our FX1 and FX2 global high yield fixed income portfolios.
Stabilizing Cash Flows
CRC’s Q1 results are truly impressive, especially in light of the fact that oil prices bottomed in the first quarter of this year around $26 per barrel. In Q1, CRC generated the same amount of operation cash flow ($115 million) after working capital compared to Q1 2015. This is a testament to the company’s commitment to effectively execute cost reduction while managing its base production.
Almost two years into the current low priced oil environment, many exploration and production companies have been forced to redefine their way of doing business. In light of oil’s continued low prices, California Resource Corporation has also taken steps to ensure the company’s long-term viability. These steps include reducing debt, reducing capital expenditures, cost reductions and the use of hedges to stabilize cash flow. CRC’s significant and highly valued asset base, along with these vital actions, recently contributed to CRC passing its redetermination for its credit agreement, confirmed and unchanged at its current level of $2.3 billion.
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 with mineral acreage consisting of approximately 2.4 million net acres spanning the state’s four major oil and gas basins. The company’s workforce consists of approximately 4,000 employees and contractors across the state. CRC has a sizable inventory of over 23,450 gross drilling locations, excluding 6,400 gross prospective resource drilling locations, with plans to exploit its significant portfolio of conventional and unconventional opportunities to generate production growth over the longer term.
Although its California operations date back to the 1950’s, CRC gained a fresh start when Occidental spun off the company in late 2014. Its largest operations are in the San Joaquin Basin, which makes up 70% of total production and most of its total reserves. The company’s other activities are located in the Sacramento Basin, Ventura Basin and the Los Angeles Basin.
Improving the Balance Sheet
Decreasing leverage has been an ongoing goal for CRC’s management given that the company inherited nearly $6.0 billion in debt when spun off from Occidental. What is most impressive is what the company was able to accomplish earlier this year, when oil prices bottomed out near $26 per barrel. Early in Q1, CRC purchased $102 million face value of its outstanding bonds in the open market which resulted in an $89 million gain. Additionally, the company sold almost $70 million of emission allowances in Q1. As a result of these items, along with the $87 million of free cash flow generated in Q1, CRC was able to reduce its debt levels by almost $700 million from the high point in 2015 to just under $6 billion at the end of the quarter.
CRC also executed a bond swap in late 2015 to shore up its balance sheet. The company offered holders of its 5.0% 2020 notes, 5 ½% 2021 notes and 6% 2024 notes the option to swap for newly issued 8% notes due 2022. The net results of the $2.8 billion bond swap resulted a reduction in CRC’s debt of $563 million.
CRC has also identified additional options it may employ in order to further deleverage its balance sheet. These options include partial sales or joint ventures of its significant upstream assets, divesting some of its midstream assets and additional debt exchanges.
Very Low Cost Production
CRC has been proactive in its efforts to bring down costs in order to improve its margins / profitability. In 2015, the company’s production costs came in at $951 million or $16.30 per BOE (barrel of oil equivalent). When compared to 2014’s production costs of $1.1 billion or $18.23 per BOE, this represents and 11% reduction per unit. Cost reduction efforts have continued into 2016. Production costs in Q1 were $184 million or $13.69 per barrel, compared to $221 million or $15.51 per barrel in Q4 and $242 million or $16.21 per barrel in Q1 2015 – representing an outstanding year-over-year decrease of 24%. General and Administrative costs (G & A) were also been reduced in Q1, down 23% from Q4 and 30% over Q1 2015. CRC’s extremely low cost per barrel translates to the company still having relatively good margins even at the low oil prices seen earlier this year.
Hedging to Protect Cash Flow
California Resources has also employed an effective hedging strategy in order to help even out cash flows due to the volatility inherent in the commodities markets. In its most recent quarterly results (Q1 2016), CRC’s hedging program boosted the realized price per barrel from $30.08 to $36.39. For the remainder of 2016, CRC has hedged approximately 30% of its projected crude oil production in excess of $50 per barrel.
Making Difficult Decisions
Oil exploration and production is, by the nature of the business, capital intensive. This translates into large annual capital expenditures (capex) for oil companies in order to maintain and / or increase their production levels. It follows that oil companies don’t take reductions in capital expenditures lightly. Since mid-2014, as oil prices began their precipitous fall, many oil companies have reduced capex in order to preserve cash flow and maintain liquidity in what has been an extended period of depressed oil prices. But few have made the sweeping cuts seen by CRC.
In 2014, capex was an impressive $2.1 billion. In 2015, that number was reduced dramatically to $401 million. Amazingly, even with the drastic reduction in capital spending, 2015 average daily production actually increased to $160,000 BOE compared to 159,000 BOE for 2014. For 2016, California Resources has issued its capex budget at just $50 million. Without a doubt, this reduced capex was a contributor to CRC’s Q1 free cash flow of $87 million. While some might view this drastic cut in capex spending as negative, more likely is the case that CRC’s management are taking the necessary steps to position the company for growth once oil prices begin to rise sustainably.
For 2015, California Resources registered adjusted EBITDA of $906 million with interest expense totaling $326 million for the year, for an adjusted EBITDA / interest expense ratio of 2.8x. With the company aggressively seeking to deleverage it balance sheet coupled with the prospect of rising oil prices in 2016, we would expect to see this ratio improving over the course of this year.
The default risk is California Resources Corporation’s ability to perform. CRC’s management has shown intense commitment to ensuring the company’s long-term liability as seen in its drastic cuts in capex, impressive cost reduction in both production and G & A costs, as well efforts to reduce overall debt. CRC’s banking supporters agree, recently confirming the company’s credit agreement at its current level of $2.3 billion. We find the excellent 30+% yields on these relatively short 42-month bonds outweighs the risks we can identify.
Certainly, commodity risk is present. CRC’s revenues are derived from the sale of oil and, to a lesser extent, natural gas. Oil prices have begun to recover since the first part of this year, however, there is no consensus as to whether they will remain at current levels, continue rising or fall back to previous lows. The company’s hedging will help to even out a portion of its cash flows for the current year.
These 5% couponed bonds, currently indicating an outstanding yield that’ve over 22%, have similar yields and durations to others reviewed on Bond-Yields.com, such as the 30% Memorial Production Partners and the 30% Natural Resource Partners bonds.
Summary and Conclusion
In its short time of operating independently, California Resources Corporation has focused its efforts on positioning the company for long-term viability and profitability. Its cost reductions and bold capital expenditure reductions have paid off, with the company generating $87 million in free cash flow in Q1. The company’s hedging program will help shore up cash flow for the remainder of 2016 as the company continues to look for ways to improve its balance sheet. These 2020 bonds from CRC (couponed at 5%) are thinly traded, making it more challenging for retail investors to buy them for less than the higher mark that brokers currently appear to be asking for them. However, Durig Capital is adding this 22% yielding bond for its clients and our global high yield fixed income portfolios, Fixed-Income1.com and Fixed-Income2.com.
Issuer: California Resources Corporation
Bond Coupon: 5%
Yield to Maturity: ~22.4%
About Durig Capital
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Disclosure: Durig Capital and certain clients may have positions in California Resources Corporation 2020 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. If you intend to use our research efforts to make an investment decision, we kindly ask that you respect our fiduciary business model and allow us the opportunity to assist in your equity acquisition. We sincerely appreciate your courtesy and understanding.
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