Positioning PDC

Bart Brookman has seen his share of downturns, beginning his career in the mid-’80s at the start of what he calls “the big one.” His insight gained from that one and those following has positioned his company, PDC Energy Inc., as one of the financially strongest E&Ps in the current oil price environment and one of Wall Street’s favorites.

“When I entered the Colorado School of Mines in 1980, petroleum engineering was one of the hottest degrees in the country; when I graduated, it was one of the least popular,” he recounted. As the industry became mired in that prolonged price famine, oil and gas companies jettisoned higher-salaried skilled staff for younger, cheaper talent. “I quickly learned to not take a job for granted and recognized that hard work and quality skills will take you a long way.”

Brookman has been a Rockies specialist his entire career. In his early years, he worked as a petroleum engineer for Ladd Petroleum, a Denver-based company owned by GE. In the ’90s, he joined Snyder Oil Corp., regarded as a signature Rockies vertical tight gas player. Snyder subsequently merged with Patina Oil & Gas Corp., forming “an unbelievable success story,” that later sold to Noble Energy Inc. in 2005.

When Patina sold, Brookman joined PDC—fka Petroleum Development Corp.—as vice president of E&P and has grown with the company. After 10 years with PDC, Brookman took the reins as CEO in January 2015 at the front end of the modern price collapse.

PDC has an enterprise value of $3 billion and today holds a desirable 96,000 acres in the heart of the Wattenberg Field’s Niobrara and Codell plays in Colorado, as well as 65,000 acres in the wet gas and condensate windows of the Utica Shale in Ohio. Its core shale assets and pristine balance sheet make it a darling among energy companies on Wall Street, with less than 1.5x net debt-to-EBITDAX at year-end. It is projecting less than 1.0x net debt-to-EBITDAX and paying down its bank credit facility, pro forma placing funds from a recent equity raise.

The Denver company entered the downturn strongly hedged and mildly levered and quickly tapped the equity market in March 2015 for a $200 million raise followed by another $300 million upsized issuance in March 2016. Both dips into the equity pool were cheered by investors with share price upswings following the actions.

Oil and Gas Investor chatted with Brookman at the end of March.

“We never, ever took our eye off the balance sheet,” said Bart Brookman, CEO of PDC Energy Inc. “Our first goal was to get to cash-flow neutral. Our drilling pace and production growth were second.”

Investor What was your top priority when you took the helm as CEO?

Brookman It was first and foremost the security of the company. My top priority at the beginning of 2015 was effectively managing the balance sheet through what was a pretty quick meltdown going on—keeping the team here focused and communicating the PDC story to the market.

We recognized this correction was moving faster and deeper than anyone anticipated. At that time we thought it would last 12 months, maybe a little longer. We never imagined it would cut deep into 2016 and potentially ’17.

Investor What lessons did you take from prior downturns that are influencing your decisions today?

Brookman It’s the recognition that these corrections are part of our business, and it is the primary reason we had a peer-leading hedge program in place. We recognized the risk.

Part of our risk mitigation is to do the best we can to stop any type of catastrophic correction from hurting the company. We knew since 2013 there would most likely be a correction. We thought it would be $70 to $80/bbl, so we were locking in hedges close to $90 at the time while the market was close to $100. Some people questioned whether we were giving up $10/bbl. We never felt that way, because our economics on our wells were so strong at $90 or $100.

And here we sit today. We’ve got 60% of our 2016 oil at an average of $76/bbl, and we’ve got 67% of our 2016 gas hedged at $3.55/Mcf. That is a direct result of the lessons we learned in prior corrections.

The assurance of cash flows gave us flexibility to not have to overreact to the market. That was a luxury to be able to take some time, understand where the market was going, manage around the balance sheet, manage our production and not overreact.

Investor What has given PDC staying power through this downturn?

Brookman Hedges, absolutely. And we never, ever took our eye off the balance sheet. Our first goal was to get to cash-flow neutral. Our drilling pace and production growth were second. But, for a variety of reasons, we’ve become more cost-efficient.

Our cost per well has improved dramatically, as quickly as I’ve ever seen it improve. We used to drill wells for $4.2 million and now drill them for $2.5 million. The wells produce 15% to 20% more, and our margins have improved. So even in a $40 environment, we continue to have respectable returns on our drilling, somewhere between 25% to 40%.

Investor How did you optimize?

Brookman The biggest stair step for us is we’ve shifted from a sleeves system in our completions to plug and perf—100%. That generates an approximate 15% uptick in our well performance, which helps drive ongoing drilling returns in our Wattenberg programs. We gained confidence so quickly using plug and perf that we built the enhancement in performance in all new 2016 wells.

We’ve also had fluid design evaluations, proppant concentration studies, stage length studies and orientation studies. We’ve got a variety of different things ongoing. We try to encourage technical innovations.

Investor Your drilling times have improved.

Brookman On the drilling side, what used to take 14 days a year-and-a-half ago now takes seven. Once the correction started in early ’15, there was an excess supply of drilling rigs, and we were able to upgrade all of our rigs to fully automated. We had the crème de la crème of crews, consistent rig designs and footprints and a series of small technical improvements related to drilling fluids and downhole tools, and our drilling efficiencies skyrocketed. We cut 50% off our spud-to-spud drill times from late ’14 until today.

We’re drilling today with four rigs what it would have taken eight or nine rigs to drill just two-and-a-half years ago. That’s just from efficiencies. Do you know what that does for your cost structure? And, obviously, we have fewer rigs running around the basin drilling the same amount of reserves. That has been a phenomenal story for us.

The drilling efficiencies, the completions optimization, the cost reductions, the margin improvements—all of that was the formula that led to returns that gave us the ability to manage the balance sheet and still grow the company.

Investor Would you be running as many rigs without the hedges?

Brookman Cash-flow neutrality is our goal. If we did not have the hedges, we most likely would have more modest growth.

But, very important, we do not use hedge prices in our drilling decisions. We hedge our PDP stream—that’s production that we’ve already drilled. Incremental drilling is production above that. Drilling decisions should be based on where the true commodity market is going.

Investor Are Niobrara and Codell economic at current prices?

Brookman Depending on the pricing outlook, generally this year is $36 to $40, and next year is $42 to $53—in those ranges we are in the 30% to 40% returns for our standard-reach laterals, and in the 35% to 45% range for our middle-reach laterals.

The program has continued to deliver good value to the bottom line of the company. Our current plan is to continue running the four rigs in Wattenberg as we go through the year, but if prices stay in the $30s as we go into the summer, you will see us give strong consideration to reducing our rig count. That’s because we are still targeting cash-flow neutrality.

Investor And the Utica?

Brookman It’s very thin, probably a 10% to 15% return. We would probably need oil at $50-plus, and we’d need netbacks for natural gas at the wellhead somewhere between $1.50 to $2/Mcf before we would add a rig back to the Utica.

Our plan in 2016 is to drill five wells. We’re doing that for a variety of technical reasons to hopefully improve the capital efficiency within the play and also to define some reserve potential and additional clarity on type curves. It’s more R&D.

Investor With about 50% of Utica acreage going to expire within three years, will you defend that if prices languish, or will you let it go?

Brookman There are going to be some critical, strategic decisions to make on whether we renew the acreage or not. If the market stays in the mid-$30s with $1.80 gas, and if deducts on the gas side in the Eastern market stay where they are, it’s tough to keep it together.

But that’s a gloom-and-doom scenario, and that’s true of a lot of basins.

Investor What gave you the foresight to tap the equity markets last March at the front end of the downturn?

Brookman We were in a position where we didn’t have to do it. We had a modest draw on the revolver at that time, and we had a debt-to-EBITDAX of about 2x.

Still, when we saw the depth of the correction that was happening, we felt there was going to be a real reward for companies with a 1-2x debt-to-EBITDAX. We recognized that, at that ratio, we were pushing our balance sheet into the incredibly strong range, and felt there would be additional confidence in our equity and our financial discipline by having that ratio extremely low.

We also wanted to protect our liquidity, and the market was open for us. The demand for it was very positive, and that gave us some clarity on 2016.

Investor And the recent March issuance?

Brookman We’re looking out at 2017 and potentially ’18 and, if this market stays at $35 a barrel through 2018, that could get a little tight for PDC. Our debt-to-EBITDA was 1.4x at year-end 2015—tremendous numbers—but through ’17 and ’18 it would be difficult to maintain that discipline on the balance sheet at that number. So we view the placement in the last few weeks as protection against that downside case where oil stays in the mid-$30s and gas stays under $2.

Also, we had to make an election last November as to how we were going to take out the convert (a $115 million 3.25% convertible senior note) that comes due in May. We’d elected to pay cash for the face amount, when we thought 2016 oil prices would be higher. This equity offering helped fund that, repay the revolver and give us a stronger outlook into 2017.

Investor What is your hedging strategy going forward?

Brookman We still use hedging as a risk mitigation tool to take the volatility out of the market. But first, we have a price outlook that we make decisions around.

For oil, we’re minimizing hedges right now based on the outlook. We have almost 4 million barrels hedged in 2017 at $47 a barrel. We view those as downside case hedges—to keep the lights on if this gets really ugly.

For gas, we’re a little more aggressive: We’ve got over 32 Bcf at $3.50 per Mcf next year. Those look incredibly attractive right now. Those were based on a very bearish gas outlook we’ve had over the last year. We can’t predict weather, but the warmer winter made the hedges even better. We feel really good about our hedges on the gas side.

Investor What is your forecast for commodity prices?

Brookman We’re modestly optimistic on a rebound for oil and neutral or slightly bearish on gas in the next two years. We believe oil has some fundamentals that indicate a range of $40 to $55 over the next year and a half that is going to become more of the norm. In December, we used a $53 price deck for our 2016 guidance, which we subsequently reduced to around $40 a barrel.

On the gas side, we’re in the $1.50 to $2.50 range, and that’s why you see our hedge position the way it is.

Investor How will the industry respond when prices improve enough to make drilling more economic?

Brookman Balance sheets are beat up and management teams are humbled enough that it’s going to be a more modest adjustment in the rig count as it comes back—and it needs to be.

I get a lot of questions as to whether the industry will go crazy again if oil goes back to $55, and there is no question operators are going to try and stabilize their production, but I don’t think you’re going to see them get overly aggressive. It’s going to take 12 months of confidence in the market that the price is not going to crash again on us.

A rebound will be a shot in the arm, but it’s going to take some time to heal. Companies are just trying to get back on their feet, and when they do, they’ll have to walk, but they’re not ready to run yet.

But at the same time we’re still the oil business, and we’re a capital-intensive, growth-focused business. If we get prices over $50 for a year or two, we’ll see the market go back to the basic expectation of good growth profiles—reserve growth, production growth and cash-flow growth.

Investor How will practices change?

Brookman The perspective of risk will change. Hedges will become more of a practice. You’ll see that reduce some of the volatility. The companies that have had hedges are getting a lot of attention right now.

Also, the market now understands there is a new paradigm around unconventional. These market swings take much longer to work out of the system from a production decline and, importantly, from a production incline mode. We have a much bigger ship to turn. You have a different system now in this country.

And, hopefully, the way companies view managing their debt and balance sheets will be slightly different. You’ll have a more conservative approach. It’ll be more cash-flow based than debt-based.

Investor Will PDC run faster if the market experiences a rebound?

Brookman It would be modest. We already have 35% growth this year. Even if we jump back into the $50s, we’d be very conservative in how we contemplate accelerating even further, so don’t expect us to go out and just ramp it up.

For 12 months, we would still manage around the balance sheet. If we went 12 months and we had confidence in the commodities market and fundamentals in the world economy stabilized, you would see us give strong consideration in our 2017 budget to modestly accelerate.

Investor With U.S. export capability now, how do you see U.S. supply fitting into the global opportunity?

Brookman Over $50 a barrel, I view us as being a force in the world. This country is very innovative. Technically, we have an unbelievable competitive edge over the rest of the world. Some of OPEC has a reservoir advantage over us, but we have access to technologies that a lot of countries don’t have.

But it’s a long-term force, not next year. Over the next 10 years you’ll see a paradigm shift, depending on where the commodity markets are. Most fundamentals point to world demand continuing to grow, and who’s going to be the leader to fill that need? The U.S. can be one of those leaders.

Investor Will the U.S. remain as the high-cost—or swing—producer in the world market?

Brookman We’re innovative enough to find a way to be competitive and not be the high-cost producer that is being eliminated. The industry in this country is technically advanced and incredibly flexible. We will be a force.

Investor What should the market understand about PDC?

Brookman We are a unique story of balance-sheet strength and financial discipline, cash-flow neutrality and growth, with a great team and great assets. It’s differentiating PDC right now from the pack. We’ve got the ultimate goal to keep that story moving forward. We’re extremely pleased with how we’ve managed through this correction.

Investor Can the Broncos repeat?

Brookman Who’s the quarterback? We need a quarterback first. It makes for a great sports section in the paper right now.