Image source: Diamondback Energy.
If you're a long-term oil bull but are unsure of how long markets will actually take to fully rebalance, there don't seem to be many options for you. With oil's latest rebound to $50 a barrel, the valuations of many energy names have exploded. Meanwhile, there isn't yet a low-cost option to gain direct exposure to oil, unless you're willing to deal with the tracking error of ETFs.
Fortunately, there is still one investable option that gives you the upside of rising oil prices, while mitigating downside should your time horizon become stretched.
Positioned for survival
With interests in the Midland and Delaware Basins, Diamondback Energy (FANG 2.21%) has built a business that can withstand prolonged industry downturns. For example, at a time when many of its competitors are struggling to raise cash and service mounting debt loads, Diamondback has cash levels of $231 million, along with an undrawn revolving line of credit worth $500 million. This compares with long-term debt of only $493 million. Net debt stands at just 0.6 times EBITDA (earnings before interest, taxes, depreciation, and amortization).
Image source: Diamondback Energy investor presentation.
While its financials are intact, Diamondback's biggest advantage comes with its low cost of production, ensuring positive operating cash flow throughout the cycle. Its all-in cost of production is under $30 a barrel. That even includes the costs of interest, depreciation, compensation, and general operating expenses. It's no wonder the company is trying to boost production as quickly as possible. Already this year, it's upped its 2016 output forecast from around 35 million barrels a day to 36 million barrels a day. In the first quarter of this year, it hit 38 million barrels a day of output, a company record.
This production growth comes at a time when many competitors are struggling to maintain output given collapsing capital-expenditure budgets. With low costs and plenty of financial power, Diamondback should have plenty of options left to boost profits. Since 2013, reserves have more than doubled, with over 300,000 horizontal acres left to drill.
Image source: Diamondback Energy investor presentation.
Big upside if oil continues higher
With low debt, access to capital, and an industry-leading cost of production, Diamondback has ensured its ability to both survive and remain profitable if oil prices return lower. Should conditions continue to improve, however, earnings are set to rise substantially, given the firm has nearly zero hedges for 2016.
In the first quarter of this year, Diamondback had fixed price hedges on 91,000 barrels at $88.72 a barrel (less than 5% of production). It has no other hedge positions for 2016. While a completely unhedged portfolio typically gives investors pause, Diamondback is among the few companies that are safest in the sector, while providing plenty of upside in an upward market.
At $50 a barrel, the company anticipates having 2,200 economical well locations (assuming a 10% rate of return). At $70 oil, this jumps to 2,600 wells. With total production costs this year expected to be $26.75 to $33.25 a barrel, investors will win with both production gains and profitability leverage. If you're a cautious oil bull, Diamondback Energy is a great way to ride out the storm.
Image source: Diamondback Energy investor presentation.
