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  • Roger S. Conrad

Upstream Update

By Peter Staas on Feb. 22, 2017

When we first added Noble Energy to the Model Portfolio in fall 2013, our investment thesis hinged on the large-cap oil and gas producer’s undemanding valuation and ability to ramp up hydrocarbon output in the then-emerging Niobrara Shale.

Today, Noble Energy remains a value story, with the market underappreciating the strategic moves that management has made to position the company to thrive in an environment where oil and gas prices remain lower for longer.

Noble Energy still boasts 352,000 net acres and an inventory of 3,220 gross drilling locations in the Niobrara Shale, an area that last year accounted for one-third of its US hydrocarbon production.

This output was roughly flat with year-ago levels, even though the company spent less capital on drilling and completion—a testament to its efficiency gains and efforts to enhance production by sinking longer lateral segments and honing its fracturing techniques.

Management plans to run three rigs on this acreage in 2017 and expects to realize further efficiency and margin gains by increasing the proportion of its wells that feature extended laterals and enhanced completion techniques. Recently, the company has enjoyed success from using larger proppant loads—crush-resistant silica sand that props open fractures in the reservoir rock—and controlling flowback to extend peak production to between the 90th and 120th day after completion.

Focusing development activity on areas served by recently created Noble Midstream Partners LP (NYSE: NBLX) will also enable the parent to retain cash flow and unlock additional value. This symbiotic relationship between publicly traded upstream and midstream operations has worked wonders for the likes of Anadarko Petroleum and Western Gas Partners LP (NYSE: WES) and EQT Corp (NYSE: EQT) and EQT Midstream Partners LP (NYSE: EQM).

Noble Energy has also bulked up and diversified its US onshore portfolio via acquisitions, though its strategy differs from many of its peers.

WPX Energy (NYSE: WPX), Devon Energy Corp (NYSE: DVN) and other upstream operators largely have relied on asset deals and purchases of private equity-backed operators to amass acreage in the Delaware Basin and the emerging SCOOP/STACK plays in Oklahoma.

What’s behind this trend? With shares of US exploration and production companies trading at elevated valuations, the prospect of an all-stock acquisition may not appeal to buyers or sellers. At the same time, some upstream operators continue to take advantage of this currency to acquire assets and privately held companies.

In contrast, Noble Energy has sought to build its portfolio via whole-company takeovers, targeting names that own high-quality acreage but also trade at reasonable valuations because of other challenges.

Noble Energy completed the all-stock acquisition of Rosetta Resources for $3.9 billion in July 2015, one of only a handful of whole-company takeovers that has occurred in the upstream segment since oil prices began to tumble in mid-2014.

The deal left some analysts scratching their heads because of Rosetta Resources’ focus on the Eagle Ford Shale, an area that has struggled to compete with the Permian Basin because the formation produces a higher proportion of natural gas and natural gas liquids. The inconsistent quality of crude oil can also present a challenge.

But Noble Energy has done a commendable job extracting value from these 35,000 net acres concentrated in Webb and Dimmit counties by optimizing drilling and completion techniques. Crude oil accounts accounted for about 19 percent of Noble Energy’s hydrocarbon output in the Eagle Ford Shale, with NGLs making up another 41 percent.

The company exited 2016 with two rigs running on this acreage and continues to perform tests on the upper Eagle Ford Shale, a formation that could have lower production costs. Noble Energy also plans to complete two times as many Eagle Ford wells this year as in 2016, reflecting a concerted effort to work through its inventory of drilled wells that have yet to be fractured.

More important, the acquisition of Rosetta Resources gave Noble Energy a foothold in Reeves County, the core of the Permian Basin. And as management pointed out at a Nov. 16 investor conference, Noble Energy paid about $10,000 an acre for Rosetta Resources’ position in the Permian Basin—compared with about $35,000 to $50,000 per acre in recent transactions.

With the pending acquisition of Clayton Williams Energy (NYSE: CWEI) for $3.2 billion, Noble Energy will expand its position in the southern Delaware Basin to 118,000 net acres—second only to Concho Resources.

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