EUR 850.00 For Business Accounts Only

Morningstar | Hess Outperforms for Second Consecutive Quarter; Market Still Over-Exuberant on Guyana

Hess delivered production of 265 mboe/d in the second quarter, which was 4% higher sequentially and 1% ahead of our 263 mboe/d forecast. This was above the top end of guidance for the second consecutive quarter, resulting in stronger-than-expected financial results (EBITDA and adjusted earnings per share were $584 million and negative $0.23, respectively, beating consensus estimates of $538 million and negative $0.29). The production surprise was attributed to the earlier-than-expected restart at the Conger field in the U.S. Gulf of Mexico, which had been shut in since the fourth quarter of 2017 due to a fire on the Enchilada platform. As a result, the firm made no change to its previous 2018 guidance of 245-255 mboe/d (excluding Libya), even though it subsequently sold its Utica assets.

The Stabroek Block in Guyana was the focus of the firm’s second-quarter conference call. Management believes that the discoveries announced thus far contain more than 4 billion barrels of recoverable oil equivalent. The partnership, led by operator Exxon, is planning for five stages of development, with the potential for more if additional prospects in the area test successfully. A third drillship will be added in the fourth quarter to maintain the partnership’s exploration momentum alongside the development of the Liza discovery, which is expected on line in late 2019 with a capacity of 120 mb/d. The second phase of the Liza development should commence production in mid-2022, with a capacity of 220 mb/d, and a third phase could be sanctioned next year with a potential start date during 2023 and a capacity of 180 mb/d. By 2025, five developments are expected to be in service, bringing gross volumes to about 750 mboe/d (30% net to Hess). That's about 30% higher than our previous forecast, which we now consider conservative. As a result, we have lifted our fair value estimate to $54/share.

But as attractive as the Guyana asset is shaping up to be, we think the market is getting carried away and that the runup in Hess shares (36% year to date) is overdone. For one thing, the capital requirements are onerous. We think the firm will need to invest at least $6 billion through 2025, assuming $4-$6 per recoverable barrel (which equates to about 25% of its current enterprise value). In anticipation, management has prefunded a portion of its commitment through divestitures. It has raised upwards of $3.5 billion since July 2017 by exiting Norway, Equatorial Guinea, Ghana, and certain U.S. onshore areas (Permian and Utica). Moreover, the staggered nature of the overall development (in five phases) ensures that latter stages can be funded with cash flows from earlier stages, capping the maximum net cumulative outflow at about $2 billion (comfortably digestible given the $2.9 billion currently on the balance sheet).

The downside is that with follow-up projects soaking up the cash flows from each development phase that comes on line, Hess is not expected to generate net free cash flows in Guyana until at least 2024, making this a very long-dated investment. And there is limited flexibility in the meantime, since Hess as the junior partner is largely beholden to operator Exxon's pacing. As the Stabroek asset is a much smaller component of the larger firm's portfolio there is little chance of reducing spending in the event of lower commodity prices, even though Hess might want to. We continue to believe that current prices are unsustainable, as shale companies--collectively the swing producer in our global framework--have responded to the last year's runup in prices by ramping activity. There are over 100 more light tight oil rigs in service now than required to keep global markets well supplied in the next few years. Without lower prices to trigger a slowdown, the resulting production surge will eventually reverse the current tightness and potentially trigger a further bout of oversupply.