Harsh Singh Chauhan
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Performance
Why Callon Petroleum Will Be Able To Sustain Its Strong Run
Jul. 6, 2015 3:14 PM ET | About: Callon Petroleum Co. (CPE)
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
CPE's performance has been resilient despite weak oil pricing in the past year, driven by a tremendous increase in production and lower costs.
CPE has reduced well costs by 20% this year, and it expects another 10% decline in well costs, taking its cost of drilling a 7,500-foot lateral well to $5 million.
CPE is using increased proppant volumes in the Midland Basin, which has helped it achieve a higher flowback rate, and this will lead to an improvement in production volumes.
Callon Petroleum (NYSE:CPE) has made a strong comeback this year, with its shares gaining close to 43% so far in 2015. The Permian Basin-based oil and gas player remained resilient in the face of weak oil and gas prices. This can be gauged from the following chart, which shows that Callon has been able to improve its revenue and cash flow slightly in the past few months, although its gross margin has taken a hit.
CPE Revenue (<a href=
CPE Revenue (NYSE:TTM) data by YCharts
However, the fact that Callon has performed better than expectations of late cannot be denied. In fact, in the last reported quarter, the company's revenue was down just 8.7% year-over-year, while it achieved break-even as far as the bottom line performance was concerned. This was better than analysts' expectations, who were looking for a loss of $0.01 per share.
The reason why Callon's top line dropped in less than double digits despite a massive drop in oil and gas prices was a 92% increase in production. Additionally, the company has been able to lower its costs at a decent pace, as can be seen in the following chart:
(click to enlarge)
Source: Company press release
More cost reductions in the cards
Looking ahead, it is likely that Callon will be able to achieve further cost reductions on account of an improvement in well completion. In fact, Callon was able to reduce its well costs by 20% in the first quarter, and intends to achieve another 10% in cost reduction this year. As a result, Callon plans to drill a 7,500-foot lateral well for just over $5 million in the next couple of months, representing a decline of 30% on an year-over-year basis.
Apart from a reduction in well costs, Callon Petroleum expects to achieve cost reductions in other areas as well, as shown in the chart below:
Source: Investor presentation
Additionally, during the first quarter, Callon had reduced its employee base by approximately 20%. Although, it led to a one-time cash cost of $7.1 million in the quarter, but Callon expects this move to help it save approximately $5 million per year in general and administrative expenses. Thus, by reducing its workforce, Callon will be able to make its operation more efficient and arrest the decline in its margins.
A closer look at the production profile
Apart from reducing costs, Callon is looking to improve its production. The results of its efforts were clearly visible in the previous quarter, as its production had almost doubled year-over-year. Looking ahead, Callon forecasts production growth of 30% from the fourth quarter of 2014 to the fourth quarter of 2015, driven by its two rig program. Moreover, for 2016, it expects incremental growth of 10% as compared to the fourth quarter of 2015. Now, the company anticipates of achieving this higher production at a lower cost, which will have a positive impact on its margin profile.
More importantly, based on its current production forecast at current oil and gas price levels, Callon expects to achieve a cash flow break-even position by the middle of next year. Thus, Callon is progressing in the right direction as far as its operational focus is concerned. The primary reason behind the company's strong production and cost profile can be attributed to its acreage in the Midland Basin of the Permian play, where it began its horizontal operations three years ago. This asset has driven Callon's production growth in the past year, and the trend is expected to continue this year:
Source: Investor presentation
Going forward, Callon is taking steps to improve its production from this asset. In the southern area of the basin, Callon is currently pumping higher proppant volumes of around 1,500 and 1,900 pounds per lateral foot. Interestingly, the wells with increased proppant at Bloxom and Garrison Draw are exhibiting higher flowback pressures and rates, and this will lead to an improvement in production volumes across the Midland Basin.
Conclusion
Callon Petroleum's approach of reducing cost and improving production is right in the current crude oil pricing environment. This will help the company remain profitable even in a low oil price environment. Thus, it is likely that Callon will be able to sustain its recently-found momentum going forward as oil prices have improved of late. As such, investors should continue holding Callon Petroleum shares in their portfolio since it might deliver more upside going forward.
