Stock of Antero resources: what costs? (NYSE:AR)
Antero Resources (NYSE:AR) has long been criticized in some quarters for having high costs. These high costs have resulted in an unattractive breakeven point for some investors when considering the natural gas prices needed to break even. However, the benefits of the company’s strategy are now becoming apparent as the price required to break even on the sale of natural gas from the production stream is extremely low. This highlights the fact that good strategies usually turn up in a commodity industry like this. Therefore, which of the best profitability strategies to execute is a management choice. In any event, shareholders will now benefit from the choices made by management.
In the past, conservative presentation often meant assuming liquid prices were relatively low “just in case” to present the “worst-case scenario” to the public. After all, it could happen in this very low visibility industry.
What actually happened is indicated by the direction on the chart. The break-even point is much lower than initial assumptions would have suggested, as liquids prices are much higher than expected. Note that no change in overall costs was necessary for this to happen. So the company was not a high cost producer in the past that became one of the lowest cost producers in the industry (faster than any company before).
As has often been the case with this company, the higher production costs allowed for a higher selling price due to a more valuable production mix. If not, then management has the option to drill more dry gas wells in the future to change the company’s production mix. Shareholders have long benefited from this flexibility because sometimes dry gas producers win in the race for profitability and sometimes they lose. This company tries to win in both scenarios.
The final component is a marketing strategy that has consistently obtained better prices for the natural gas produced than was the case for neighboring competitors. As the chart above shows, the natural gas price difference is quite significant right now. This is a strategy that will help a company seen by the market as having higher costs even when liquids production is not as profitable as management had hoped.
Maybe at some point, competitors will have a similar strategy that would take away the premium shown above. But at present, such a strategy is not in evidence. It takes time to develop a premium pricing strategy, as contracting out the midstream capacity needed to execute a premium pricing strategy is often time consuming.
The other industry change that doesn’t get as much attention is that the two integrated (like Tellurian (NYSE:TELL) above) and stand-alone companies are rapidly adding capacity to export natural gas to more lucrative markets.
Therefore, investors should expect North America to have less oversupply going forward. Much of the natural gas produced is considered inexpensive. The fact that much of the world pays more for natural gas than we do now indicates long-term protection against lower natural gas prices in the future.
This change in cycle likely means that the bear cycle lows will gradually improve over time, as much of the world is used to higher prices than was the case in North America. So, after a long period of surplus due to the rapid growth of unconventional activity, it now appears that the future will be very different from market expectations in that it is much brighter.
It doesn’t take much change to create a shortage. All that happened in this case was the destruction of coronavirus demand which led to abnormally weak industrial activity. Thus, the supply of natural gas fell a step or two while demand continued to climb.
What keeps the supply from growing too quickly is the demand from lenders that companies live within the limits of cash flow. Even the debt market has no appetite for debt-fueled growth. Thus, the industry must now have sufficient cash flow and decent ratios to borrow money. The money that was lent for the promised cash tomorrow is now gone because these lenders have learned the hard way about the cyclical nature of the industry.
The exports listed above are likely to grow in importance to the industry. If non-conventional businesses show rapid growth in the future, they may face increasing export capacities to maintain domestic market balance. How quickly this future will arrive will depend on the willingness of the market to finance these liquefaction and export capacities.
Management clearly controls the leverage of the business. Last winter saw an exceptionally profitable “freezing” period which will provide a difficult comparison in the first quarter. This profitable first quarter was followed by a hot summer which provided yet another cash flow bonanza.
Thus, the coming year presents some challenges with respect to earnings comparisons. Now, the current Nina is likely to provide another “freeze” that will offer some profit potential. But the rest of the year is unpredictable. This is why growing export capabilities is so important to the industry. A large surplus in North America can be exported in the future to markets where prices are higher.
Clearly, the current price disparity justifies much of the growth in export capacity. Just as clearly, it will be simple to sell abroad while getting a better net selling price than is currently the case in the domestic market. The slide shows many opportunities around the world for US natural gas producers. Much of the world does not have our climate change concerns. So there is no impediment to continued growth in the use of natural gas in much of the world.
The company forecasts a good amount of free cash flow. However, conditions in this industry rarely “stay in place” for more than a few months, let alone five years. Nonetheless, Antero is well positioned in several growth markets and well positioned to continue to receive above average prices for the time being.
Relatively low debt levels will allow management to continue to take advantage of changing industry conditions. This management has the free cash flow and low debt to grow while paying a future dividend. Right now the market seems to be demanding a return of capital. But at some point it would make sense to increase production to take advantage of the high price environment. Antero Resources can now do it without more debt. It is one of the few companies in the sector in this position. This puts Antero Resources shareholders in the “catbird seat”.