Ring Energy (NYSE:REI) reported relatively strong results in Q1 2023, with sales volumes at the high-end of its guidance. However, at low-$70s WTI oil for 2023 combined with weak near-term realized prices for its natural gas and NGLs, it may now only end up with around $34 million in free cash flow this year.
REI stock appears roughly fairly priced for long-term $70 WTI oil currently, but may be worth an estimated $2.80 per share at long-term $75 WTI oil. This is a slight reduction from my earlier estimates due to lowered expectations for 2023 free cash flow.
Ring’s financial performance should be decent with mid-$70s or better oil, but its leverage becomes more concerning if oil drops to the mid-$60s or lower.
Low Realized Prices For Non-Oil Production
Ring’s switch to treating gathering, transportation and processing costs as a deduction from revenues as opposed to an expense item has highlighted how its non-oil production can sometimes be of limited value. When benchmark NYMEX natural gas prices are at $5+, realizing over $2 less than NYMEX still results in a decent realized price. However with sub-$3 NYMEX gas, Ring is realizing only a modest amount for its natural gas.
In Q1 2023, Ring realized $0.66 per Mcf for its natural gas and $14.30 per barrel for its NGLs. Approximately 31% of its 18,292 BOEPD in Q1 2023 sales volumes were either natural gas or NGLs, so it realized $8.86 per BOE for those non-oil sales volumes in Q1.
Ring’s lease operating expenses were $10.61 per BOE in Q1 2023 and its ad valorem taxes were $1.01 per BOE. Production taxes at 5% of revenues would be $0.44 per BOE for the non-oil sales volumes. Thus the total production costs (if applied evenly across Ring’s production) per BOE for the non-oil sales volumes add up to $12.06 per BOE, which is $3.20 per BOE more than the related sales revenues for Ring’s non-oil production.
Ring does benefit from having some fixed costs spread out over a larger volume of production, so its non-oil production isn’t really of negative value. Still, the above numbers illustrate that in the current market environment, Ring’s non-oil production has pretty limited value though.
As a result of the lower prices for non-oil production, the asset-level EBITDA for Stronghold may only be around $100 million at current strip for 2023 now. The $465 million purchase price seems relatively high in relation to that, although Ring paid around half of that with common shares, so at Ring’s current share price the purchase price would be closer to $350 million.
Realized natural gas prices should improve in late 2023 into 2024 though.
Updated 2023 Outlook
Ring delivered strong performance in Q1 2023, with sales volumes of 18,292 BOEPD (69% oil). This was at the high-end of its 17,800 to 18,300 BOEPD guidance range for the quarter and also represented +2% production growth compared to Q4 2022.
At current low-$70s WTI strip, Ring is now projected to end up with $338 million in revenues after hedges if it ends up around the midpoint of its full-year guidance for 17,800 to 18,800 BOEPD. Ending up at the high-end (18,800 BOEPD) of its full-year guidance would add approximately $9 million to Ring’s revenues.
| Barrels/Mcf | $ Per Barrel/Mcf (Realized) | $ Million | |
| Oil | 4,542,060 | $71.00 | $322 |
| NGLs | 1,001,925 | $13.50 | $14 |
| Natural Gas | 6,813,090 | $0.50 | $3 |
| Hedge Value | -$1 | ||
| Total Revenue | $338 |
Ring is now projected to generate $34 million in free cash flow at current strip prices. It is also dealing with higher interest costs, with its credit facility debt having an 8.2% weighted average interest rate in Q1 2023.
| $ Million | |
| Production Expenses | $75 |
| Production and Ad Valorem Taxes | $23 |
| Cash G&A | $20 |
| Capital Expenditures | $153 |
| Cash Interest Expense | $33 |
| Total Cash Expenditures | $304 |
Weaker commodity prices are contributing to Ring’s projected year-end 2023 leverage now reaching 1.7x (with the same working capital deficit that it started 2023) to 2.0x (with no working capital deficit).
Notes On Valuation
Ring’s leverage is a bit higher than ideal, so debt reduction will likely be a key focus for a while. Ring has a decent amount of liquidity with its $600 million credit facility borrowing base, but utilization is still projected to be over 60% at the end of 2023.
As long as Ring has over 50% borrowing base utilization and/or leverage above 1.25x, then it is required to hedge at least 50% of its projected production from PDP wells on a rolling 24 month basis.
I now believe Ring’s value to be around $1.90 per share in a long-term $70 WTI oil scenario and $2.80 per share in a long-term $75 WTI oil scenario now. This is slightly reduced from my previous estimates due to lower expectations for 2023 free cash flow.
I am not comfortable with oil’s ability to sustain a significantly higher price than $75 WTI oil currently due to the tendency towards increased drilling activity at $80s or better oil. Thus I am sticking to $75 WTI oil as my long-term price expectation. This is still a fair bit above the strip, with the 2025 strip currently sitting around $65.
Conclusion
Oil prices have dipped to the low-$70s now, contributing to Ring’s projected 2023 free cash flow ending up at around $34 million. Ring’s free cash flow has also been negatively impacted by higher interest costs (interest may end up around $5 per BOE) and relatively weak realized prices for NGLs and natural gas.
Ring’s production is still high-60s oil, so it is still able to achieve solid margins on its production. However, it will need to continue with its debt reduction efforts to get its leverage down to more ideal levels. I believe that Ring is fairly priced for long-term $70 WTI oil now, but may have decent upside still with long-term $75 WTI oil.
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