For all the new #EFT members:
A primer on E&P investing:

1. A long only strategy in E&P companies IS a commodity bet. Long term shale co-WTI return correlations sit 35-60%. A long shale strategy requires a bullish oil thesis.

2. The basis of this is the business model.

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There is no sustainable advantage in E&P. The companies are price takers in a volatile, capital-intensive market.

3. The companies are simply an aggregation of assets. Each well has a type curve. Model type curve, find your required discount rate, and you get the value of

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a well. If you want to come up with a company value, you don’t use any ratios (EV/EBITDAX). You aggregate ALL wells and create a firm-wide type curve, then pull out your G&A and you arrive at net asset value. This is the only way to get a true value number.

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4. Energy has dedicated fund managers because it is a whole different beast. Most people stay away because they can’t commit the time to do all the work described in 3. These are the smart people. It requires an immense amount of work.

5. A L/S strategy is still exposed to

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serious commodity risk. The reason boils down to leverage. If you buy “quality” (PXD, EOG) and sell crappy (CPE, WLL), it’s still only works in a falling price environment. Crappy companies are saved by higher prices and valuation skyrockets at $100 WTI (only to crash later)

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6. Break even oil price for a firm should be seen as the strike price on a call. Your delta is highest right near break even, so profitable companies (b/e at $55) don’t have as much to gain from the move from $80-$100 as a company that breaks even at $75.

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7. This is all to say that E&P investing is incredibly difficult and requires immense attention to detail and expertise. If you’re feel attacked my this thread, maybe you should sit on the sidelines. In the end you will be happy you did.

Going to finish with the best quote ever

“It’s not what you don’t know that gets you into trouble. It’s what you know that just ain’t so.”

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