Nice write-up based on a much larger nice write-up. I believe that DEC is on top of the methane problem and faces little risk in that department. They get an A+ on methane.
However when it comes to Asset Retirement Obligations there is far too much conjecture and hope involved for my investment comfort. Further, I have little doubt that NextLVL has, or will have, sturdy competition given the huge amounts of money floating out of government coffers to fund well retirements. The spread between $20K+- for DEC's own wells and $120K+- for government funded retirements is just too juicy and does not pass the smell test.
I think the investment case for DEC needs to be based on the near certainties of the near few years. The economics of the business look reasonably solid; however the treadmill of decline dictates continuing acquisitions. DEC's slashing of the dividend thoroughly discredited the case for sustainable cash flows from paid off wells. (I am in the camp that the size of the reduction was unnecessary.)
What has not changed is the Asset Retirement Obligations. DEC had 70K wells, which assuming a 50 year life (probably a stretch), requires an average retirement rate of 14K wells per year. I'm certain that the 6000+- wells spun off into the SPV were not DEC's oldest wells so their age profile has quite likely gotten older.
Accepting the ARO risk and a modest portion of commodity risk was acceptable at a 15% yield when I began purchasing DEC stock on the LSE. A 9% yield does not do it for me, especially when compared to lesser risks in energy at similar (mineral royalties) or slightly lower yields (pipelines).
One other point relevant to the investment case. I have been watching for some positive analyst coverage and for aggressive stock buybacks using what were our dividends. I've seen neither ... so far.
Thanks Earl. This morning the news on aggressive stock buybacks addresses your latter point, while Tennyson, Cavendish and Dowgate have all recently given positive coverage (I believe Peel Hunt too but I do not have access to review their research).
I have reviewed AROs across DEC's competitors and have not found DEC to be wanting. In fact compared to EQT for example, DEC arguably better accounts for its ARO. Yet there is a continued angst about this - specifically and only for DEC. I do not hold any companies involved in offshore oil & gas but those have terrifying and complex AROs. Yet no one speaks to those, do they? I fully appreciate how a royalty/pipeline investment would avoid AROs - but surely these won't be mispriced either - so it comes down to your risk/reward appetite surely.
Finally regarding NextLVL the conjecture is only based on a continuation of existing growth and to speak to the growth delta which must occur if the US actually wants to tackle the 2.5m wells (and methane) across its territory in the 21st Century. The idea that NextLVL could grow to a $300m turnover business is tackling only a very small proportion of those per year, in what is currently a very fragmented market lacking vertical integration, at least in the Appalachia (where DEC is the largest and $28m turnover is "largest" tells you a lot)
I've said enough on the ARO's but the stock buyback announcement this morning is a bad joke.
DEC approved the repurchase of 5M+- shares 10 months ago (May 2023) during which it repurchased only 20% of the authorization while the price was in the tank. Now, after taking 2/3 of the dividend, DEC makes the grand announcement that they will repurchase the remaining 4M+- shares at prices up to double what the shares have sold for until recently. There is no new news. Anyone expecting a new buyback program funded with the reduced dividend can pound salt. This is really the gang which can not shoot straight.
One more item ... the buyback applies exclusively to UK shares.
Comparing ARLP and DEC side by side, as well as yield that you've pointed out, 15% gearing vs 222%; P/FCF of 6.2 vs 8.1 definitely show ARLP has an edge by being relatively debt-free. But Dec's 2023 FCF of $155m and Interest of $134m show that DEC's underlying P/FCF (excluding interest) is actually stronger than ARLP.
And ARLP on a P/E of 4.3 vs DEC's 0.7 means you are paying 6X more relative to earnings.
Also comparing yields ignores the NAV return of buy backs.... ARLP don't appear to be engaging in any buy backs.
I see 80% of ARLP's EBITDA is from Coal mining and 20% is O&G Royalty (presumably what you refer to as "pipeline"). So "definitely less risk" is a matter of perspective when thermal coal appears to be rapidly declining in use in the US and coal faces various legislative and competitive pressures.
I was thinking more about your "definitely less risk" ARLP. I see ARLP has a $266m ARO obligation but has only accrued $150m. It speaks to a surety bond but there is no actual asset set aside in the balance sheet. I see there's a Workers' compensation and pneumoconiosis liability of $132m. (Taken from the 2023 accounts)
So an ARO of $400m so it's true that that's only about 1/4 of DEC, but ARLP have no NextLVL to offset any costs and presumably the idea of mining coal until 2095 is not on the cards. No ideas around carbon capture (CCUS) or repurposing either.
When Coal demand is precipitously reducing (12% reduction in demand in 2024) how can there be definitely less risk, than natural gas with growing demand?
Do those ARO take into consideration the fact that mines emit methane? ARLP only considers methane in relation to its pipelines and not its coal business. Meanwhile MERP covers "abandoned" coal mines. Is there not a risk it will extend? (depending on who is in the WhiteHouse of course)
Does the black lung liability take into consideration that compensation could envolve and grow? For example as medical improvements and treatments grow, could the compensation grow too? For me a medical liability is far more uncertain than the cost of plugging a small wellhead in the ground.
While ARO activists specifically target DEC and not any other O&G or coal business (for reasons best known to them), is there not a risk that these same activists and Democratic Senators one day might watch a Bloomberg documentary covering why Coal mine methane is a major risk? I see there are activists speaking about coal:
In a similar vein that activists speak that X number of DEC wells should be retired each year, what if they begin demanding X number of mine shafts (or whatever the parallel would be) be retired each year?
As I consider both ARLP and DEC in parallel I don't see such a simple dichotomy of "definitely less risk" that you do.
The methane issue looks like it’s been put to bed which is a plus sign. Also looks like sentiment is shifting a degree as the share price has started to climb. Only got to increase another 90% and it will be back to where it started a while ago. Although then the yield would be somewhat less which was the original attraction of the share in the first place.
ARO does look like a future issue and I wouldn’t be surprised if it crops up again but it may depend on who is the next president. If it’s trump then nobody will care but if it’s Biden then there may be more scrutiny industry wide.
The whole carbon credit section of the article is pie in the sky and really needs a bit more rigour. I’m fairly certain the credit is for the company implementing the CCS so it would be the power station, not the owner of the well it’s stored in, or the builder of the direct air CCS. Cost to build and implement at a power station is expensive and probably not in DEC’s skill base. Direct air is a whole different ball game with costs estimated at $600 a ton and nobody has a plan to scale it up properly to the hundreds of millions of tons range needed.
Blithely mentioning pipelines kind of glosses over the issue of building thousands of miles to connect power stations to thousands of different wells. I would assume the wells would still have to be plugged at some point to seal them permanently once full of CO2?
DEC was tipped at 1076p in my ideas for 2024. It's now at 1106p and rising strongly. It also returned 6.89% in its Q1 dividend. Your comment about "only got to increase 90%" doesn't belong here - if you are being fair.
I speak to being fair because I note the tone of your comment.
The methane issue has proactively been dealt with ever since acquiring assets, and it was obvious that the 2023 Sustainability Report was going to show strong progress. My comment about DEC being like "Coach Carter" and comparing to Eton is unfair has proven to be correct.
You mention "ARO does look like a future issue", but correctly go on to say the problem is "industry wide". DEC, in my analysis, is ahead of most of its peers in asset retirement not least because it can profit from it to offset cost. DEC continually gets singled out for asset retirement and that DEC should retire thousands of wells post haste... is like a popular urban myth, a very tired, urban myth. These people trot out the same well-trodden argument which has much less basis in fact.
You then claim DEC's work on carbon credits is pie in the sky. Do you have any evidence to support why you believe this? Or is your pie in the sky comment just pie in the sky? Using an exhausted well for storage isn't a new concept. Your logic that DEC lacks the skill to build a power station being a reason not to engage in the storage of Carbon Dioxide is simply bizarre. It reflects your lack of knowledge and experience in this area, and rather undermines the credibility of your line of thinking.
I don't speak to building thousands of miles of pipes - that is your invention. I speak of the economics of earning $50-$85 per tonne. If the economics of pipebuilding and storage are there then they'll do it. If it's not they won't. Surely that is obvious? A ton of natural gas is 51.7mmbtu. So $85/51.7 = $1.65 per "mmbtu" of Co2. Compared to the sale of natural gas, $1.65 isn't as profitable but I'm sure DEC will consider the business case, and indeed the risks. If $180/tonne were given (as with sequestration) then that is $3.48 per mmbtu - that seems more doable.
And, yes, of course the wells would still have to plugged. Surely that is obvious too?
You’ve been publishing articles on DEC far longer than the January date so it is fair to mention the significant drop since then.
You have not read my comment properly. I did not say they would build power stations I said they would have to build the CCS to get the credit. I know quite a bit about CCS and the reasons isn’t gone anywhere so far. DEC are not likely to be able to build an entire infrastructure just to get a carbon credit. The point about the pipeline is that you are indicating they could make money by storing CO2 and ignoring the actual reality that to do so requires getting it to the well - the most cost effect way is pipelines which would need to be built. A non trivial obstacle.
This comes back to the theme in many of your articles in that you don’t consider the risks or issues, only the bright side.
"Cost to build and implement at a power station is expensive and probably not in DEC’s skill base."
So what did I misread exactly? Perhaps it's more accurate to concede that you didn't explain yourself very well. And in fact you haven't demonstrated any particular kind of expertise in your own comments despite claiming to "know quite a bit about CCS". If you are the expert and I am "only the bright side" amateur why don't you actually demonstrate that? Which risks and issues do you think I do not consider?
You don't seem to even be able to maintain a coherent criticism.
For example you've just said "you are indicating they could make money by storing CO2 and ignoring the actual reality that to do so requires getting it to the well"
Yet pipelines are covered in my article and you should be able to recollect this because you invented "thousands of miles of pipelines"!
Read slower. Cost to build AT A power station. The previous sentence was discussing the CCS and I said build AT A power station. Not build A power station.
When I first read the article there was no mention of pipelines. But just in case I missed it the point was that to build that amount of pipeline is incredibly difficult (regulatory hell) so hence a significant risk to ever achieve CO2 storage at the wells.
CCS at power plants are expensive to retro fit and do not capture all the emissions. Very few have been implemented so scaling up will be another risk (materials, skills, labour).
Demand risk. Companies have avoided doing CCS and will probably continue to do so until their dying breath.
Technical risks. Wells have to be assessed for suitability. I’ve not looked in detail at using gas wells but there will be complications with multiple wells in a large gas formation as all bites need to be suitable (if other companies access the same gas formation that introduces extra complications).
Once filled with co2 the company is then on the hook for a long term risk of any leakages. Likely to be more scrutiny of these wells than end of life gas wells that have been plugged. At some point governments would introduce some sort of regulation and standards if the process took off.
Nice write-up based on a much larger nice write-up. I believe that DEC is on top of the methane problem and faces little risk in that department. They get an A+ on methane.
However when it comes to Asset Retirement Obligations there is far too much conjecture and hope involved for my investment comfort. Further, I have little doubt that NextLVL has, or will have, sturdy competition given the huge amounts of money floating out of government coffers to fund well retirements. The spread between $20K+- for DEC's own wells and $120K+- for government funded retirements is just too juicy and does not pass the smell test.
I think the investment case for DEC needs to be based on the near certainties of the near few years. The economics of the business look reasonably solid; however the treadmill of decline dictates continuing acquisitions. DEC's slashing of the dividend thoroughly discredited the case for sustainable cash flows from paid off wells. (I am in the camp that the size of the reduction was unnecessary.)
What has not changed is the Asset Retirement Obligations. DEC had 70K wells, which assuming a 50 year life (probably a stretch), requires an average retirement rate of 14K wells per year. I'm certain that the 6000+- wells spun off into the SPV were not DEC's oldest wells so their age profile has quite likely gotten older.
Accepting the ARO risk and a modest portion of commodity risk was acceptable at a 15% yield when I began purchasing DEC stock on the LSE. A 9% yield does not do it for me, especially when compared to lesser risks in energy at similar (mineral royalties) or slightly lower yields (pipelines).
One other point relevant to the investment case. I have been watching for some positive analyst coverage and for aggressive stock buybacks using what were our dividends. I've seen neither ... so far.
Thanks Earl. This morning the news on aggressive stock buybacks addresses your latter point, while Tennyson, Cavendish and Dowgate have all recently given positive coverage (I believe Peel Hunt too but I do not have access to review their research).
I have reviewed AROs across DEC's competitors and have not found DEC to be wanting. In fact compared to EQT for example, DEC arguably better accounts for its ARO. Yet there is a continued angst about this - specifically and only for DEC. I do not hold any companies involved in offshore oil & gas but those have terrifying and complex AROs. Yet no one speaks to those, do they? I fully appreciate how a royalty/pipeline investment would avoid AROs - but surely these won't be mispriced either - so it comes down to your risk/reward appetite surely.
Finally regarding NextLVL the conjecture is only based on a continuation of existing growth and to speak to the growth delta which must occur if the US actually wants to tackle the 2.5m wells (and methane) across its territory in the 21st Century. The idea that NextLVL could grow to a $300m turnover business is tackling only a very small proportion of those per year, in what is currently a very fragmented market lacking vertical integration, at least in the Appalachia (where DEC is the largest and $28m turnover is "largest" tells you a lot)
Oak
I've said enough on the ARO's but the stock buyback announcement this morning is a bad joke.
DEC approved the repurchase of 5M+- shares 10 months ago (May 2023) during which it repurchased only 20% of the authorization while the price was in the tank. Now, after taking 2/3 of the dividend, DEC makes the grand announcement that they will repurchase the remaining 4M+- shares at prices up to double what the shares have sold for until recently. There is no new news. Anyone expecting a new buyback program funded with the reduced dividend can pound salt. This is really the gang which can not shoot straight.
One more item ... the buyback applies exclusively to UK shares.
EarlA; as a pipeline investment, ARLP for example, is definitely lesser risk - but it isn't slightly less yield - it's well over 11%
Comparing ARLP and DEC side by side, as well as yield that you've pointed out, 15% gearing vs 222%; P/FCF of 6.2 vs 8.1 definitely show ARLP has an edge by being relatively debt-free. But Dec's 2023 FCF of $155m and Interest of $134m show that DEC's underlying P/FCF (excluding interest) is actually stronger than ARLP.
And ARLP on a P/E of 4.3 vs DEC's 0.7 means you are paying 6X more relative to earnings.
Also comparing yields ignores the NAV return of buy backs.... ARLP don't appear to be engaging in any buy backs.
I see 80% of ARLP's EBITDA is from Coal mining and 20% is O&G Royalty (presumably what you refer to as "pipeline"). So "definitely less risk" is a matter of perspective when thermal coal appears to be rapidly declining in use in the US and coal faces various legislative and competitive pressures.
Damien,
I was thinking more about your "definitely less risk" ARLP. I see ARLP has a $266m ARO obligation but has only accrued $150m. It speaks to a surety bond but there is no actual asset set aside in the balance sheet. I see there's a Workers' compensation and pneumoconiosis liability of $132m. (Taken from the 2023 accounts)
https://investor.arlp.com/files/doc_financials/2023/ar/2023-Annual-Report-1.pdf
So an ARO of $400m so it's true that that's only about 1/4 of DEC, but ARLP have no NextLVL to offset any costs and presumably the idea of mining coal until 2095 is not on the cards. No ideas around carbon capture (CCUS) or repurposing either.
When Coal demand is precipitously reducing (12% reduction in demand in 2024) how can there be definitely less risk, than natural gas with growing demand?
Do those ARO take into consideration the fact that mines emit methane? ARLP only considers methane in relation to its pipelines and not its coal business. Meanwhile MERP covers "abandoned" coal mines. Is there not a risk it will extend? (depending on who is in the WhiteHouse of course)
https://www.whitehouse.gov/wp-content/uploads/2022/11/US-Methane-Emissions-Reduction-Action-Plan-Update.pdf
Does the black lung liability take into consideration that compensation could envolve and grow? For example as medical improvements and treatments grow, could the compensation grow too? For me a medical liability is far more uncertain than the cost of plugging a small wellhead in the ground.
While ARO activists specifically target DEC and not any other O&G or coal business (for reasons best known to them), is there not a risk that these same activists and Democratic Senators one day might watch a Bloomberg documentary covering why Coal mine methane is a major risk? I see there are activists speaking about coal:
https://ember-climate.org/insights/research/in-the-dark-underreporting-of-coal-mine-methane-is-a-major-climate-risk/
In a similar vein that activists speak that X number of DEC wells should be retired each year, what if they begin demanding X number of mine shafts (or whatever the parallel would be) be retired each year?
As I consider both ARLP and DEC in parallel I don't see such a simple dichotomy of "definitely less risk" that you do.
OB
The methane issue looks like it’s been put to bed which is a plus sign. Also looks like sentiment is shifting a degree as the share price has started to climb. Only got to increase another 90% and it will be back to where it started a while ago. Although then the yield would be somewhat less which was the original attraction of the share in the first place.
ARO does look like a future issue and I wouldn’t be surprised if it crops up again but it may depend on who is the next president. If it’s trump then nobody will care but if it’s Biden then there may be more scrutiny industry wide.
The whole carbon credit section of the article is pie in the sky and really needs a bit more rigour. I’m fairly certain the credit is for the company implementing the CCS so it would be the power station, not the owner of the well it’s stored in, or the builder of the direct air CCS. Cost to build and implement at a power station is expensive and probably not in DEC’s skill base. Direct air is a whole different ball game with costs estimated at $600 a ton and nobody has a plan to scale it up properly to the hundreds of millions of tons range needed.
Blithely mentioning pipelines kind of glosses over the issue of building thousands of miles to connect power stations to thousands of different wells. I would assume the wells would still have to be plugged at some point to seal them permanently once full of CO2?
Thanks for your comments Ian Mears.
DEC was tipped at 1076p in my ideas for 2024. It's now at 1106p and rising strongly. It also returned 6.89% in its Q1 dividend. Your comment about "only got to increase 90%" doesn't belong here - if you are being fair.
I speak to being fair because I note the tone of your comment.
The methane issue has proactively been dealt with ever since acquiring assets, and it was obvious that the 2023 Sustainability Report was going to show strong progress. My comment about DEC being like "Coach Carter" and comparing to Eton is unfair has proven to be correct.
You mention "ARO does look like a future issue", but correctly go on to say the problem is "industry wide". DEC, in my analysis, is ahead of most of its peers in asset retirement not least because it can profit from it to offset cost. DEC continually gets singled out for asset retirement and that DEC should retire thousands of wells post haste... is like a popular urban myth, a very tired, urban myth. These people trot out the same well-trodden argument which has much less basis in fact.
You then claim DEC's work on carbon credits is pie in the sky. Do you have any evidence to support why you believe this? Or is your pie in the sky comment just pie in the sky? Using an exhausted well for storage isn't a new concept. Your logic that DEC lacks the skill to build a power station being a reason not to engage in the storage of Carbon Dioxide is simply bizarre. It reflects your lack of knowledge and experience in this area, and rather undermines the credibility of your line of thinking.
I don't speak to building thousands of miles of pipes - that is your invention. I speak of the economics of earning $50-$85 per tonne. If the economics of pipebuilding and storage are there then they'll do it. If it's not they won't. Surely that is obvious? A ton of natural gas is 51.7mmbtu. So $85/51.7 = $1.65 per "mmbtu" of Co2. Compared to the sale of natural gas, $1.65 isn't as profitable but I'm sure DEC will consider the business case, and indeed the risks. If $180/tonne were given (as with sequestration) then that is $3.48 per mmbtu - that seems more doable.
And, yes, of course the wells would still have to plugged. Surely that is obvious too?
A couple of points
You’ve been publishing articles on DEC far longer than the January date so it is fair to mention the significant drop since then.
You have not read my comment properly. I did not say they would build power stations I said they would have to build the CCS to get the credit. I know quite a bit about CCS and the reasons isn’t gone anywhere so far. DEC are not likely to be able to build an entire infrastructure just to get a carbon credit. The point about the pipeline is that you are indicating they could make money by storing CO2 and ignoring the actual reality that to do so requires getting it to the well - the most cost effect way is pipelines which would need to be built. A non trivial obstacle.
This comes back to the theme in many of your articles in that you don’t consider the risks or issues, only the bright side.
You wrote:
"Cost to build and implement at a power station is expensive and probably not in DEC’s skill base."
So what did I misread exactly? Perhaps it's more accurate to concede that you didn't explain yourself very well. And in fact you haven't demonstrated any particular kind of expertise in your own comments despite claiming to "know quite a bit about CCS". If you are the expert and I am "only the bright side" amateur why don't you actually demonstrate that? Which risks and issues do you think I do not consider?
You don't seem to even be able to maintain a coherent criticism.
For example you've just said "you are indicating they could make money by storing CO2 and ignoring the actual reality that to do so requires getting it to the well"
Yet pipelines are covered in my article and you should be able to recollect this because you invented "thousands of miles of pipelines"!
Read slower. Cost to build AT A power station. The previous sentence was discussing the CCS and I said build AT A power station. Not build A power station.
When I first read the article there was no mention of pipelines. But just in case I missed it the point was that to build that amount of pipeline is incredibly difficult (regulatory hell) so hence a significant risk to ever achieve CO2 storage at the wells.
CCS at power plants are expensive to retro fit and do not capture all the emissions. Very few have been implemented so scaling up will be another risk (materials, skills, labour).
Demand risk. Companies have avoided doing CCS and will probably continue to do so until their dying breath.
Technical risks. Wells have to be assessed for suitability. I’ve not looked in detail at using gas wells but there will be complications with multiple wells in a large gas formation as all bites need to be suitable (if other companies access the same gas formation that introduces extra complications).
Once filled with co2 the company is then on the hook for a long term risk of any leakages. Likely to be more scrutiny of these wells than end of life gas wells that have been plugged. At some point governments would introduce some sort of regulation and standards if the process took off.