Ring Energy: A Look At 2023 With $70 Oil

Ring's Energy's (NYSE:REI) Q4 2022 earnings report and its official guidance for 2023 gives us an initial look at Ring's performance and expectations now that its Stronghold acquisition (closed at the end of August 2022) is fully impacting its results.

Ring's production has nearly doubled, but a decent amount of that added production is lower value natural gas liquids and natural gas. Ring's oil cut is expected to be approximately 68% in 2023 compared to 86% in Q2 2022. Meanwhile its lease operating costs are expected to creep up to $11+ per BOE despite adding gassier production and switching to three-stream reporting.

Ring's guidance for 2023 was a bit weaker than what I previously expected, although it should still be able to generate approximately $44 million in free cash flow at the current $70 strip for West Texas Intermediate oil in 2023. However, its relatively high amount of leverage means that it will likely need to focus on debt reduction (instead of returning capital to shareholders) for quite some time.

Notes On Ring's Guidance

Ring's 2023 guidance was slightly weaker than expected. It provided a preliminary 2023 outlook in October 2022 that called for it to "maintain or slightly grow" its 2023 sales volumes compared to Q4 2022 sales volumes.

At that time, Ring expected its Q4 2022 sales volumes to be approximately 18,000 to 19,000 BOEPD (with a 70% oil cut). Thus Ring's preliminary outlook for 2023 suggested around 18,500 to 19,000 BOEPD in sales volumes. This was with a capital expenditure budget of $150 million to $175 million.

Ring's official guidance for 2023 is for 17,800 to 18,800 BOEPD in sales volumes, with a 66% to 70% oil cut. At guidance midpoint this is probably around 2% lower sales volumes than its preliminary outlook, along with an oil cut that has decreased by around 2%. This is still a slight increase versus Q4 2022 sales volumes, although Q4 2022 was negatively affected by gas midstream constraints and severe winter weather conditions.

Ring's capex budget for 2023 is a bit lower as well at $135 million to $170 million, so that capex reduction probably affects sales volumes by a bit over 1% compared to its preliminary outlook.

Notes On Stronghold Acquisition

The economics of Ring's Stronghold acquisition have been negatively affected by weaker commodity prices.

Ring may realize close to zero for its natural gas in 2023. It realized negative $3.79 compared to NYMEX for its natural gas in Q4 2022. Even if the average 2023 differential narrows by over a dollar, that would still leave it realizing around $0.25 for its natural gas with the 2023 NYMEX strip a bit under $3 currently.

Ring also realized only $17.21 per barrel for its NGLs in Q4 2022, about 21% of WTI oil. This percentage (compared to WTI) should improve in 2023, but that would still result in a sub-$20 per barrel realized price for Ring's NGLs.

When the deal was announced, Stronghold was producing around 9,100 BOEPD (including 54% oil, 21% NGLs and 25% natural gas).

So Ring's Stronghold assets may realize around $72 per barrel for the 54% of its production that is oil, but less than $10 per BOE in 2023 for the 46% of its production that is NGLs and natural gas.

Thus at 9,100 BOEPD in production and 2023 commodity prices, the Stronghold assets could generate less than $100 million EBITDAX in 2023. The $465 million purchase price doesn't look as good in that context, although some components of the purchase price (such as Ring's stock and the assumed hedge liabilities) don't add up to as much value now.

2023 Outlook At $70 WTI Oil

At guidance midpoint, Ring expects to average 18,300 BOEPD (68% oil) in sales volumes during 2023. At current strip of roughly $70 WTI oil, Ring may generate $336 million in oil and gas revenues before hedges.

Ring's 2023 hedges have slightly positive ($4 million) in value at $70 WTI oil. It has hedges covering approximately 38% of its projected oil sales volumes and 35% of its projected natural gas sales volumes for 2023.

This results in a projection that Ring will now end up with around $44 million in positive cash flow in 2023.

Debt Reduction

Ring added to its debt with its Stronghold acquisition. It ended 2022 with $411 million in net debt. With $44 million in projected free cash flow in 2023, it may end 2023 with around $382 million in net debt. This includes the effect of the $15 million in deferred cash consideration that Ring paid to Stronghold at the end of February 2023.

Ring's projected year-end 2023 leverage is approximately 1.7x at current strip prices. This is a relatively high amount of leverage for an E&P company these days, although it is not at a critical level yet. Ring's leverage does mean that it will need to focus on reducing its debt before returning capital to shareholders.

Ring mentioned potentially doing more acquisitions in 2023 or 2024, but it will need to be careful about how it structures those acquisitions due to its leverage.

Estimated Value

Ring's estimated value has been reduced due to it having lower projected free cash flow in 2023 now, along with lower sales volumes than I had previously modeled.

Ring's 2023 sales volumes are expected to be higher than its Q4 2022 sales volumes, but lower than its Q3 2022 sales volumes proforma for its Stronghold acquisition. Ring's 2023 capex budget can be considered roughly maintenance level.

In a $70 WTI oil scenario (and with improved realized natural gas prices), Ring may be able to generate around $50 million per year in unhedged free cash flow while maintaining production levels. At a low-teens free cash flow yield, this would translate into an estimated value of a bit over $2 per share for Ring. At $75 WTI oil, Ring's estimated value would increase to around $3 per share.

Conclusion

Ring is now expected to generate around $44 million in free cash flow in 2023 at $70 WTI oil, while keeping production relatively stable. Ring's revenues from natural gas and NGLs (a combined 32% of its production) are relatively low, with a realized price estimated at under $10 per BOE for 2023.

A $70 WTI oil scenario is okay for Ring, but its leverage may become more concerning at sustained lower oil prices. I am maintaining my long-term oil pricing outlook at around $70 to $75 though, which suggests a value of approximately $2 to $3 for Ring.

With Ring at $1.71 per share right now, it does appear to still have some upside in a $70 to $75 longer-term oil environment.

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