Hess Corporation Valuation Report, July 2010 - Strategic and Operational Analysis

03 Aug 2010 • by Natalie Aster

Hess Utilizing Internal Cash Flow and Other Financing Sources to Support Its 2010 Capex Plan

Hess has been focusing on the development of its crude oil and natural gas portfolio globally. In line with its development program, the company plans to spend significant amount of funds in the next four to five years. Hess plans to spend around $4.1 billion, of which around $2.4 billion will be directed towards production, $800m for development and $850m towards exploration programs in 2010.

With its increased development activities across Bakken play, the company plans to spend around $1 billion in this play in 2010. This allocation of $1 billion will be primarily used to increase number of operating rigs (from an initial three to 10 rigs) and boost up its production from this play. In line with its aggressive development activities in this play, the company plans to increase its production level to about 80,000 boepd by the end of 2015. The company’s remaining expenditure of around $1.4 billion will be directed towards the development of its core assets including Shenzi assets, redevelopment of Valhall field, additional developmental drilling in Equatorial Guinea, Malaysia-Thailand Joint Development Area and Pangkah field in Indonesia. Apart from producing and developing assets, the company requires significant funds to support its exploration program and build a balanced oil and gas portfolio.

In line with the huge capex requirement, the company plans to fund maximum part of its capex from its operating cash flows in 2010. Hess primarily relied on the operating cash flows to fund their capex requirement in the recent past. During 2009, the company generated around $3.05 billion from operating cash flows to fund its capex of around $2.93 billion.

Figure 1 shows comparison of Hess’ operating cash flow as a percentage of its capital expenditure with that of its peer group from 2007–2009. This ratio depicts that the company has been relying on its operating cash flow to fund its capex plan. However, operating cash flow is highly dependent on the economic environment and commodity price movements. Hence, with the recovery of global economies and strengthening of the commodity prices, GlobalData expects that the company will be able to fund its capex requirement by its internal cash flow in 2010.

Apart from operating cash flow, the company also plans to use debt and equity offerings to fund its capex requirement in 2010. It has a revolving credit facility of around $3 billion, of which $2.9 billion is committed until 2012. Under this facility, the company can borrow up to $1 billion, which in turn will be used to support its capex requirement in 2010. Moreover, the company has an optimized capital structure with a debt to capital ratio of around 24.8% as of Q3, 2009.

Figure 2 compares Hess Corporation’s debt to capital ratio with its peer group from 2007–2009. In line with the optimized capital structure coupled with its significant capability to generate operating cash flow, GlobalData expects that the company will be able to support its capex plans comfortably in the coming years.

Additionally the company has large exploration acreages with around a 100% interest in Ghana and Libya. GlobalData expects that company can utilize its farm out option in these acreages to support its capex plan and de-risk its portfolio in the coming year.

Significant Exploration Assets in Queue; Timely Execution and Smooth Capital Funding Required

Hess has significant exploration assets in Australia, Libya and Egypt. The company has been focusing on the development of its assets in order to drive its future growth. In line with the development of these exploratory assets, the company successfully drilled nine out of the 11 drilled wells through its WA-390-P license in Australia. Additionally, the company has a further commitment to commence drilling in another five wells by the end of Q1, 2010.

Hess plans to exploit the opportunity to commercialize the resource development from the WA-390 license in Australia. The company reported a natural gas discovery through its first drilled well (Noblige 1) via its WA-404-P license in Australia. Further, the company plans to drill eight wells by the end of 2010. However, Hess’ future development strategy and upcoming plan will be based on the results of its appraisal and drilling operations in Australia.

Hess plans to spud the wells in the deepwater Tano/Cape Three Points block and Semai V block in Ghana and Indonesia respectively in 2011. Currently, the company is involved in gathering the seismic data and is expected to complete by the end of 2010. Similarly, its Libya and Egypt operation’s seismic data is expected to be reprocessed by 2010. Moreover the company will initiate talks with the Libyan government for future commercialization plans in Area 54 license. Adding to its exploration program, the company is trying to acquire equity stakes in potential fields and utilize innovative exploration techniques (Wildcat) to carry out the appraisal wells and exploit the maximum benefits.

With its increased exposure across the exploration assets, the company is highly dependent on the successful development of these assets. These developments require substantial capex, which in turn depend on the company’s capability to generate free cash flows. As the company funds its capital expenditure requirement from its free cash flows, a major goal is to generate enough free cash flow to support the development of these exploratory assets. Apart from free cash flow generation, the company should execute these exploratory assets quickly in order to avoid cost overrun and delay in its production growth in the coming years.

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