There's Gold in Them There Hills

Further Hindsight - April 12th 2024

If you don't mind the much reduced divi hang on to DEC for a while. They have flipped to a serious growth prospect with a 34% rise since March 26th following their revamped strategy, which the American market seems to have bought. SimplyWallStreet have a ￡42.88 fair price on them. The potential upside looks huge, but it is unclear as to wether the dividend will track the share price. A top quartile pro forma yield target has been articulated recently, but so has a fixed 29c quarterly dividend for at least three years. If the share price rises substantially, the declared fixed dividend will start to look miserly. Nevertheless, with a trading profit in mind, my suggestion of a derisking strategy is sell 5 equal parcels of your DEC shares, adjusting the first disposal quantity if necessary so you are left with four equal parcels, commencing at 1673p (+20% on the current price), at increasing price increments of 23.5%. The final price in this sequence will land you at 80% of the ￡48.66 current fair value price (80% of fair value being deemed the lower limit of the fair value range). Happy days if the final disposal is achieved !!

Hindsight - April 2nd 2024

Capitulation. Dividend slashed. DEC have had an ah-ha moment. The dividends paid in Q1-Q3 (3 x 87.5c) have been slashed to 4 x 29c (116c p.a.) for at least three years, a massive cut. Yield-wise this still places them in the top quartile though. Any upside have been killed off too. Expect some appreciation in the share price but don't hold your breath. Sorry. View those first divis as a partial repayment of capital. May I recommend a switch to VanEck Semiconductor ETF (SMBG:LN).

DEC's latest capital allocation strategy is a tacit admission detractors were correct. The idea of a fund to cover abandonment costs has been tossed into the bin. Its more of the same old bullshit I'm afraid. And Rusty has awarded himself a huge share payout as a reward for the cock-up. That's American Capitalism for you. The 87.5c divis were, indeed, too good to be true....

Hindsight - March 5th 2024

The dual listing has not worked out as planned - the law of unintended consequences strikes. Diversified have provoked two powerful antagonists in the form of House Democrats and some hedge funds intent on shorting them. The core issue centres around the innovative business model's deferment of Asset Retirement Obligations (AROs). Hutson is digging in defending the current game plan - but this is unlikely to be effective on its own. A pissing contest that no-one is going to win - to put it bluntly - is on the cards. The best bet lies in bolstering ARO funding with a ring-fenced fund invested in high-growth low-cost financial instruments such as ETFs. This plays to Diversified's innovative nature. Funding when the Henry Hub spot gas is running at around 5% premium to its 12 month moving average would require a contribution every four months - on average. An uncorrelated ETF such as VanEcks Semiconductor offering looks like a winner....

Over to Rusty then... The extended deferment of well abandonment needs a more rigorous demonstration that these costs can be met when they arise. The current detractors will not be silenced simply by reiterating the current business model. Given the anticipated declining revenue stream as depletion plays out, something more robust is needed. A ring-fenced fund, added to when gas prices are a premium, can provide a flexible solution that investors and politicians can buy into. By investing in non oil-correlated high-growth investment vehicles, a truly low cost innovative business model for mature oil and gas facilities can be devised.

Pre-Christmas Close - 22nd Dec 2023

Diversified, industry analysts and myself, have all been caught out by the curved ball letter from some Democrats on the House of Representatives COMMITTEE ON ENERGY AND COMMERCE sent to them on the first day of NYSE trading (18th Dec.)

In essence this letter represents a challenge to Diversified's business model. In particular it takes aim at low-balling and long-term deferral of well shut-in and abandonment costs. Essentially Diversified are levering off a single important charaterisitic of fracked wells, namely a much extended production tail. They are doing this in two key ways; accessing cheaper finance using ABS notes, and deferring abandonment to future income. This is eminently sensible but it makes US Politicians nervous of the humungous abandonment costs that are racking up with every days that passes. The letter itself acknowledges the vast magnitude of the growing problem.... quote...

.... There are already more than 120,000 known orphan wells scattered across the country that are not properly plugged and are leaking methane and other pollutants into the environment. According to EPA estimates, there may be as many as 3.7 million additional undocumented orphan wells. In Pennsylvania alone, the state estimates there may be as many as 200,000 abandoned wells from its 100-year history of oil and gas extraction. The environmental liabilities from both orphaned and marginal wells are a great concern for Committee Democrats.... unquote

The full abandonment costs of these wells is eventually going to fall to the american taxpayer. This already amounts to a huge legacy cost not currently accounted for anywhere. America's historical baggage is vast...

DIversified's subsidiary has already undertaken some 3rd party work where the cost per well has turned out to be significantly higher than Diversified's estimate for its own wells. Just how well Diversified explain themselves out of this will pan out in the coming weeks and months and their share price will react accordingly. At this juncture it is a tad too early to detect any analyst response to the congressional letter.

It is nevertheless very clear Diversified's success will depend upon how well it manages to morph from a mature-asset producer of hydrocarbons into a well-abandonment specialist. The tail is going to have to wag the dog.... eventually. As an outsider I cannot help but feel there may a quite benfeicial outcome from all this. Time will tell.

1st Feb 2024 Update.

Diversified share price has been hammered by challenges to its business model from two quarters - Congress and short selling. 2023 has panned out exactly in line with earlier guidance. The criticism includes a detailed critique from Snowcap here..

Detractors have largely focussed on Diversified's deferral and downsizing of its AROs. These criticisms are not without some merit however they do not consider future acquisitions to counteract production decline of current assets. Infill drilling is not considered either. There will be serious low-hanging fruit that will become relevant as Diversified develops and fine tunes its strategy. Upticks in Henry Hub gas price will be pounced on too. Patience is called for. In the mean time take advantage of the awesome yield. There is already a juicy dividend on the table which goes ex on March 2nd.

A Strategy?

An ongoing asessment of annual ARO outlay should be resourced by a contingency fund that is resourced when the gas price movies to a premium to a moving average value. This need not be funded during periods of depressed gas prices.

____________________________ Start of Article______________________________________

The UK investment community does not understand how niche oil companies work, least of all those operating unconventional strategies towards the back end of field life in mature regions, notably the US. Many of the bigger players there see mature assets in decline as non-core. Fearful of abandonment and higher maintenance and operating costs, they offload them at an appreciable discount. One company has accumulated a huge well count over many years and crafted an optimised operating strategy designed to suit (and in fact driven by) the unique nature of its assets. It is well versed in tail-end operation, abandonment, production hedging, and has reduced costs to a minimum in the Appalachian basin and beyond. This oil and gas company, Diversified Energy Company (L:DEC), has not however done well on the back of its listing in London. It has decided to go for a second listing in New York. A profound rerating is on the cards as a result, and savvy investors can take advantage of this.

On the back of all this one shrewd analyst has recently declared a price target for DEC of 150p (Ethan Davis at Cavendish). On Nov 21st, DEC closed at 71.55p which easily makes it a doubleton. At the end of November it goes ex-dividend, paying a generous quarterly dividend of 4.375c per share at the end of the year. Another quarterly dividend of 4.375c has just been announced guaranteeing a juicy income stream covering all of H1 2024. The annual dividend sits at around 12.0p which produces a yield of 16.8% p.a. The upwards pressure on its price will manifest itself once trading commences in New York. DEC is planning on this happening on Dec 11th. The elevated yield and exposure to a more knowledgeable audience guarantees a significantly higher stock price. It actually gets even better - Diversified's modus operandi has legs.

It is undoubtedly a smart operator (see below) making a tidy profit. Core assets consist of fracked wells that possess a long production tail. It has infill well drilling expertise and employs experienced staff. A timely infill program is underway as I write. A focus on fugitive emissions adds to the bottom line. Future expansion prospects are obvious and it already has a toehold in East Texas. DEC will still be around long after the bigger players have departed.

To accommodate the New York listing it is undertaking a 20:1 share consolidation. If you are going to buy, do so in multiples of 20.

And, yes indeed, I already have a holding, but the current price is still in the buy zone. I am still accumulating. If like me you are ex-oil&gas, you will love this company, it is streetwise and has immense potential. Tullow players will note that Sandy Stash is on the board.

Potential UK investors should also note DEC is a US company and attracts 15% US Withholding tax unless you can find a platform that permits you to hold it in a SIPP. Unfortunately an ISA does not avoid the US WHT but you can avoid further taxation if you decide to hold it in one. One tactic worth contemplating is derisking via a switch to a conventional income fund once the share price appreciates and the dividend yield drops back to more conventional levels. This avoids sacrificing income when you do the switch. My current favourite is a UBS global fund - Enhanced Equity Income Sustainable Fund C Inc. Its dividend yield is well above the average. Always remember however a high dividend payout compromises long term capital appreciation. Fidelity's Investment Finder is helpful because it permits ranking within a focussed search. Happy Christmas !!!

Here is a summary of DECs modus operandi....

DEC have a unique strategy based on a streetwise/prolonged/sustained asset accrual? strategy. Critcally and most importantly, their producing assets are mature and have a long-life low-decline profile. This enables DEC to more easily lock-in margins with production hedging. DEC is also able to fund itself using asset-backed securitisation which is also facilitated by the above nature of its assets. DEC is unique amongst oil companies, its ABS Notes are rated debt instruments endorsed by Fitch as BBB+ (Stable). Essentially their ABS offerings are fixed coupon amortisation notes which pay down over time. They are in high demand, enhanced by their BBB+ Fitch rating. DEC are different inasmuch they fund their operations and acquisitions using both equity and ABS securitisation. They are already big. Their London market cap grossly understates. As of Oct 2021, they own over 69,000 oil and gas wells, making them the largest well owner in the US. All this justifies a massive hike in their status and share price which will be triggered by their NYSE listing.

A recent interview of DECs CEO Rusty Hutson can be found here..

Rusty Hutson Interview

30th Nov Update....

DEC went ex-dividend today and dropped to around 65p. The dividend accounts for about 3.5p. As is usual, the dip is overdone, so the share price at this level still represents a nice buy opportunity. The next quarterly dividend has already been announced and is the same as the one just gone. It goes ex on March 2nd and pays on March 28th. From here on it gets interesting. US trading on Dec 11th should signal the start of a bull run. The upside target is 150p. A lot will depend on the next update, and wether DEC can maintain the dividend. The year end report is due in March.

5th Dec Update....

DEC has now consolidated. It trades mid-session at around 1300p. The target price is 3000p and the next quarterly dividend is 87.5c/69.3p. The estimated annual yield is 21%. DEC is heavily oversold at this level and remains a compelling bargain. It is going to trade in the US commencing next Monday (11th Dec). Exactly why this is occurring is something of a mystery. Lack of true understanding of the business model has to be in play. Sqeezing value out of mature oil & gas assets is not very sexy. What is going on here vindicates DEC management in seeking a US listing. Next week's trading should be interesting.

15th Dec Update....

Still no NYSE trading to date. I have been advised DEC will also be the exchange ticker however the bottleneck appears to be the listing bureaucrats. Meanwhile the southwards drift in the share price continues as does DECs buying back their own shares. Diversified clearly believe their shares are oversold. This hiatus is not good for DEC or its shareholders as more will be read into the depressed share price than justified. Also, subdued `Christmas / New Year trading commencing Mon 18th Dec will deter significant buying until 2024.

18th Dec Update....

NYSE trading commenced but upside US pricing did not cross over into the LSE and vice versa in the opposite direction. This is somewhat ominous. Shareholder support for dual listing was premised on efficient parallel market making while both markets are open simultaneously and this clearly did not occur. Market makers do not currently seem to be eqipped to do this. This is made worse by the Forex element arising from dealing in GBX in London and USD in NY. Fingers crossed this is temporary. If it isn't then DEC have created an unfair dual share system which is heading towards disadvantaging existing shareholders.

The first days trading was also spoiled by a miraculously timed letter from the Democrats on the House Committee on Energy and Commerce. It was 9 pages long and amounted to a detailed challenge to DECs business model and particularly its lowball well abandonment costs. This appears to emanate from a somewhat unholy alliance of DECs competitors and the environmental lobby. The frontman appears to be Frank Pallone, on whom I need to do some digging before commenting further. Pallone has served as the U.S. representative for New Jersey's 6th congressional district since 1988.