Inventory Questions Plague Cabot-Cimarex Merger

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Rumblings grew a bit louder last week that the merger between gas-focused Cabot Oil & Gas and oily Cimarex Energy could be in jeopardy after a leading analytical firm issued a report casting more doubt on Cabot’s stated inventories. But it’s the ramifications that give that possibility true import, a close observer told Energy Intelligence. “If this deal falls apart because of inventory concerns, that will be a shot heard literally around the world.” RS Energy Group, which is under the Enverus umbrella, recently released an updated evaluation of Cabot’s inventory suggesting its core holdings and overall inventory are lower than the Appalachia-focused company purports. A source familiar with the report noted that it estimates Cabot has two years of core inventory at a $2 per thousand cubic foot break-even and 2½ years of inventory that breaks even below $2.25/Mcf, assuming a 50¢/Mcf differential. These numbers are cumulative, so the report sees 4½ years of total inventory that breaks even at under $2.25/Mcf. However, the companies' presentation detailing the merger estimate 10 years of inventory at $40 per barrel crude and $2.25/Mcf gas, meaning Cabot is contributing nearly half of it. Cabot spokesman George Stark told Energy Intelligence that the firm has an ample drilling inventory, but did not give specifics. "Cabot foresees over two decades of drilling opportunities in front of us," he said. Scrutiny Not New RSEG’s findings are not a shock as this isn't the first time Cabot's stated inventories have been called into question (NGW May31'21). Nor is it the only Appalachian E&P suspected of inflating its core inventories. A tempest erupted last year when an anonymous analysis castigated CNX Resources for allegedly inflating its producible gas inventories and drilling outlook, leading some to maintain that the bounty of cheap Marcellus and Utica Shale supply could dry up by the latter half of this decade (NGW Nov.23'20). However, this latest report has also heated up simmering concerns about the Cimarex-Cabot union and led some to speculate that it could be rejected by Cimarex shareholders who are meeting Sep. 29 to vote on the merger. "Cimarex buying COG will go down as the most overvalued deal since Exxon bought XTO,” tweeted one industry analyst, citing the new figures as in line with his own analysis that Cabot could have 2½ years of core inventory left and two years of noncore inventory. In the report's wake, Cabot shares were plumbing 52-week lows, although this would not impact the share swap arrangement. Nonetheless, sources tell Energy Intelligence, the merger always appeared more favorable for Cabot shareholders, who are gaining exposure to Cimarex's long runway of Permian inventory, although Cimarex shareholders stand to benefit in other ways, such as exposure to a growing natural gas market. Another enticement is a possible $100 million reduction in annual general and administrative expenses mainly by combining the firms' upper management teams, which also means the new firm can drill fewer wells to attain a cumulative free cash flow (FCF) target of $4.7 billion in 2022-24. And while industry gossip holds Cimarex shareholders might nix the deal, that rarely if ever happens in deals of this magnitude. Larger Implications However, that is not the larger message being broadcast, Bison Interests Managing Partner Josh Young told Energy Intelligence. “It may bring the merger into question, but it defiantly brings the gas supply into question,” he explained. It also puts higher-cost plays, as in Oklahoma, where there is gas that’s been given very little value back on the table. “Economic gas is scarcer than people think,” Young said. “Your gas may be more valuable than everyone thinks, because there is not infinite gas in Appalachia. And there’s certainly not infinite gas at a $1 gas supply cost.” Young first wrote about Cabot’s potential inventory issues in July 2019, which he said were manifested by worse than expected capital efficiency. “This problem has snowballed and may continue to get worse as core inventory is more fully depleted,” he said in another report in February. But the key criticism he levels at Cabot is it failed to expand its inventories through accretive mergers with inventory-rich firms like Range Resources and Antero Resources when the opportunity presented itself. Management Stands Firm If questions over Cabot's actual inventories has shaken Cimarex management's confidence in the deal, it's not apparent. According to a Marcellus Drilling News report, a key telltale that Cimarex President and CEO Tom Jorden is still firmly on board in his decision to forgo an immediate payout and instead be awarded stock that vests over time, thereby tying his fortunes to that of the new company. Jorden will head the $17 billion yet-to-be-named independent that will be created by the all stock deal. Cimarex shareholders will get 4.0146 shares of Cabot in exchange for each Cimarex holding; Cimarex shareholders would own 50.5% of the combined entity, with Cabot’s investors holding the remaining 49.5%. The deal also combines Cimarex’s oily 560,000 net acres across the Permian and Anadarko Basins with Cabot’s 173,000 net acres mainly concentrated in northeast Pennsylvania's Susquehanna County from which it produces about 2.3 billion cubic feet of dry gas per day. Cabot is also considered a low-cost producer with a reputation for reliable dividends, a healthy FCF and a very small debt-to-earnings ratio. If the merger goes through, Cabot CEO Dan Dinges will become executive chairman of the board. Tom Haywood, Houston

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