Old hedges are killing US Energy Corp. (NASDAQ:USEG)

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Many traders believe that US Energy Corp. (NASDAQ: USEG) is a great way to negotiate sky-high oil and gas prices – until they look into the details. Past hedging transactions have significantly limited the benefits of the current high level energy price. A portion of future oil production is hedged at just $49.99 and a portion of natural gas at just $2.96. A large percentage of its production was hedged in January when energy prices were well below current prices. Hedges aside, the company has a very conservative balance sheet, even after acquiring three private oil and gas producers in January.

Catastrophe cover

Just after the effective date of the merger agreements in early January (see below). USEG arranged the funding. As is often the requirement to obtain financing, the lender required that a portion of its projected future oil and gas production be hedged. (Bankers are interested in securing loan repayments with a stable and predictable amount of cash flow and they are much less interested in future income growth. They are lenders, not shareholders). USEG has hedged most of its projected oil and gas production for 2022 and much of its production for 2023. Absolutely terrible timing considering what happened to energy prices a few weeks later.

Oil and gas hedges

USEG oil and gas coverages contained in 1Q 10-Q

Oil and gas hedges (sec.gov)

Hedges completed prior to January for 2022 production must have been completed at prices well below the average prices in the table above, as its last 10-Q stated “on January 12, 2022, the company entered into…contracts commodity derivative collars for a total of 210,500 barrels of crude oil from February 1, 2022 to December 31, 2022 with a floor of $65.00 and a cap of $89.40”. higher than the average prices in the table above, but they are still well below current and forecast energy prices.

Assuming USEG has the same 90,821 barrels. oil production in 2Q as in 1Q, it would seem that only 7,321 Bbls. are not covered [90,821-(73,500 + 9,000)] for 2Q. Using the chart above it also looks like it’s not until Q3 2023 that there will be a significant reduction to just 52,600 barrels hedged and that’s assuming he hasn’t done any additional hedging since he filed his quarterly report. (I wonder if USEG’s bullish stock traders are even aware that the company isn’t really currently profiting from rising energy prices.)

Keep in mind that energy prices didn’t really spike until the start of Q1, so the average prices USEG received for oil of $86.25, 5, $79 for gas and $73.50 for BOE in Q1 are respectable. The problem was that these numbers did not reflect the impact of the hedges. USEG lost $1.644 million on oil-derived settlements in Q1 and $97,000 on gas. The total derived losses including these figures were $6.296 million for oil and $541,000 for gas. This implies that it incurred a loss of $4.749 million on hedges for expected future production after the first quarter and $444,000 for gas.

Comparison of USEG stock price and WTI spot price

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Data by Y-Charts

The result of these hedging losses of $6.837 million is reflected directly in its income statement. (I personally think these should be treated the same as extraordinary income statement items because the current method confuses investors, but GAAP dictates which method is used.) Its balance sheet has a total of current and non-current derivative net liabilities of $8.344 million.

First quarter 2022 income statement

Income statement 1Q USEG content 1Q 10-Q

Q1 2022 income statement (sec.gov)

USEG assumed $3.152 million in derivative liabilities as part of the merger agreements (see below), but I’m not sure why management decided to hedge about 90% of its projected 2022 oil production in January. . His new credit agreement has the usual coverage requirements (section 8.19), but they are not so restrictive. Its initial borrowing base was set at $15 million. USEG would be required to hedge at least 15% of its projected production, if it borrowed up to 25% of the borrowing base, and at least 30%, if it borrowed between 25% and 50% of the base. Even if it borrowed more than 50%, it would only have to cover at least 50% of its projected production for the next 12 months and at least 30% for the following year.

He only borrowed $3.5 million, which is just below the 25% level; thus, under the credit agreement, he would only be required to cover 15%. I wonder if he expected to use more of his line of credit to purchase additional production assets. Management has never stated its hedging decision considerations.

January 2022 Merger

US Energy Corp. has been around for decades in Wyoming, but its stock price has been a disaster for investors. Because it had a 1 for 6 reverse split in 2016 and a 1 for 10 reverse split in 2020, its current price is actually around $0.07 on a pre-split basis.

Long-term stock prices

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Data by Y-Charts

Effective January 5 of this year, USEG merged with three other “mother and mother” sized energy companies for which it paid a total of $88.657 million. This purchase price included the issuance of 19,905,736 USEG shares, or approximately 80.8% of the new total number of shares. The “old” USEG shareholders held 19.2% of the newly merged company. The merger used a stock price of $3.40 in valuing the purchase price. This $88.657 million includes the cash payment of $1.25 million and the assumption of $9.614 million in pension liabilities, $3.152 million in hedging liabilities and certain other liabilities. The effective cost of buying these companies was actually higher because the transaction was considered a change of ownership under Section 382, ​​which placed very strict limits on USEG’s future use of its NOLs. $8.9 million (as of December 31, 2020).

The merger of these three private companies with USEG was a way for these companies to collectively go public. At this point, it is unclear if the owners wanted a method to sell their USEG shares they had received in the market or if they intended to use USEG to become a major oil producer. and gas. The merger did, however, cause some internal control issues according to its latest 10-Q. USEG has hired a comptroller to try to resolve these issues.

According to his latest proxy, insiders hold 21,019,310 shares of the 25,677,875 shares outstanding. USEG’s free float is a very small 4.658 million shares, which means it is only a retail stock as institutions are very unlikely to buy it.

USEG valuation

USEG is a very legitimate oil and gas producer, unlike another publicly traded company, Indonesia Energy Corp. (INDO), which I recently reported on about its “dodgy” business model. USEG even pays a quarterly dividend of $0.0225. This, however, does not automatically make USEG stock a buy.

There are two USEG stock prices of interest that should be considered when trying to determine an appropriate value for the stock. First, the terms of the merger used a value of $3.40 per share, which was the closing price on October 1, 2021. Second, USEG sold just over 1.1 million shares at $5.10 in February 2021 to raise funds. The prices for both of these stocks were back when oil and natural gas prices were much lower than they are now.

Reserves April 1, 2022 – Presentation to investors

Reserve figures as of April 1, 2022 PV-10

Reserves April 1, 2022 (usnrg.com/wp-content/uploads/2022/05/USEG-Investor-Presentation-May-2022.pdf)

The current total capitalization is $113 million using the latest USEG price of $4.41. That’s a bit above its last PV-10 PDP of $110.6 million, but if proved non-producing reserves are included, equity capitalization is below the PV-10 total of $131 million. . These values ​​used the 1Q SEC price of $75.24 for oil and $4.09 for natural gas. Given that current energy prices are much higher, the values ​​are likely to be significantly higher. Another positive is that he has almost no net debt. Management even said it had no plans to leverage its balance sheet. This, of course, reduces the risks for shareholders.

Conclusion

Unlike many other meme-traded stocks, USEG actually pays a small dividend and is currently priced rationally after meme traders boosted the stock price earlier this year to nearly $14 per share. .

The problem with USEG is its massive hedge positions which are well below current energy prices. It is highly likely that USEG will continue to report significant losses through 2023 as hedging losses are included in the income statements. These declared losses can have a negative psychological impact on potential investors. At this point, I view USEG as a hold/neutral, but investors may want to continue to monitor the stock and its hedge positions in future SEC filings. Depending on future energy prices and its future hedging policies, USEG could become a buyer.

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