Black Stone Minerals: Hedges And Shelby Trough To Power Upside

Feb. 08, 2023 seekingalpha.com  Written by Geoffrey Seiler

This is an excerpt.  For the full article, click on this link:  https://seekingalpha.com/article/4576336-black-stone-minerals-hedge...

The full article also covers BSM’s Austin Chalk assets.

Summary

• High-priced nat gas hedges will power results in 2023 and 2024.
• Shelby Trough development deals to increase production.
• Stock upside to $20 given its strong FCF profile.
•  

The roll-off of low-priced hedges into more attractive hedges this year and next year bode well for Black Stone Minerals (NYSE:BSM). Meanwhile, development deals in its core Shelby Trough should drive production growth, while its Austin Chaulk acreage provides optionality. As a royalty interest company, BSM is also not directly exposed to the same inflationary pressures as E&P companies.

Company Profile

As a mineral interest holder, BSM owns the commodities under tracts of land that it leases to producers in exchange for a royalty interest. E&Ps drill the land and take out the oil and natural gas to sell, while BSM gets a percentage of the production or revenue from the production, typically 20-25%. Unlike E&Ps, it does not have to pay any operating and transport costs, nor does it have to pay F&D costs (finding and development). The company will also often get upfront cash payments when it leases new land called lease bonuses.

BSM has several types of royalty interests, including nonparticipating royalty interests (NPRIs) and overriding royalty interests (ORRIs). If you want to dig into the nitty-gritty of mineral interests, I'd check out this article.

BSM also has some non-operated working interests, mostly in the Haynesville. With non-operated working interests, it is required to pay its portion of the costs associated with drilling and operating these wells.

The company also has a few farmout agreements where third parties fund the development of wells drilled by its partner Aethon. BSM has two development agreements with Aethon in the Shelby Trough that calls for increasing well counts annually for exclusive access to its acreage and preferred royalty rates.

In the first year, Aethon was required to drill 15 wells. The required number of cumulative wells went up to 25 in September 2022, and will go up to 27 wells next program year. The Shelby Trough is in the southern extent of the Haynesville and Bossier play in East Texas and is BSM's largest producing area.

BSM has 20 million gross acres (7.4 million net). Approximately 25% of it is leased, while 75% remains unleased.

Over 70% of production on BSM's assets are natural gas. Nearly half comes from the Haynesville/Bossier and Shelby Tough plays in East Texas. It typically hedges 70% of its production 1-year out and 50% 2 years out.

Opportunities

BSM's biggest tailwind is that a large percentage of its low-priced natural gas hedges will roll off at the end of the year and will be replaced by hedges that are on average priced 62.5% higher in Q1 2023. The average weighted price on its nat gas swaps will go from $3.12 in Q4 to $5.07 in Q1 2023 and then up to $5.15 for the rest of the year.

The company will also see an increase in price on its oil hedges. Its swap contracts are currently locked in at $66.47 for Q4, and will rise to $78.99 in Q1. The contracts will move to $80.42 for the rest of the year.

The next biggest opportunity for BSM is with its Shelby Trough acreage.

The company should see solid growth in the Shelby Trough given its development deals with Aethon, which it gave royalty relief back in 2020 in exchange for increased drilling.

Back in 2018, the Shelby Trough represented about a third of BSM's total production, and when COVID hit and natural gas prices fell, operators BP (BP) and XTO, a subsidiary of Exxon Mobil (XOM), stopped drilling the acreage. That led to big volumes declines into 2021.

However, in 2020 BSM remarketed BP's acreage and signed an agreement with Aethon to develop the acreage with increasing ramps in yearly wells in exchange for lower royalty rates. In 2021, BSM and XTO partitioned some of their acreage, which led to a second development program with Aethon to develop this acreage as well. XTO even returned to the acreage and drilled some wells this year.