Diversified Energy Share Discussion Threads

[tysoepr] 03/4/2022 17:20

Many thanks to everyone for your time, help and expertise with this, it has helped a great deal! There were bits in all explanations that really helped and redtom1's explanation really brought it home for me.

Much appreciated - thank you all!

[redtom1] 03/4/2022 15:27

Lord Knome,

I did a lot of hedging in my previous job so hopefully I can explain it a little.
When we say hedging in the context of DEC we generally mean selling forward, ie we agree to sell a certain amount of future production at a known price on a known date. Some of DEC's hedging is a bit more complicated that this but their basic hedge strategy is to sell future production to ensure certain CASH income.
And, as others have already said, the reason that DEC hedges future production is to provide a steady and predictable cashflow to pay running costs, debt repayment, dividends and for further acquisitions.
The key to remember here is that this is all about the cash flow not the accounting profit (which I will explain below).
So using an example. Let's say as of today (3 April 2022) the company knows that it will produce 100 units of gas in 2023 (or this is their best estimate). And let's say the future selling price offered for delivery of 100 units on 31 Dec 2023 is $2 per unit. The company strikes a deal (ie enters a hedging contract selling 100 units at $2 per unit for delivery on 31 Dec 2023).
Therefore the company knows for certain that it will have $200 of cash income for 2023. It can do its financial planning based on this knowledge. Of course it will do forward sales for many years and different percentages so it can forecast cashflows going out years. If it has hedged 100% of future production then it does not matter what the gas price does in the future as the company is guaranteed cash income of $200. This is the key point. A boom or bust in gas price has no impact on cashflows if hedged.
But here is the accounting glitch under IFRS based on the accounting policies adopted by DEC. At the end of a financial period DEC is required to value these future hedging contracts (referred to as marked to market)based on the prevailing cost of gas at any given date.
So we get to 31 Dec 2022 and we still have these 2023 hedges at $2. But the gas price has shot up during 2022 and sits at $3 on 31 Dec 2022. So we are required to value these hedges. Keeping the maths simple, we have sold at $2 whereas it is now $3 so DEC will record a non cash loss of $100 in its accounts. This looks awful in isolation. But roll forward to 2023 and let's assume that the price is still $3 at 31 Dec 2023. Two things can be done. Either we physically deliver the gas to the hedge provider (as we had agreed to sell 100 units) or what is normal practice, sell on open market and do a reversing (ie closing) hedge transaction.
So we sell our 100 units at $3 in the general market (sales of $300 and cash income of $300). We also have to close out our hedge by taking out a new but opposite hedge so we buy 100 units at $3 for delivery on 31 Dec 2023. The 2 hedges mature on same day (and need to be cash settled), the original one produces cash income of £200 and the new one costs us $300. So cash outflow from the 2 hedges is $100.
So overall we have net cashflow of $200 (ie $300 - $100) on 31 Dec 2023.
But for accounting, we have a P&L loss of $100 in 2022 and a P&L profit of $300 in 2023. The 2 years together produces exactly the same accounting result, ie $200.
This is the issue faced by DEC and others with rising gas prices. There will be huge accounting losses in the early years but counterbalanced when the hedges mature. I hope this helps!!

[owenski] 03/4/2022 10:55

Some good knowledge on hedging here, appreciated.

[asp5] 03/4/2022 10:36

My basic take on this topic:

DEC has to comply with International Financial Reporting Standards (IFRS). The intent of these standards is to give investors more transparent and relevant information, however expertise is required to process and make sense of this information. I am far from an expert on this subject but my layman’s understanding is as follows:

DEC uses financial derivatives (swaps, collars etc.) aka hedges to insulate their cash flow from commodity price volatility to ensure they can repay debt and make dividend payments. They basically hedge (agree a price in the future they sell their gas) at levels that lock in a healthy cash margin for the business.

These hedges are assets under fair value accounting rules. As these assets don't maintain the same value as their original purchase price, the accounting standard require them to be re-valued regularly at current market prices. A process know as mark-to-market.

This means DEC could take out hedges that locks in a great margin from a cash perspective - delivering the cash the business needs to make acquisitions, pay debt, pay dividends etc. but any unrealized hedges may get valued lower if the price of gas increases above hedge price.

Given DEC hedges many years out, the value of all these hedges needs to be discounted to the current year and be reflected in the P&L. Hence why DEC refer to this as a non-cash charge. It is reflecting the change in valuation of the hedges in the P&L but does not impact the actual cash position they are using to run the business.

When a hedge is realized, my understanding is that the difference between the current market price and the price agreed in the hedge is booked in the P&L, which is a cash loss if current market price is higher than the agreed hedge price. Again this does not impact the cash position that is being used to run the business.

I hope this helps – but if there are any accountants out there, it would be great to get their feedback on the above especially treatment of realized vs unrealized hedges.

[scrwal] 02/4/2022 23:04

King

Not sure about the tax treatment as the hedge loss is more akin to a provision which can be excluded from the tax calculation so the company would still pay full tax on the "proper profit" that we would recognise after eliminating the paper effect of the hedges.

The hedge effect is amplified in early years if prices rise rapidly and there has been heavy hedging which is what DEC does. There will be some unwinding but if there isn't a corresponding fall in prices then a total liability and perpetual loss may always exist as the longer term hedging would tend to be lower than the prices achieved at point of fulfillment because of the ongoing necessary high hedging policy used. This won't be the case say 30 years down the line when production is starting to decline so that far less hedging would be needed.

[king suarez] 02/4/2022 21:39

LG - think that is a pretty good description.

The hedge is a contract to sell X amount of oil/gas for X price at a future date. If the contract is fulfilled, then there is no 'gain or loss' overall, but between start date and fulfilment of the contract there is a P&L gain or loss, depending on commodity price movement.

In the case of DEC, the gas price has risen, so there is a mark-to-market loss - this effectively represents the cost the company would incur if this derivative contract were saleable today to a 3rd party (another producer or commodity trader?) - since no producer would want to agree terms to receive less than market rate for equivalent gas production, DEC would have to pay another producer to take the contract commitment - they would then be able to sell at market rate and recover the loss over time, if gas prices stayed at the current market rate (i.e now being unhedged). So it currently represents a derivative liability.

In reality, there is no intention for DEC to trade derivative contracts, but they still account for this as if it were a tradeable security. If 'held to maturity' then the net effect is zero, since the liability unwinds over time as more of the gas is delivered, until finally the contract is fulfilled and all gas has been delivered - there is then nothing against which any 'unrealised' mark-to-market loss can be calculated.

All else equal, over time, and if no further hedges were added and the gas price remained stable, DEC would start making hedging gains annually, that equal to the cumulative derivative losses to date, by the time the hedges end. Thus DEC would pay less tax this year, and more tax in future years as the hedges unwound - but overall the tax would be the same as if the company had not hedged - just a timing thing that presently is helping boost free cash flow, from lower taxation?

[lord gnome] 02/4/2022 20:47

The treatment of hedges in accounts is a dark art rather than a science. If the hedge is at $2 and they sell it for $3 they are simply handing the extra to the hedging company. It hits the P / L in that they are not making as much profit as they could without the hedge, but you don't actually see it.For some reason the future money 'lost' on hedges must be shown in accounts when hedges are marked to market. This unwinds when hedges closed.Hope this helps. Can anyone else explain it better?

[tysoepr] 02/4/2022 19:04

I just happened across DEC. It looks a good investment, but I really don't understand how the hedging accounting works. If I understand things correctly - say they hedge prices at $2/boe, but the market price is actually $3boe then they are taking that as a $1boe loss in the P&L? I can't see how that explanation can be right as it doesn't actually cost them $1. It would explain how they could ignore it from the adjusted measures as a non-cash cost, but the reported profits and therefore tax are negative because of it - which just doesn't seem right? Can anyone put me right on this, or point me towards something that would explain it? I've dug through the reports and googled to the point of going nuts, but I'm not getting anywhere!

[scrwal] 01/4/2022 17:06

This is the link



I usually get it via Investegate company announcements.

[asp5] 01/4/2022 14:50

First Berlin has an updated research note out and a 1,50 GBP price target. If I remember correctly someone posted a link to the pdf of a previous update - would be great if someone could so again !!

hxxps://firstberlin.com/first-berlin-diversified-energy-plc-research-update-01042022/

[asp5] 01/4/2022 11:16

Just to add to Gary's post the CFO emphasized the phrase "non-dilutive acquisitions/growth" in the investor call yesterday.

The securitization approach also plays well with developments in the price curve where long term hedges can be secured locking in the full amortisation of debt over term.

Do not see any chance of an equity raise.

[gary1966] 01/4/2022 10:44

Taken from the 24/02 RNS:

Pro forma for this transaction, our year-end 2021 liquidity is the highest in Diversified's history, strengthening our ability to transact attractive acquisition opportunities without relying on new equity contributions.

Having significantly expanded our portfolio of producing assets last year with our entry into the Central Region, we look forward to pursuing additional ABS transactions this year given a favourable commodity price backdrop and increasing investor demand for securitisations of well operated oil and natural gas assets."

Think you can take it pretty much as read that there will be no more equity dilution. Every addition will then have securitised debt added shortly afterwards to free up more available cash/credit.

[sunbed44] 01/4/2022 09:47

Yeah but lets hope they fund anything with cash and debt and not equity

[aleman] 01/4/2022 09:37

You're welcome. I don't know if it was in the investor call but Shares Mag indicates Hutson will be disappointed if there are not as many acquisitions this year as last, i.e. 4.

[sunbed44] 01/4/2022 09:10

Aleman thank you very much they make sense now and your posts are valued. Have a nice weekend

[gary1966] 01/4/2022 08:51

Good volume this morning supporting the rise. Looks like 120.7p is the key hurdle to get through.

[asp5] 01/4/2022 08:15

In the investor call yesterday Rusty Hutson did mention DEC would look to take advantage of the price movements at the longer end of the curve as shown in the graphs.

He also mentioned that he wanted to increase liquidity from the published $412M to a $600 - $700M range.

This to me suggests more ABS deals with long dated hedges based on further acquisitions which he mentioned they are actively pursuing.

[aleman] 01/4/2022 07:51

It's just the futures contract prices for Henry Hub gas so should be similar to the prices DEC are contracting forward at. I posted some months ago and somebody said they appreciated it so I have continued to post them any time there is a significant move, which seems to be all the time just lately.

[sunbed44] 31/3/2022 20:04

Can you please give us some context here and bring the charts to life for us all in your valued opinion of course. Im struggling to get your message when you just keep copying charts on to the board. Tx

[aleman] 31/3/2022 17:17

I said I'd stop posting these when they calm down but the rises feel relentless just lately. I guess there'll be more dividend increases in the pipeline?

April 22, 24, 26, 28


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[nimbo1] 31/3/2022 15:28

Just listened to the presentation today... quite a lot to aim for I think price wise on the basis these companies moves from being seen as filthy to important for American energy security needs etc...

[my retirement fund] 31/3/2022 09:59

Thanks, I guess they simply rounded it up in the company announcement, they should have explained the conversion rate instead

[shanklin] 31/3/2022 09:49

Re the dividend, just received this helpful reply from HL.

"I have spoken with colleagues in our Dividends team who have informed me that the announcement of the Diversified Energy Company dividend was rounded to 2 decimal places, showing a rate of 3.25p.

However, when you apply the exchange rate provided in the announcement of $1 = £0.76356, this provides a more accurate price per share for the dividend payment.

Essentially, the 4.25 cent dividend payment when converted into GBP is 3.245143p per share, giving you at total dividend payment of" ...

[asp5] 30/3/2022 13:40

The main concerns holding back the share price have at least been addressed:

Dilution risks - ABS based approach for acquisitions
ESG risks - net zero strategy, independent audits and best in class stewardship
ARO risks - plugging cost optimization & subsidies from selling excess capacity

If progress continues to be demonstrated as updates are published / acquisitions made, then these should re rate to a significantly higher level.

Think its a case of some patience and in the meantime sit back and enjoy the divi