Thanks to Danpech and Value_Hunter for their useful comments yesterday, concerning how to think about Elk's debt-levels and prospects, as well as prospects for re-financing.
About Elk's hedging, my understanding is that Elk did use options to hedge the downside-risk for Grieve production. Happily, this approach offers protection - at a fixed/extra cost - while also permitting Elk to participate in the upside of $60-plus dollars-per-barrel oil prices . . . even for the volume of production protected through options.
Less happily, Elk chose to protect their downside on Aneth through swaps rather than options. If oil-prices had stayed below $50 . . . where they were when the Aneth acquisition was negotiated . . . this swaps-strategy would have saved money while keeping the lenders happy that their down-side risk was protected.
Said another way, Elk essentially paid for insurance to protect downside risk for Grieve production, while still benefiting from upside profits resulting from a rising oil price.
Elk saved the money for insurance-premiums to protect downside risk for Aneth production at the - much higher, in hindsight - cost of forgoing upside profits for the 4-plus thousand barrels of Aneth oil hedged using fixed-price swaps.
Call that penny-wise and dollar-foolish - in hindsight, which is always 20/20 - sigh . . .
Because at today's $65-plus price per barrel for WTI oil, capping the upside on 4 thousand barrels of production per day at $50 dollars will cost Elk roughly US$22 million per year.
The good news is the remarkable value accretion resulting from buying the fabulous Aneth asset at such a great price. Despite leaving money on the table - by using swaps instead of options to hedge - Elk shareholders are much better off owning Aneth than not.
I score the Aneth deal as an 8. The full 10-points-upon-10 for the original transaction, minus 2 for the unfortunate economizing on hedging-insurance-costs. Still a great deal which deserves both thumbs-up!
All of the above is based only on my (limited) knowledge of the Grieve and Aneth financial engineering. Any fellow investors with more/better insights, please jump in and correct any wrong perceptions or misunderstandings.
Sign me still long-term bullish on Elk!
ELK Price at posting:
9.0¢ Sentiment: Buy Disclosure: Held
