Message from the CEO

Message from the CEO

Todd A. Stevens

Taken from CRC’s 2016 Annual Report

We believe California Resources Corporation (CRC) is at an inflection point, very well positioned to move from defense to offense as crude markets normalize. 2016 marked year two of a supply-driven commodity price decline during which CRC continued focusing on delivering value. Throughout this challenging period, we made significant progress on our vision of providing Californians with needed ample, affordable and reliable energy produced exclusively in California — while we diligently focused on shareholder value and setting the stage for meaningful growth. In short, we did what we said we would do on items in our control, and as a result we believe we enter 2017 stronger and well positioned to create value and grow.

Our actions were rooted in the strategic logic of our spin-off in late 2014: creating a company with a singular focus on California’s world-class oil and natural gas resources. We launched CRC with a value-creation purpose and a commitment to live within our means. To implement these principles across our leading acreage position in California, we have created an exceptionally flexible business model. We have replaced the culture of our multinational former parent to become an increasingly agile, nimble independent. Our energized team is focused on creating value and our entrepreneurial spirit is already generating fresh ideas as well as new and expanded opportunities.

During the first two months of 2016, crude oil prices sank to their lowest point of the downturn. In view of the challenging pricing environment and the debt we inherited from the spin-off, our primary goal for the year was to preserve value and strengthen our balance sheet by taking advantage of the liability management opportunities afforded us. We made significant progress, reducing our debt by nearly $1.5 billion since the post-spin peak. We also executed on three key operational priorities: protecting our base, defending our margins and building actionable inventory, all with an unwavering dedication to safe operations and protecting California’s unique environment. I am proud of the commitment and execution of each of our team members as they enhanced CRC’s resource base and ability to create shareholder value.

The 2016 deleveraging efforts began with open-market purchases of our subordinated bonds in February. We took advantage of several dislocations during the year between the debt and equity markets, including favorable equity-for-debt swaps and a series of transactions that allowed CRC to buy back unsecured bonds at a discount. We worked closely with our bank group to gain the necessary flexibility to execute these transactions. Our bank group has shown a deep understanding of our assets and operational decision-making. Despite lower prices and activity, we believe CRC stands apart from its peers in its generation of free cash flow during the downturn, some of which we utilized to reduce debt. This is an especially important accomplishment given the depth of this commodity cycle trough which had not been seen in 30 years. We believe our cumulative reduction of debt by $1.5 billion, including from operating cash flow, and our disciplined approach to potential joint ventures will benefit shareholders for years to come.

We are ultimately targeting a leverage ratio between 2x - 3x on a mid-cycle basis. We believe investing in our rich inventory of projects to delever organically, while maximizing the value of our capital investments, provides the fastest route towards this target ratio. However, we will evaluate all opportunities to accelerate this deleveraging and act on them as long as they are accretive to shareholder value.

While strengthening our balance sheet, we also set a stronger foundation for growth by applying our value creation index, or VCI metric, to guide project selection and development decisions. This metric measures the value of discounted cash flows generated over the life of a project against the discounted investment required. In conjunction with our principle of living within cash flow, this formula serves as the touchstone for our capital allocation decisions. Allocation of resources, whether financial or human capital, is one of the most important responsibilities of our management team. Applying a 1.3 VCI hurdle for new projects positions us for at least a 30 percent return over the life of a project, even after accounting for a 10 percent cost of capital — and sets a threshold against which projects eligible for capital are vetted.

We apply this rigorous discipline to our extensive resource base, which is complemented by our integrated infrastructure that is rarely found among independents. This integrated business model amplifies the power of our VCI metric. California is fortunate to have five of the 12 billion-plus barrel fields that have been discovered in the lower 48 states. As the largest private mineral holder in the state with over 2.3 million net mineral acres, CRC operates in four of these billion-plus barrel fields. Unlike other basins in the United States, California has not been fully explored or developed, and has great untapped potential. While major oil companies invested actively in California into the 1980s, new development halted as ownership transferred to fewer players and the majors turned their attention to international opportunities. With an estimate of over 40 billion barrels of original oil in place1 in the Golden State, we believe that we can more than double CRC’s resources from our existing portfolio by applying modern technology and the proper focus. Our geological and engineering teams have had encouraging success uncovering significant opportunities for development and we believe our talented workforce and value-focused approach will continue to drive shareholder value.

Notably, CRC has a distinctly low-decline reserves base characterized by multiple drive mechanisms. We estimated that CRC’s base production decline rate would be between 10-15 percent per year, depending on downtime. From the fourth quarter of 2015, we witnessed a decline of just 10 percent, excluding the impact of Production Sharing Contracts (PSC) in our Wilmington field, or under 13 percent with the PSC impact. This modest decline contrasts quite favorably with decline rates of 25-35 percent that are more typical of peer producers in other markets. It is even more remarkable in light of the limited capital of $75 million we invested in 2016, the majority of which was directed to mechanical integrity and ensuring safe operations. We directed only $31 million toward drilling and development projects. By way of comparison, we invested $401 million in 2015. Our teams did an excellent job of safely reducing our downtime through proactive maintenance and detailed well surveillance to protect our base production.

Today, CRC has over 8,800 producing wells and an additional 3,000 injectors and monitoring wells which we manage to maximize our production. We have a state-of-the-art consolidated control facility at our Elk Hills field which monitors each well stroke of the 5,800 wells in the area. This advanced surveillance system has minimized downtime, aided preventative maintenance, enhanced safety and environmental performance and reduced costs. Our teams have decreased operating costs significantly at Elk Hills and our adjacent fields to about $10 per barrel, which yields favorable field-level margins well below the current Brent oil price. Our company applied a fresh, margin-driven perspective post-spin to benefit from California’s Brent-correlated pricing on our crude sales and to sustain our cash margins during the downturn.

Another highlight of 2016 was the increase in our actionable inventory. Our teams challenged geological assumptions, improved mapping, reduced costs and collaboratively altered designs, which resulted in a doubling of our drillable inventory that meets our 1.3 VCI benchmark at $55 Brent. We have also materially increased identified resources above that price level. This exercise has built real value for CRC, attracting joint venture partner interest and registering significant increases in the 3P1 (Proved, Probable and Possible) value of our reserves. Currently, we estimate the mid-cycle value of our 3P Reserves at $12 billion, almost double our current enterprise value.

With stabilizing prices, CRC’s disciplined capital allocation and our flexible business model, we believe that CRC is at a critical inflection point as we enter 2017. Looking forward, we plan to increase our capital investments in the business for the first time since the spin. This follows two years of taking the largest percentage budget cuts in the sector. Importantly for CRC shareholders, our high degree of operational control and our resilient, low-decline assets allowed us to curtail drilling and development capital, and even suspend it entirely for the first half of 2016, without a material decrease in our underlying reserves base. Our bank group also recognized the low capital intensity and low decline rate of our assets as one of the attributes that sets CRC apart from many of our peers.

With our current investment plan, and additional available capital from our recent $250 million Joint Venture with Benefit Street Partners, we expect our crude production to begin increasing in the second half of 2017. As we have since the spin-off, we expect once again to meet our tenet of living within cash flow in 2017. We will monitor crude oil prices and utilize our VCI metric to direct capital to our best opportunities, whether back in the ground or applied to further debt reduction.

To prepare for this anticipated growth, we have built alliances with key stakeholders, including organized labor and agriculture, who recognize the importance of affordable, reliable and local energy production to sustain California’s economy, society and environment for the coming decades. We are proud to work with the California Building and Construction Trades to champion good-paying construction and industrial jobs in California’s oil and natural gas fields that provide a path to the middle class for working families across the state. To support California’s farmers and ranchers, CRC supplied nearly four billion gallons of treated water to agricultural water districts in 2016, and we continue to explore projects to help meet the Central Valley’s needs. In addition, CRC’s operations again delivered exceptional safety and environmental performance, receiving recognition from the National Safety Council and the Wildlife Habitat Council. This is validation of our commitment to serve as the operator of choice in California.

The steepest and longest price downturn in a generation set the backdrop for our strategy and actions in 2016. Importantly, we made the hard decisions and took disciplined measures to preserve and create value that will only strengthen CRC as we advance through 2017. We determined the best value decision was to preserve capital for a more opportune pricing environment. We recognized CRC’s operational leverage to crude oil and safeguarded our exposure, while positioning CRC for future growth. Our entrepreneurial team, world-class assets and flexible business model were all critical factors as we continued to strengthen CRC’s balance sheet in 2016 — without selling any significant assets at the bottom of the cycle or significantly diluting shareholders.

Your management team, the Board and our employees are fellow shareholders, and we took numerous steps in 2016 to increase shareholder value. We believe we have a unique investment proposition at CRC. We are primed to create value and drive smart, sustainable growth that will benefit our shareholders, our partners and all Californians.


Todd A. Stevens
President and Chief Executive Officer

1 See Investor Relations for important information about 3P reserves and other hydrocarbon resource quantities as well as additional cautionary statements.