Peyto Exploration: Far-Fetched Explanations

Looking at Peyto, for instance, it was suggested that because our capital expenditures in 2017, plus our dividend, exceed our projected funds from operations, that this was, or is, a bad thing. That type of thinking struck me as illogical (much the same way that half-cycle economics do) and not because leveraged returns can be very powerful but more because if you carry that thinking through the logical conclusion, I don’t think that’s actually where investors want to end up.

Darren Gee, CEO of Peyto Exploration, June 2017 President’s Monthly Report

As you can see, for Peyto’s (PEY) CEO, the high dividend doesn’t matter. There are two points of interest presented in June’s Report:

Firstly, capital investments are ultimately funded from cash flows […]

Darren Gee, CEO of Peyto Exploration, June 2017 President’s Monthly Report

In other words, if you borrow money, overspend your cash flow, and pay the bank the next year, your capital expenditures are funded from cash flow. But it’s not what’s happening at Peyto’s, because debt isn’t repaid.

[…] and secondly, that material profits are generated.

Darren Gee, CEO of Peyto Exploration, June 2017 President’s Monthly Report

However, if generating material profits isn’t possible, and you can’t have high earnings, you need to make your stock trade on the basis of cash flow instead.

When E&P companies are fully taxable they generally don’t trade on before tax cash flow multiples, they trade on after tax earnings multiples. But if you don’t generate very much in the way of earnings, as illustrated in the example above, you won’t be trading on much. So like I said, I don’t think this is where investors actually want to end up. I suspect they would much rather companies continue to trade on before tax cash flow multiples, which requires tax shelter or pools that can only be generated from capital expenditures well in excess of cash flow. Thus the flaw in the concept of free cash flow only.

Darren Gee, CEO of Peyto Exploration, June 2017 President’s Monthly Report

Lastly, the CEO lists a couple more reasons in July. Those aren’t more convincing.

Perhaps one of the single greatest reasons we pay a dividend is out of respect for the rightful owner of the money. As a management team, we invest our shareholder’s capital. True, the vast majority of the Peyto team are also shareholders, but it doesn’t change the fact that this is not Peyto’s money – it’s your money.

Darren Gee, CEO of Peyto Exploration, July 2017 President’s Monthly Report

A steady dividend or distribution also broadened our investor base, as those investors that required a dividend could now invest in Peyto. The broader the investor base, the more liquidity we provide for all shareholders. A variable or sporadic dividend doesn’t accomplish this.

Darren Gee, CEO of Peyto Exploration, July 2017 President’s Monthly Report

A steady dividend or distribution also broadened our investor base, as those investors that required a dividend could now invest in Peyto. The broader the investor base, the more liquidity we provide for all shareholders. A variable or sporadic dividend doesn’t accomplish this.

Darren Gee, CEO of Peyto Exploration, July 2017 President’s Monthly Report

Not for republication on Seeking Alpha.

Point Loma Resources: Insider Ownership

Here are the current holders of Point Loma Resources (PLX).

Evenergy Company Ltd.InvestorJianjun Cui, Director of Dayou Energy Ltd., the parent company of Evenergy Company Ltd., is on the Board of Directors8,375,000
Terry MeekDirector, CEO1,922,691
Doug DafoeDirectorCEO of Ember Resources Inc.115,690
Steve DabnerDirector, ChairmanVP Exploration of Madalena Energy Inc.60,000
Jay ReidDirector0
Donald BrownDirector1,171,244
Kevin BakerDirectorDirector at Calfrac Well Services Ltd.6,052,011
Al KroontjeInvestorOwner of Kasten Resources Inc.4,410,291
Richard YurkoInvestor3,981,535

Insiders own 22% of outstanding shares.

Disclosure: I am long PLX. Not for republication on Seeking Alpha.

Painted Pony: Making Sense Of The Guidance

Fellow contributor Dutchtender made me realize there is something wrong from Painted Pony Petroleum’s (PONY) guidance of January 2017 and May 2017.

Painted Pony - January 2017 & May 2017 Guidance

Guidance2017 Production (boe/d), Liquids Pourcentage2018 Production (boe/d), Liquids Pourcentage2017 Leverage (YE Net Debt/CFO)2018 Leverage (YE Net Debt/CFO)
May 201748,400 (8%)84,800 (7%)1.51.2
January 201748,000 (10%)72,000 (11%)1.31.2
August 201646,00070,0001.91.4

Source: Corporate presentations

Something is going on. Leverage is increasing considerably despite AECO prices being somewhat stable and despite adding over 60 million new shares. More surprisingly, leverage fell from the August 2016 guidance to the January 2017 guidance, despite lower AECO prices. Let’s find out what is causing this.

Painted Pony - 2017 & 2017 Capital Expenditures

Guidance2017 Capex (C$M)2018 Capex (C$M)Total (C$M)Production Growth (boe/d)Efficiency (C$/boe/d)
May 201734830164961,60010,536
January 201731938570449,00014,367

Source: Corporate presentations

The company is more efficient. The additional leverage was not because of higher capital expenditures.

Painted Pony - Cash Flow From Operations

Guidance2017 CFO/Mcf (C$/Mcf)2018 CFO/Mcf (C$/Mcf)
May 20171.411.55
January 20171.621.85

Source: Corporate presentations

Part of the problem is that less cash will go into Painted Pony’s coffers. The changes are staggering: cash flow per unit decreases 13% in 2017 and 16% in 2018.

Lastly, I think the biggest reason is the new way leverage is calculated in these presentations. In the recent presentations (January and May 2017), leverage is taken as year-end net debt to Q4 CFO annualized. Because Painted Pony’s production growth is achieved primarly at year-end, the cash flow is substantially higher in Q4 than the average in the rest of the year.

As such, the substantial increase in leverage is due to the way leverage is calculated, to 20% higher costs, and, to a lesser extent, slightly lower realized prices and slightly lower liquids production.

Disclosure: I am long PONY. Not for republication on Seeking Alpha.

Price Differential Of Canadian Bitumen

Knowing the price differential, or how it is calculated, will give you an hedge compared to other investors.

Indeed, Canadian oil is cheaper when sold in the US. It is fairly obvious for anyone invested in Canadian oil and gas companies, especially in the oil sands industry.

WCS Comparison Prices US Feedstock January 11

Source: Oil Sands Magazine

As we can see, the Mexican Mayan sells for $10 extra versus the Western Canada Select, despite both being comparable heavy oil grades. This price differential is also known as the heavy oil discount.

Light sweet crude oil requires less energy to refine and should theoretically sell for a better price. This might have been true in the old days but the logistics of moving the right type of crude to the right customer creates price differentials that go far beyond just quality.

Source: Oil Sands Magazine

The realized sales price is a function of the cost of actually moving the Canadian heavy oil to the refineries.

WCS Shipping Costs January 11

Source: Oil Sands Magazine

We can estimate a minimum heavy oil discount of $10 per barrel. The transportation costs will double depending on the route taken by the oil, say if your oil is moved by train.

Not for republication on Seeking Alpha.

Choosing An Unlevered Canadian Energy E&P

I raised cash after selling part of my Amaya position (I bought back some, as I said on StockTwits). To let you know: I already spent that cash on Gear Energy last week. My quick calculations were right: Gear Energy is cheap.

I will be looking for a solid balance sheet just in case the rout in oil prices continues. As you know, I already own MEG Energy, a leveraged E&P company. One is enough.

I made a basic stock screening of Canadian oil E&P companies (75% or more liquids production) with low debt (total debt on equity needs to be under 30%).

Unleveraged Oil E&P - TSX Screening

TSX TickersNet debt (C$M)EV (C$M)FFO (C$M)Net debt/FFOEV/FFO

Source: Corporate presentations and my own work.

I already own Raging River Exploration. I will include the company in today’s comparison nonetheless. I have been handsomely rewarded by holding on Raging River Exploration, let’s try and repeat that.

As you know, I need an unlevered company. Gear Energy is an unlevered company in disguise for three major reasons:

First, 38% of Gear Energy’s debt is convertible to equity. The extra dilution from these convertible debentures is included in the EV/CF ratio.

Second, Gear Energy’s cost profile will improve. Indeed, the company purchased Striker Energy, a light oil producer in Western Alberta. This will increase corporate netbacks by over 25%.

Finally, Gear Energy plans to increase production by 10% next year while holding debt steady.

The additional cash flow and decreasing leverage warrant a higher EV/CF ratio. Furthermore, Gear Energy’s transformation is complete after multiple dilutive equity placements.

The company took care of its balance sheet and bought a light oil producer to diversify its production away from heavy oil. It also has an incredible board member in Neil Roszell (CEO of Raging River Exploration), which I know well.

I will update the table above with estimated numbers for next year. I believe the picture will be even clearer.

In conclusion: I’ll buy the dips.

Disclosure: I am long GXE. Not for republication on Seeking Alpha.

MEG Energy: North American Crude Benchmark Analysis

How does crude oil sold by MEG Energy (Access Western Blend, AWB) compares to other crude oil benchmarks, mainly WTI and Western Canada Select (WCS)?

The AWB/WTI differential depends mainly on the season. In other words, Canadian crude demand goes up and the differential narrows when oil demand grows in the summer; hence the tighter differentials in Q2 and Q3.

See in the graph below (4-year average):

MEG Differential Per Quarter August 18

Source: MEG Energy, my own work

As you can see, MEG only gets 41% of WTI in Q1, 57% in Q2, 58% in Q3 and 48% in Q4.

Other factors influence the price MEG gets for its heavy crude. The crude oil collapse that lead to a fenzy in early 2016 was very bad for MEG’s business. The wider differential could be explained by the growing oil stockpiles in the US and very high oil imports, lowering demand for Canadian heavy crude. The price differential was under clear pressure from Q2 2015 to Q1 2016.

MEG Differential August 18

Source: MEG Energy, my own work

As we can see from the table above, MEG could only fetch 25% of WTI in Q1 2016. This could explain why the company’s oil sold for C$11 per barrel… Yes, $8.31 per barrel.

The realized price recovered to normal levels in Q2 2016, with AWB fetching 53% of WTI (4% under Q2’s 4-year average). The higher differential reflects the slow return back to normal for the oil market in Q2 2016.

Disclosure: I am long MEG. Not for republication on Seeking Alpha.

Pine Cliff Energy’s Insiders To The Rescue!

We heard good and bad news today from Pine Cliff Energy. First, we know management truly have shareholders in their mind. They will lend C$11M to the company to help it ride the current bank redetermination process. Fortunately for us:

The Debentures mature on July 29, 2018, can be repaid at any time without penalty and will bear interest at 0.25% less than the monthly average effective interest rate paid to the Syndicate.

Source: News release

Secondly, Pine Cliff sold a non-core oil asset for C$5.5M, or C$55,000 per flowing barrel. It’s close to a fire sale at first sight. However, considering the pressure the company is under to renew its credit facility and the current energy environment, it’s acceptable.

Total divestiture amounts to C$30M plus C$11M in insider debentures. Debt will amount to C$156M at the end of Q2 using a conservative -C$12M funds flow from operations.

Therefore, the current credit facility stands at C$115M when ignoring June and July funds flow from operations. Total debt stands at C$125M. This is a considerable credit squeeze considering the existing C$185M credit facility.

The bank redetermination process has been extended to August 10.

Disclosure: I am long PNE. Not for republication on Seeking Alpha.

MEG Energy: Q2 Earnings Update

While the market disagrees (the stock was down 5% yesterday), I think it was an interesting quarter. Let’s recap some of the highlights of the quarter to give you a general idea.

First, non-energy costs were down to C$5.81 per barrel. This is good news for the future as these costs are mostly fixed. Lower costs combined with a better WTI to WCS differential brought extra cash, as we can see from the cash flows of the company.

Maintenance capital has been lowered to C$140M this year, thanks to the efficiency of MEG’s eMSAGP technology. Total capital expenditures will amount to C$170M total in 2016, adding C$30M in growth capital. Despite of the rise in capex, the credit facility will be left untouched this year.

Finally, the company plans to add 30,000 bbls/day in short, high impact growth projects. Those are expected to yield results in 6 to 12 months time.

All in all, I think it was far from a bad quarter. At least MEG was able to break-even in Q1. The company generated C$7M of funds flow from operations in Q2, compared to -C$130M in Q1. Furthermore, the company has a current break-even of $45 WTI oil price, given the ongoing cost reductions, the advantageous exchange rate and a decreasing WTI to WCS differential. This is great news. The first pillar of share appreciation, cash flow, is under control.

Now it leaves us with the second pillar: the Access pipeline sale and the balance sheet deleveraging. The sale is still pending. It is highly probable that management isn’t getting the price it wants. There is a simple solution: the growth in oil production will translate to higher transportation volume, act as a sweetener to the pipeline deal and therefore increase the sale price.

In conclusion, we got the confirmation this quarter that the two pillars of share appreciation became one. Indeed, the pending pipeline sale is currently the only major setback. Management repeatedly told investors the pipeline sale would be done by the second half of 2016. This setback is not enough for me to sell my shares. I am holding on and will buy more if the stock dips lower.

Disclosure: I am long MEG. Not for republication on Seeking Alpha.

MEG Energy: What To Look In Q2 Tomorrow

MEG Energy will release it’s Q2 results tomorrow. What should investors be looking for? I’ll be looking for mainly two things:

  • The progress on the Access pipeline sale.
  • The general cash flow picture.

First, as we know, Devon Energy sold its 50% stake in the Access pipeline for $1.1B in mid-July. Did MEG finally sold its stake, and for how much?

Given that MEG has a poorer balance sheet than Devon, the sale won’t bring $1.1B for the same deal: it’s riskier to deal with MEG than with Devon.

However, MEG could promise volume growth in the future to compensate its riskier profile and add value for the buyer. This will bring more money on the table. On the other hand, the company will commit itself to greater future expenses to grow production and respect its new transportation agreement.

Could this be the reason why management included talks about brownfield expansions in their corporate presentation in the last couple of months?

In short, the pipeline sale is all about trading short-term relief for long-term expenses. Indeed, while it’s not the best solution, MEG has no choice: the current circumstances in the oil market simply doesn’t fit the company’s balance sheet.

Second, cash flows will be of a tremendous importance tomorrow. Even though the company burned C$280M in Q1, MEG expects to keep its credit facility untouched this year, with C$125M in cash still on the books.

Operations will burn about $50M in Q2 versus C$230M in Q1 because of the oil rally.

To me, these are the two pillars of share appreciation. Unfortunately, these pillars have been pretty weak, weaker than I thought honestly. Maybe I underestimated the time it will take for oil to recover.

Lastly, I will look at hedging. Management talked about hedging their production in the latest conference call. Maybe they were aggressive given the oil’s rally during that time.

All in all, let’s be patient for now…

Disclosure: I am long MEG.

Pine Cliff Energy Saved By Natural Gas’ Impressive Recovery

Natural gas recovered to more than $2.70 per MMBTU from the lows of early March, and it was even better in Alberta: price had a two-bagger in a matter of months. AECO spot price is currently trading at C$2.00 per MMBTU.

AECO Natural Gas Spot Price July 19


Take a look at my other quick analysis back in early April: natural gas price barely broke the C$2.50 per MMBTU mark in the winter. The picture is quite different today.

AECO Natural Gas Monthly Index July 19


This rally couldn’t happen at a better time for Pine Cliff: the company was in trouble. Indeed, the company is currently in the process of redetermining its credit facility by a syndicate of banks. Needless to say that capital was scarce. The company would have been obligated to raise capital at unfavorable terms for us current shareholders. Even though the natural gas rally is helping, Pine Cliff could still need to raise capital depending on how hungry the banks are. The redetermination process will be completed by July 30.

Now, with the collapse of AECO natural gas price behind us, I believe Pine Cliff learned a lesson. It needs to hedge at least part of its natural gas production. The banks could already be pushing for this. As we can see, AECO futures are already in backwardation: it makes sense to hedge.

The credit facility’s redetermination is certainly a big catalyst, good or bad depending on the outcome. The stock will have more upside should the credit facility remains untouched.

Disclosure: I am long PNE. Not for republication on Seeking Alpha.