My newsletter presents in depth research on oil and gas companies in which I invest. I eat my own cooking (but not so much it would bias me). This is an example of the type of report I intend to produce for paying subscribers. Petrobank (OTCPK:PBEGF) will likely be the largest company I ever cover; most energy companies will be between 2000-20,000 bopd. Please read below to discover why I chose Petrobank first.
Petrobank Energy is an oil producer I believe can deliver increasing growth in production and cash flow even during low oil prices.
It is one of the lowest cost operators, at roughly CAD$28/barrel. Low cost=high netbacks (profit per barrel of oil). These are the stocks with the best leverage to oil now.
These larger, intermediate producers will have the biggest moves FIRST for investors as the oil price and the world economy stabilizes.
PBG will be able to grow production in 2009 even in a low oil price environment.
It has three unrelated main fields, each of which have years of low risk development drill locations. Analysts and institutional investors like this diversification in geography.
Management has proven it is technologically innovative – by tweaking existing oil production methods, they have increased production in the field – their new extraction method for heavy oil and oil sands in particular holds huge promise, and is much more environmentally friendly than existing technology as well. This gives the stock a huge speculative appeal for such a large company.
PBG can be a long term hold or it can be a trader’s paradise as it is liquid and has 5%+ swings almost every day.
Debt. While it is “manageable” (the new buzzword in the industry), PBG has $331 million in Convertible Debentures (CD) and $315 million in regular debt. Only a select few companies get my attention with this amount of debt, but this is one of them. I will get into this debt issue more in the Capital Structure/Financial section.
The CD holders can convert their debt into stock at US$28/share – which is only about 11% dilution. But if the stock is below that when it comes due in 2012, PBG will have to finance at whatever price their shares are trading at - and if the market smells a financing, they will trade the stock lower.
- Canada – Light oil, Saskatchewan
- Colombia - Light oil production
- Canada – Heavy oil production
BAKKEN PLAY, SASKATCHEWAN
PBG has grown production in this very profitable field from almost zero to over 22,000 bopd in just two years. PBG was one of the first companies to become large players in the Bakken, the most high profile new oil field in North America. It straddles the Dakotas in the US and Saskatchewan in Canada. It was the first large oil field that was opened up by horizontal drilling (HD). And it has one of the lowest costs of any field in North America.
PBG has more than 550 low risk, HD well locations in the Bakken still to drill. That’s after 161 wells drilled in 2008 with a 99.4% success rate. Large undeveloped land positions in ideal HD fields is a key to continued fast growth for any company in this market.
Other companies had horizontally drilled Bakken but those wells had a lot of water. PBG had a different idea, using smaller Multi-Stage Fracs (MSF) that were more strategically placed in the Bakken reservoir, and not quite as forceful, so the frac did not go into adjacent zones, which is where the water was coming from. (Fracing is sending a special, custom fluid down into the well bore at high pressures out into the oil bearing rock – fracturing it, and allowing the oil to get to the well.)
This new strategy resulted in better production than they had hoped. PBG stayed quiet after their initial success and then went into the April 2007 land sale and bought a huge chunk of the whole play, giving them the critical mass to hugely quickly ramp up production through 2007 and 2008.
With lower oil prices, PBG now only has 2 rigs in the Bakken, compared to 10 last year, and in 2009 will probably drill only 40 wells if the oil price stays around US$40/barrel. Should oil move up to US$60, PBG says they could drill over 100 wells. They have lots of flexibility in their 2009 program.
Most analysts who cover PBG expect their production in the Bakken to stay constant during 2009; with only 40 wells - the new discoveries will only offset declines from current production and PBG will see no growth from the current 22,000 bopd.
PBG production from Bakken costs only CAD$28.41/barrel to produce. With oil at US$45 and the US$ worth CAD$1.20, oil is worth CAD$54.00, leaving PBG with CAD$27.50 profit per barrel – few companies can give shareholders that kind of profit at these oil prices.
PBG grew reserves by 95% to just under 60 million barrels. This is the asset that bankers lend against, and the asset just grew 95%. So even though PBG has debt of $315 million out of a possible $380 million line of credit, this increase means there is realistically no danger of the banker calling any part of the loan or reducing it or making covenants more restrictive.
They are continually improving upon their fracing methods to further increase production. Their innovation and competence in the science/art of fracing is what can make these oilfields so prolific for them and shareholders. They are using that HD ability in other fields, which we will mention briefly below.
COLOMBIA – LIGHT OIL
Colombia will be the growth engine for the company in 2009. PBG’s Colombia operations are actually in a separate publicly traded company, Petrominerales, (PMG-TSX: $10.51, 100 M shares out). PBG owns 76.5% of PMG and has the same management. They have hit some very big wells, and have costs, at roughly CAD$25/barrel, $3.50 lower than even their Bakken play in Canada.
PMG operates in three fields in Colombia right now – the Llanos Basin in the eastern central area, where their prolific Corcel field is located, and in the Orita and Nieva fields in the southern part the country. February 2009 production was 25,897 bopd, an increase of some 40% over the 15000 bopd they were doing just in December 2008.
The team has discovered wells producing 9700 bopd for Corcel-D3, 8770 bopd for Corcel D1 in the Llanos Basin. For comparison, a well of 100 bopd in Canada is considered a success.
CEO John Wright and CFO Corey Ruttan had worked for an oil company in nearby Ecuador, Pacalta, and were bought out by natural gas giant Encana. Wright and Ruttan went back to Encana and bought Pacalta’s Colombian assets. They steadily grew production through to 2004, when the Colombian government made new land available and Wright & Ruttan were able to get 2 million acres. The acreage in Colombia were in known but undeveloped basins. And they have had great success.
When you hit wells that big, you end up with very low costs per barrel – all in costs of roughly CAD$25/barrel. This will keep cash flow strong even if oil retreats to sub-$40. I expect costs to lower even more in 2009. The Corcel wells are 90% of their production and all that oil is trucked to pipelines right now. As they get infrastructure built to move that oil directly from the wellhead, costs could easily drop another $6/barrel.
The PBG team says that Colombia is the best jurisdiction for oil in the world, when you consider both its economic and geological potential. Royalties of 6-25% and taxes of 33% are roughly the same as you see in most western countries. Oil investment in the country is up dramatically in the last 5 years, and the state oil company Ecopetrol no longer has the ability to back in to any plays.
I spoke with Petrobank CFO Corey Ruttan about security and he says the country has improved dramatically. All their sites do have security, but he feels completely safe walking around the capital city Bogota.
Petrominerales has net cash of $50 million, but does have an $81 million convertible debenture due in December 2010 with an exercise or strike price of CAD$27.35. With their growth rate and high netbacks, management should have no problem, even if oil prices are low then, at raising equity to pay for it or rolling it over. They also have an $80 million revolving line of credit (the industry calls this a “revolver”) that is undrawn.
Corcel is the field of dreams for PBG/PMG. It’s a new field they discovered, with boomer wells, and a large undeveloped land position. At the Nievo and Ortia fields, PMG is doing work-overs and recompletions, essentially trying to get more production out of existing wells. That will steadily add to production but it’s Corcel that for the near term should be the big driver in increased production.
There is also some heavy oil potential for PBG’s proprietary technology in that field, which I will talk about next.
Ruttan would not say how much money PBG will spend in Colombia this year, but even in a year of tight credit, he expects them to spend more than the $50 million cash that PMG now has. He estimated they would drill at least 6 wells in the Corcel field this year. Any results that come close to previous wells can still have a big impact for PBG/PMG. Because of the potential for big wells, look for their capital expenditure (capex) be anywhere from $65 - $100 million depending on their confidence and oil prices.
PBG/PMG added over 10,000 bopd in Colombia in early 2009 – an increase of 30% for the company - and the stock did not move. I don’t think that has been fully priced into the stock.
CANADA – HEAVY OIL PRODUCTION
This represents huge potential for Petrobank and its shareholders. It is increasingly common knowledge that Canada’s oil sands have huge reserves - as much or more than all of Saudi Arabia. But costs are higher in the oilsands. And the U.S. green lobby is against oil sands projects because of their need large amounts of water, natural gas and the carbon emissions generated in processing them.
The entire Bakken play is estimated to have maybe 4 billion barrels of reserves. Just one of PBG’s heavy oil plays could have reserves of more than 20 billion barrels.
And they have the worldwide rights to a new, proprietary technology that could lower costs and be a lot more environmentally friendly than current practises.
PBG has the THAI process. It operates much like horizontal drilling, with an added twist: At the far end of the HD hole, PBG drills another vertical well to meet it, and sends down oxygen to create a combustion – a fire – in the horizontal well. The fire moves along the HD well, heating up the cold oil sands and making them more viscous; the oil flows easier, lowering costs.
That’s the simple version. Less heat has to be used than conventional oil sands technology, such as SAGD (Steam Assisted Gravity Drainage) where two wells are sunk into the sands and heated. PBG also says their THAI process can retrieve 75-80% of the in-situ product, whether it is oilsands or just heavy oil, compared to 25-30% for everyone else.
They also project 50% less greenhouse gases, being able to use the natural gas produced in their system to power it all, use less water – it almost sounds too good to be true.
This is probably why analysts aren’t giving them much credit for it yet. PBG is moving ahead quickly on 3 properties – the Whitesands Project and May River in Alberta, and the Kerrobert project in Saskatchewan, a joint venture with True Energy Trust (TUI.UN-TSX: $0.80).
Ruttan told me the cost for a THAI well is $5 million, and from two wells they would hope to get 600 bopd of 13 degree API oil. (The API scale from 1-70 denotes how dense a petroleum liquid is – the higher number the better – the best Canadian light oil is about 41 API) Most oilsands product is 8-12 API. There is a discount (sometimes a big one) in world pricing for heavy oil; you don’t get WTI or Brent crude benchmark
So costs for the THAI process is much more similar to regular oil wells than conventional oilsands technologies, and THAI has the potential to increase the reserves from a reservoir 300-400%. The process is patented.
I think all the major oilsands players could consider buying PBG for the THAI process alone, should it prove out. At a minimum, analysts could give PBG a large upward re-valuation on a massive increase in reserves at its projects should THAI work.
The heavy oil part of the business, including THAI, is given very little value by analysts and investors basically get this for free.
PBG has purchased some large land tracts in the Horn River and Montney natural gas plays of North East British Columbia, and some oil plays in Peru, but none of those properties will see any significant spending this year and aren’t relevant to investors’ valuation of the stock at this time.
- Shares Outstanding: 83.2 million
- Fully Diluted: 99 million
- Market Cap: $2.08 billion
- Total Debt $0.646 million
- Enterprise Value $2.726 billion (Market Cap + Debt)
- Est. 2009 CF $502 M (US$45/b, 1:1.2 US-CAD$)
- Est. 2009 Debt:CF 0.62
- Est Debt:CF with CD 1.29
- Est. Cash Flow Per Share $6.03
For my calculations I used $45 oil, a US$ worth $1.20 CAD, 50,000 bopd average production and a netback of $27.50.
There are two major convertible debentures:
US$250 million paying 3% and is convertible into 8.7 million common shares of Petrobank at US$28.49/share, due May 2012.
A US$81.7 million debenture is convertible into common shares of Petrominerales at US$27.35 per share, and that is due in December 2010. PMG actually repurchased $18.3-million of this CD at a 39-per-cent discount in 2008.
Banks lend against cash flow and/or reserves. PBG’s estimated $500 million cash flow (most analysts are actually in the $600 million range) is more than enough to cover interest and buy back enough principal to keep the bond holders happy. And their reserve growth was so impressive – more than doubling in 2008 – so bond holders will just be looking for conversion or an equity raise from PBG to pay them out.
The regular debt, or revolving debt for regular operations, was $315 million at year end 2008, and their debt ceiling is $380 million. So like most Canadian companies, they are close to their limit. (The attitude among almost all Calgary management teams is a bit striking for me – anybody not within 20% of their ceiling, i.e. leveraged 80% to capacity – feels like they have nothing to worry about.)
But again, even with lower commodity prices PBG has enough profit per barrel to pay interest and some principal. Most intermediate producers are now well over 2:1 debt to cash flow at US$45 oil, and the juniors are even worse at 3:1. PBG is 0.63:1 not counting the debentures, and 1.29:1 if you do include it.
Their PMG subsidiary has $50 million cash and its $80 million facility is undrawn. The PBG team is very well respected in the industry and I believe could always raise money to reduce debt, even in times of low oil prices.
PBG could sell some or all of their stake in PMG as well, netting them up to $1 billion at current prices – but don’t expect that. In other words, unlike many debt laden peers, they have lots of options.
The enterprise value of a company is market capitalization plus debt – and because all these energy companies have so much debt you need to include that in your valuation. PBG has an enterprise value of $2.7 billion, and estimated 2009 cash flow of $500 million – so at US$45 oil it trades at 5.4x cash flow to its enterprise value. (PBG’s enterprise value over debt adjusted cash flow is also 5.4x)
Canadian brokerage firm Canaccord Capital, has an average 5.7x multiple cash flow to enterprise value (using my US$45 oil and 1.2 US$-CAD$). Using a premium 6.1x multiple for PBG implies a target price of ($500 M cash flow x 6.1 multiple /83.2 M shares out =) $36.65 per share, and looking at its peer group, that’s the price target I will hold for my stock personally. I believe that’s a justifiable premium valuation for a company with this growth profile and low costs.
Another simple way to value a company is how much it is worth per flowing barrel. Talisman just sold their Bakken interests to two companies, TriStar Oil & Gas and Crescent Point Energy, for $70,000 per flowing barrel. For PBG, their 22,000 barrels would then be worth $1.54 billion, and not count their large undeveloped land position. In Colombia, a company called Hocol just sold some production to Ecopetrol for $44,000 per barrel – making their 25,000 barrels worth $1.139 billion – for a combination of $2.67 billion, or roughly the enterprise value of the company now. And investors get the upside of the heavy oil business for free.
What Do the Analysts Say?
Securities Firm Target Price for PBG
- Haywood $36/share
- Merrill Lynch $36/share
- Fraser Mackenzie $40/share
- First Energy $61/share
- Dundee $30/share
After collapsing from $60 - $17.50 in the second half of 2008, the stock held a tight and steady trading range of $18-$25 from October – March. It has now just gingerly broken out to the upside, with the 30 dma crossing positively over the 90 dma – and this happened after a brief pullback to the moving averages; a bullish sign. However this has NOT taken place on any increase in volume, indicating to me this is likely a false breakout. The 200 dma, which will provide resistance, is at roughly $29.
The very long flatline of the stock since its drop indicates to me that when the stock moves, it will be a big move and a quick move – potentially to $35 to fill the gap you see on the chart.
On Balance Volume (OBV) is (very) slowly improving. This surprises me; PBG’s success, and the market respect it gets, would lead me to believe it would be one of the first intermediate oil stocks under heavy accumulation. OBV does not say this.
Stochastics now shows the K-line coming down from 100 about to meet the D line at 75 also highlights the possibility of a pullback.
BOTTOM LINE – Without an increase in volume on a big up day for PBG, I expect a pullback to its moving averages of roughly $22 and I will consider being a buyer then.
Large, low cost producers like PBG have the most leverage to oil right now. Management is not just competent, but innovative. Their ability to frac HD wells better than most has proven invaluable to their growth. I see little potential for negative surprises. New Colombian wells have the potential to increase production 10-20% each, so that will likely be the catalyst for the shares to move higher. Later in the year, progress at their heavy oil project at Kerrobert in Saskatchewan with True Energy could also see analysts finally give the company and the stock credit for THAI.
However, in the face of an uncertain oil market and technical indicators in PBG’s stock chart and in the USO and XOM charts, I chose to be a patient buyer and will wait for a pullback on the stock into the $22 range (unless oil breaks out).
Disclosure: No positions.