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The first article of the series has introduced the Carbonate Triangle of the renowned Canadian oil sands. The region is the world's third largest oil reserve with its rich carbonate-hosted bitumen deposit located in the northern Alberta's deep underground. Precisely, the Carbonate Triangle is situated between three major bitumen areas, Athabasca, Cold Lake and Peace River.

Source: Sunshine Corporate Presentation, August 2013

In today's investment guide on the Carbonate Triangle and also the last one of the series, I will present the main characteristics of the Athabasca area to have a better assessment of its potential. Then, I will discuss one small oil producer involved in Athabasca. So far, I looked into several producers involved in Peace River and Cold Lake regions of the Carbonate Triangle:

Peace River's most notable producers:

  1. PennWest Exploration (PWE), see article here.
  2. Royal Dutch Shell (RDS.A), see article here.
  3. Baytex (BTE), see article here.
  4. Strata Oil and Gas (SOIGF.PK), see article here.
  5. Petrobank Energy & Resources (PBEGF.PK), see article here.

Cold Lake's most notable producers:

  1. Husky Energy (HUSK.PK), see article here.
  2. Pengrowth Energy Corporation (PGH), see article here.
  3. Southern Pacific Resource (STPJF.PK), see article here.
  4. Canadian Natural Resources (CNQ), see article here.
  5. Devon Energy (DVN), see article here.
  6. Imperial Oil (IMO), see article here.
  7. Baytex, see article here.
  8. Bonavista Energy (BNPUF.PK), see article here.

Athabasca's most notable producers:

  1. Suncor Energy (SU) (Part 1), see article here.
  2. Suncor Energy (Part 2), see article here.
  3. Athabasca Oil (ATHOF.PK), see article here.
  4. Canadian Natural Resources, see article here.
  5. Imperial Oil, see article here.
  6. Cenovus Energy (CVE), see article here.
  7. MEG Energy (MEGEF.PK), see article here.
  8. Devon Energy, see article here.
  9. Royal Dutch Shell, see article here.
  10. Ivanhoe Energy (IVAN), see article here.
  11. Nexen (CNOOC) (CEO), see article here.
  12. BlackPearl Resources (BLKPF.PK), see article here.

An analysis of the current operations of the company will be examined with the objective to provide the most complete information available to potential investors before deciding to seize the opportunity that the 54,132 square miles of the Carbonate Triangle has to offer. Let's start by introducing Athabasca, a famous and most prolific region in the Canadian oil sands as well as one of the largest reserve in the world.

Athabasca Region

The Athabasca oil sands are named after the Athabasca River which cuts through the heart of the deposit, and traces of the heavy oil are readily observed on the river banks. Commercial production of oil from the Athabasca oil sands began in 1967, when Great Canadian Oil Sands Limited, now incorporated into an independent company known as Suncor Energy, opened its first mine, producing 30,000Bls/d of synthetic crude oil.

The Athabasca region can be defined with two major oil sands deposits: the Grosmont Formation and the Wabiskaw-McMurray Formation. The Grosmont Formation is a late-Devonian shallow marine to peritidal platform carbonate consisting of four recognizable units within the deposit. All of the hydrocarbons are located in an updip position, structurally trapped along the erosional edge and contained by the overlying Clearwater Formation.

Source: ERCB

The McMurray Formation was deposited on an exposed karstic landscape of ridges and valleys and varies in thickness from being absent over Devonian highs to over 426 feet thick in the Bitumont Basin. Bitumen-rich reservoirs formed within estuarine valleys stacked above the Lower McMurray channel sands and are assigned to the Upper McMurray Formation.

Source: ERCB

The Athabasca region is estimated to hold total reserves of 1.34 trillion barrels of oil. Approximately 8-10% would be recoverable with current technology, which would represent a total reserve of 134 billion barrels. Compared to the estimated 7 billion barrels contained in Peace River and approximately 16 billion barrels in Cold Lake, the Athabasca region is the most prolific and the most promising of the three, located in the Carbonate Triangle.

Sunshine Oilsands (SUNYF.OB)

Sunshine Oilsands is a Calgary-based company focused on the development of its significant holdings of oil sands leases in the Athabasca. The company owns and controls 100% of its 1,156,376 acres of land leases, equivalent to approximately 7% of the total oil sands leases granted in the Athabasca region.

Source: Sunshine Corporate Presentation, August 2013

Sunshine's growth is being led by a strong corporate governance and capital cost discipline. As a matter of fact, the experienced team has a proven record of creating significant value in managing successful large projects at companies such as Rally Energy, Deer Creek Energy, Total E&P Canada (TOT), Flint Energy Services and Amoco Canada Petroleum.

Michael Hibberd, one of Sunshine's founders and current co-chairman of the board, dispenses professional advice to energy companies with gusto: he chairs Heritage Oil PLC (HTGLY.OB), Canacol Energy (CAAEF.PK), and Greenfields Petroleum (GEEPF.OB), runs his own law firm, and serves as a director of Skope Energy, Montana Exploration (ATDEF.OB) and Pan Orient Energy (POEFF.PK).

Songning Shen, the other co-founder and co-chairman, boasts a resumé spanning geological work for a subsidiary of CNOOC managing exploration for Connacher Oil and Gas (CLLZF.PK), and performing oil sands assessments for Koch Exploration Canada LP.

Sunshine's president and CEO, John Zahary, also owns a work history, including stints in senior positions at Imperial Oil, Texaco Canada, Gulf Canada Resources, Canadian Oil Sands (COSWF.OB) and PanCanadian Petroleum.

A Strategy Based For The Long Term

The ultimate goal for Sunshine is to deliver maximum shareholder value. To do so, the producer said that it will use its oil sands knowledge and business experience to realize the potential of its significant oil sands land positions. Sunshine relies on a team with proven operations experience in numerous hydrocarbon plays including conventional heavy oil, cretaceous sandstones and carbonate reservoirs.

Furthermore, to create growth, the producer plans to develop the full potential of its multiple asset grouping portfolio characterized by high value potential, medium term maturity with long term value and short line of sight to cash flow. The operating activities will be with thermal recovery only, from which it does not require tailing ponds or mining pits and uses long-term brackish water, sourced from the deep geological formation.

Sunshine holds a premier land position that includes eight primary operational areas and has the expertise to extract significant value from its assets. The producer is developing a project portfolio consisting of three core asset types:

  • Cretaceous sandstones properties
  • Conventional heavy oil properties
  • Carbonate bitumen resources properties

Notably, Sunshine's principal operating regions in the Athabasca area are Muskwa, West Ells, Thickwood, Legend Lake and Harper. Sunshine's average production totaled 578Bls/d, mainly from its Muskwa asset in 2012.

Source: Sunshine Corporate Presentation, August 2013

Cretaceous Sandstones Properties

Sunshine is commencing its initial cretaceous sandstones development construction, unlocking what management anticipates to be an important area of focus for rapid SAGD oil sands production. This development will be executed in modular and scalable phases to manage project timing and cost pressures and to take advantage of evolving recovery technologies. On the basis of its management assumptions, Sunshine expect its base case clastic assets to have a total productive life of 55 years.

The company estimates that the recovery rates for these assets will be greater than 60%. These assets are characterized by an expectation of reliable and predictable results due largely to the homogeneity of its large deltaic deposition reservoirs.

Conventional Heavy Oil Properties

(click to enlarge)

Source: Sunshine Corporate Presentation, August 2013

Sunshine's land position in the Muskwa region consists of 21 leases covering 251,343 contiguous gross and net acres and is located within the Athabasca oil sands region, approximately 29 miles from Wabasca and adjacent to the Pelican Lake producing areas.

The producer owns 100% of the mineral rights in the areas covered by its leases. The first approved Muskwa primary recovery scheme covers 1,897 acres. It has received application approval to expand to 11,386 acres.

The Muskwa region is being developed in phases to manage capital exposures and ensure efficient development of the asset. The company is currently producing conventional heavy oil from its Muskwa property and management estimates that production will increase with further development of the Muskwa property.

Carbonate Bitumen Resources Properties

Sunshine's principal operating regions in the carbonate bitumen area of Athabasca are West Ells, Thickwood, Legend Lake and Harper properties.

Source: Sunshine Corporate Presentation, August 2013

Sunshine continues to explore and delineate its vast carbonates resource. Its carbonate holdings of approximately 46 billion barrels of PIIP (Petroleum initially in place) have the potential to provide significant upside as commercial extraction technologies emerge. The producer's management team is advancing its carbonate development plans and it will have a carbonate commercial application submitted in 2015 to realize commercial production from its carbonate assets in 2017, at the latest.

Harper Asset

The Harper area contains 694 contiguous sections, and is located 12 miles North of Shell Canada's significant oil sands leases. The company applied to the ERCB and Alberta Environment to conduct a pilot extraction scheme in the Grosmont carbonate reservoir in October 2008. The pilot project was approved by the ERCB in November 2009.

Source: Sunshine Corporate Presentation, August 2013

In Q1 of 2011, the company mobilized equipment to the pilot site and demonstrated reservoir response to thermal stimulation. The producer applied for a pilot project extension to continue the demonstration of reservoir response to thermal stimulation. This pilot application extension was approved in October 2011 and Sunshine mobilized equipment to complete CSS cycles in Q1 of 2012.

The Harper asset represents a significant land base and contains several prospective horizons, including the Viking, Grosmont and Wabiskaw. Future programs are designed to identify these opportunities, to assess resource potential and to plan future operations. The Harper pilot was a first step in development of these lands as it initiated activity in the region. Sunshine will be submitting more carbonate pilot applications for its other carbonate formations as well.

Harper is estimated to hold reserves of 371Mmbls in proved and probable plus contingent resources.

West Ells Asset

The West Ells region covers 24,354 contiguous gross and net acres. A 10,000Bls/d commercial SAGD application to construct the first phase at West Ells was submitted in March 2010. The company received approval in January 2012. With the completion of an all-season road at the end of September 2012, which provides full access to the West Ells facility location, construction began in early October 2012.

Source: Sunshine Corporate Presentation, August 2013

The first phase of the West Ells SAGD project will proceed in two phases of 5,000Bls/d each. Modular expansions will increase production in phases. After the first two phases (first phase is expected to start in early Q4 of 2013), Phase A3 has been announced and will have a capacity of 30,000Bls/d. Start-up is scheduled for 2018.

Sunshine now expects capital cost for Phase 1 and 2 to be approximately $525 million, an increase of $29 million or 5.5% from the last budget update in April 2013. This latest cost increase is primarily due to the impacts from extraordinary rainfall at the project site and flooding in the Fort McMurray and Calgary areas, as well as further work related to design and other changes initiated by the external engineering firm.

Supplemental phases of one 20,000Bls/d and two 30,000Bls/d have been announced as well but no timetable has been determined yet.

Source: Sunshine Corporate Presentation, August 2013

According to its management assumptions, West Ells is expected to be capable of producing greater than 100,000Bls/d of bitumen from the Wabiskaw zone over a period of 18 years with a productive life of over 50 years. The West Ells area will be developed in phases to help control costs, implement improving technologies and capture efficiencies.

Source: Sunshine Corporate Presentation, August 2013

Sunshine said that the capital cost forecast for the West Ells project has increased to $496 million from the previous estimate of $468 million. Steam injection is now expected to begin near the end of Q3 of 2013 or the start of Q4 rather than in Q3 as previously scheduled.

West Ells is estimated to hold reserves of 796Mmbls in proved and probable plus contingent resources.

Thickwood Asset

The Thickwood region consists of land leases covering 14,549 contiguous gross and net acres and is located approximately 56 miles from Fort McMurray and 25 miles from West Ells.

Source: Sunshine Corporate Presentation, August 2013

On the basis of Sunshine management's assumptions, it anticipates that Thickwood will be capable of producing greater than 50,000Bls/d of bitumen and is expected to maintain a productive life of 47 years. A 10,000Bls/d commercial SAGD application to construct the first phase was submitted in October 2011 and start-up is expected for 2015.

Source: Sunshine Corporate Presentation, August 2013

The area will also be developed in phases. Thus, two additional phases of 30,000Bls/d in capacity are scheduled and commissioning is expected for 2018 and 2021 respectively. Thickwood is estimated to hold reserves of 504Mmbls in proved and probable plus contingent resources.

The Thickwood asset team has completed the design base memorandum and is progressing the front end engineering and design as well as structuring agreements for long lead equipment and services.

Legend Lake Asset

The Legend Lake region consists of 27 land leases covering 160,677 contiguous gross acres and is located approximately 71 miles from Fort McMurray and 9 miles from West Ells.

Source: Sunshine Corporate Presentation, August 2013

Sunshine anticipates that Legend Lake will have a 44-year productive life, achieving greater than 50,000Bls/d of bitumen for 20 years. A 10,000Bls/d commercial SAGD application to construct the first phase was submitted in November 2011.

The area will include three additional phases of 30,000Bls/d but no timetable has been determined yet for the commissioning of these phases. Like Thickwood asset, Legend Lake team has completed the design base memorandum and is progressing the front end engineering and design and is structuring agreements for long lead equipment and services.

Legend Lake is estimated to hold reserves of 621Mmbls in proved and probable plus contingent resources. Now that we have reviewed the main assets of Sunshine in Athabasca, let's take a look at its financials.

Financial Highlights

For the three and six months ended June 30, 2013, the company had a net loss of $8.3 million and $16.6 million compared to $4.7 million and $37 million in 2012, respectively. The net loss was primarily attributable to general administration costs of $5.7 million and $10.3 million, $2.2 million and $4.9 million for share-based payment expense and finance costs of $0.8 million and $2.6 million, respectively.

As seen in the chart below, Sunshine is accumulating net losses quarter after quarter. Can this situation be rectified? This surely creates cause for concerns.

SUO Net Income Quarterly Chart

As of June 30, 2013, Sunshine had $94.3 million in cash and cash equivalents compared to $282.2 million at the end of 2012. The change of $187.9 million in the cash and cash equivalents balance for the first half of 2013 can be attributed to investment in development for $185.9 million, primarily at Sunshine's West Ells project area, and $8.9 million used in corporate operating activities offset by net cash provided from financing activities of $6.9 million.

SUO Cash and Equivalents Chart

Cash flow used in operations in the three and six months ended June 30, 2013 totaled $5.7 million and $10.3 million compared to $2.9 million and $5.8 million for the same periods in 2012. The change of $8.6 million for Q2 of 2013 is primarily due to $10.9 million for expensed IPO costs offset by $6 million of foreign exchange gains for the same period in 2012 and change in net loss by $3.7 million.

For the six months ended June 30, 2013, the decrease in cash flow used in operations was $4.6 million due to savings in finance costs of $14.6 million and $10.9 million of expensed IPO costs, offset by $20.5 million for the change in net loss for the same period in 2012. Given the nature of its business and stage of development, it is obvious that cash flow used in operations is a small portion of the company's total cash needs and expenditures.

Sunshine's strategy is to access sufficient capital, through equity issuances, joint-ventures and the utilization of debt, in order to maintain a strong capital base for the objectives of maintaining financial flexibility and to sustain the future development of its operations. However, I have some doubts with the successive net losses incurred in the last few years.

The company has no debt drawn on a credit facility of up to $200 million. Sunshine's management is well positioned to use the financing capital available if required, to ensure its projects' development.

Furthermore, the company's liquidity may be adversely affected if its access to the capital markets is hindered, whether as a result of financial market conditions generally or as a result of conditions specific to the company. Therefore, liquidity is a primary component that needs a constant attention for a junior producer in order to pursue its ongoing operations due to the precarious situation in which it evolves.

Notably, at June 30, 2013, Sunshine had negative working capital of $35.4 million and an accumulated deficit of $184.7 million. The company's recent losses and negative cash flow have resulted in a material uncertainty that casts significant doubt about the appropriateness of the use of the going concern assumption.

SUO Cash from Operations Quarterly Chart

The appropriateness of the going concern basis is dependent upon, among other things, the ability to obtain debt or equity financing in order to have sufficient funding to meet its obligations that enables it to continue as a going concern, the ability to generate sufficient cash from operations and future profitable operations.

Notably, the company is exposed to risks arising from fluctuations in foreign currency exchange rates and the volatility of those rates. Thus, exchange rate fluctuations can affect the fair value of future cash flows.

Net cash used by Sunshine for its operating activities for the three and six months ended June 30, 2013 was $5.1 million and $9 million compared to cash generated of $4.4 million and $3.5 million in 2012, a change of $9.5 million and $12.5 million, respectively. Net cash used for operating activities includes movements in working capital of $0.7 million and $1.4 million for the three and six months ended June 30, 2013 compared to $1.6 million and $9.3 million for the same periods in 2012.

Future Outlook

As Sunshine develops and initiates production at the West Ells, Thickwood and Legend Lake to achieve approximately 300,000Bls/d, the company will market the bitumen. For the first phases of West Ells and Thickwood, Sunshine will truck "dilbit" to local sales terminals. The expected approval of the TransCanada (TRP) Grand Rapids Pipeline in 2014, will allow Sunshine to deliver its product by pipeline by 2015. This would be a great fit to its development and production schedule.

According to the company, the latter has a potential production of more than one million barrels per day once its most notable projects will be commissioned.

(click to enlarge)

Source: Sunshine Corporate Presentation, August 2013

That tremendous potential will only be possible if Sunshine can find a way to develop them without undergoing too much losses along the way. Since it started buying land in 2007, the company has acquired more than 1.1 million acres in Alberta and Sunshine ranks as the largest non-partnered leaseholder in the entire Athabasca region.

The company estimated that it would need around $35 billion to develop its entire resource base. Its fundraising efforts will need to reach staggering proportions to get there, but management seems to have a few tricks up its sleeve.

Following that strategy, Sunshine announced on August 19, 2013 that it has entered into a joint-venture framework agreement with an undisclosed third party to develop its Muskwa and Godin oil sands properties. The joint-venture agreement calls for 50/50 development investment of up to $250 million.

The reserves and resource evaluation completed by independent evaluators for the end of 2012, resulted in approximately 70 billion barrels of best estimate PIIP. It assessed approximately 5.1 billion barrels of best estimate contingent resource with a value of $10.3 billion and, 446 million barrels of proved plus probable reserves valued at $990 million. The following charts illustrate Sunshine's reserves progression.

Source: Sunshine Corporate Presentation, August 2013

Compared to its peers, Sunshine's reserves represent the third best potential reserve among them, trailing behind Athabasca Oil and MEG Energy. That gives an interesting perspective about its terrific potential.

Source: Sunshine Corporate Presentation, August 2013

Bottom Line

Sunshine's stock is also listed on the HKEX (Hong Kong Stock Exchange) besides the TSX (Toronto Stock Exchange). The company is supported by prominent Asian entities such as Sinopec (SHI), China Investment Corporation, Bank of China (BACHF.PK), China Life Insurance (LFC) and Orient Group. This burgeoning Chinese connection made an Asian stock listing a natural choice and allowed the producer to rely on a solid capital base.

Source: Sunshine Corporate Presentation, August 2013

Even if the average retail investor in Hong Kong doesn't know oil sands from quicksand, Sunshine's ability to explain its business to institutional Asian investors and secure funding from them is well-developed from the expertise of its management team. As a matter of fact, despite the reluctant IPO, the company still generated $580 million in funding in a single day, which surpassed the estimated total budget of its West Ells SAGD project.

In a report published late last year, CIBC World Markets analyst Andrew Potter wrote that a joint-venture in which Sunshine would give up half its interest in its resource base could boost the stock price by almost 150%.

Finally, according to John Stephenson: "Sunshine is cheap from a valuation perspective", said the fund manager with First Asset Investment Management in Toronto, which manages $2.6 billion in assets. However, besides these statements, I believe that there is a huge risk that they will not be able to fully develop its vast land resources, which gives the producer no choice but to look for partnership to bridge that funding gap.

On the down side, as of August 31, 2013, the consensus forecast amongst 3 polled investment analysts covering Sunshine advised investors to hold their position in the company. This has been the consensus forecast since the sentiment of investment analysts deteriorated on July 29, 2013. The previous consensus forecast advised that the producer would outperform the market.

Sunshine shows an EV/EBITDA multiple of 33.93x for the next 12 months. This financial ratio is significantly higher than the median of its peer group with 4.37x. The following chart resumes the ratios for each company in the peer group.

Sunshine Oilsands Peer Group
CompanyEnterprise Value (thsd $)EV/EBITDA 2014EV/EBITDA Nxt 12
EOG Resources$48,226,8145.69x5.92x
Inpex$15,549,4322.07x2.03x
Denbury Resources$9,490,5676.23x6.28x
Newfield Exploration$6,189,0404.14x4.22x
Ophir Energy$2,717,375--
DNO International$2,165,2253.31x3.90x

According to these financial ratios, the producer's valuation is way above the market valuation of its peer group. This is significantly higher than the average of its sector with 5.02x. According to these financial ratios, Sunshine valuation is way above the market valuation of its sector.

Here are the upsides for a potential investment in Sunshine Oilsands:

  • Low-risk pure play focused on in-situ oil sands
  • Over 1.1 million acres of land representing approximately 7% of the total oil sands leases granted in the Athabasca region
  • Tremendous potential for shares growth with over 5.1 billion barrels of best estimate contingent resource and a value of $10.3 billion
  • Virtually no corporative debt and positive working capital are definitely not the norm for a small-cap energy company, which gives plenty of flexibility to pursue the development of projects and gives sufficient time to find the right partnership
  • A valuation way above the market valuation of its peer group, reflecting higher long-term growth
  • The experienced management team is definitely an asset, adding to its powerful Chinese connection business

The following downsides are not to be taken lightly before investing in this junior producer:

  • High-risk high-reward producer could be the next home run or the next bust in the oil industry
  • Net losses accumulated put a lot of pressure on the company's liquidity
  • Its ability to find the right partnership in order to fulfill the large funding requirement is unpredictable
  • Exposure to high crude price differentials would put pressure on its cash flow and fluctuations in foreign currency exchange rates brings uncertainties as well as adding significant risks

Conclusion On The Carbonate Triangle Series

This article ends the series on the Carbonate Triangle Investment Guide, in which we discussed in-depth, of 26 small and large oil and gas producers engaged actively in the area. I hope you had as much enjoyment reading these articles as I had in writing them.

The Carbonate Triangle offers a lot of potential in the abundant oil sands of Alberta. As a matter of fact, since the region is the third largest crude reserve in the world, I believe that the region's potential is huge.

The oil sands represent a very good opportunity for oil producers since the contribution of carbonate-hosted bitumen to Alberta's oil total production is increasing year after year. Furthermore, the ERCB estimated that the production of this unconventional resource will more than double by 2021.

Finally, about 13% of Canadian global oil reserve or 169 billion barrels are recoverable from bitumen with today's technology. That said, this reserve estimate could increase significantly since technology evolves over the years.

The total oil reserve is estimated at more than 1.8 trillion barrels in the tremendous region of the oil sands of Alberta. This is, and will be for many years to come, one of the best oil producing area in the world and a terrific place for any investor.

Source: Carbonate Triangle's Athabasca Investment Guide: Sunshine Oilsands Edition