Pengrowth: Growing Amid The Giants

Nov.29.13 | About: Pengrowth Energy (PGH)

Pengrowth (NYSE:PGH) is moving ahead with its Lindberg project, which is located in the Cold Lake Area of Alberta, Canada, where it plans to drill 23 well pairs. In this project, Pengrowth has been running pilot programs that have delivered strong results. The company uses the steam-assisted gravity drainage, or SAGD, process, which requires a pair of wells to extract bitumen from the reservoirs. The pilot program's two well pairs were able to produce around 2,000 barrels per day of bitumen during the third quarter, and the cumulative production from these two well pairs reached more than 840,000 barrels of bitumen as of the end of September, which is around 35% of the total estimated ultimate recovery, or EUR.

All wells have a natural decline rate. The general decline rate of wells in the Lloydminster area, where the Lindberg project is located, varies between 25% and 60% of the initial production in the first year, and this provides Pengrowth with a unique advantage. The decline rate during the first year in other parts of the Western Canadian tight oil play are around 70% to 80% during the first year. So, a comparatively low decline rate of the Lindberg project will provide the company with sustainable production in the coming quarters.

The well decline rate in the Lloydminster region is estimated at around 25% to 60% yearly while decline rate of the project as a whole is expected to be around 10%. What this essentially means is that the amount of capital required to reinvest into the project to replenish the decline will be low. The amount of capital required for sustaining the project is around $4,000 per barrel of oil equivalent per day, or boepd. Therefore, the company will be able to generate free cash flow, which will be available for distribution to the investors.

Technology plays a significant part in today's oil production worldwide and the same holds true for Pengrowth. During the third quarter of this year, the ISOR of Pengrowth's SAGD process was around 1.8. ISOR is a measure that denotes how efficiently steam is used to extract bitumen from the reservoirs. Steam oil ratio, or SOR, measures the amount of steam needed to produce a barrel of oil, so a lower ratio indicates higher process efficiency. A value of SOR below 3 is generally accepted as an efficient process operation. However, according to the company the ISOR is expected to increase when the pilot program well pair enters the phase of natural decline.

Well cost is a major metric of oil and natural gas operations across the world. So a reservoir that requires lower well cost is a definite advantage to any oil and natural gas operator. The average oil supply cost for new production in the Western Canadian Sedimentary Basin is around $64 per barrel for vertical wells and $40 per barrel for horizontal wells. Pengrowth estimates the cost of bitumen production from the Lindberg project to be in the range of around $45 per barrel to below $50 per barrel. With the WTI price for crude oil at an average of around $97 per barrel during this year and $95 per barrel during next year, Pengrowth will be able to recuperate its well costs and maintain a healthy margin. With this kind of cost economics and an expected reservoir life of around 25 years, the project is expected to deliver sustainable cash flow from its operations in the coming quarters.

Additionally, Pengrowth might realize significant advantages from the Lindberg project in terms of quality of the bitumen reserve in the project area. In general, the American Petroleum Institute, or API, degree of oil sands in the Alberta region ranges between 7 and 10. API gravity is a measure of heaviness or lightness in a petroleum product and is generally denoted as API degrees. Most values of petroleum range between 10 API degrees and 70 API degrees. The API degree of the reserves of bitumen in the Lindberg project is 11. An API value greater than 10 means that the crude is light enough to float on water, and an API degree below 10 means the crude is heavier and will sink in water. This is significant because crude lighter than the average oil sand deposits will make bitumen extraction from the Lindberg project easier.

While Pengrowth is focusing its growth on its asset in the Lloydminster area, giants like Canadian Natural (NYSE:CNQ) and Suncor (NYSE:SU) have a diversified asset base in the Canadian oil sands, and the Canadian Natural thermal in-situ process is becoming the bread and butter of its production growth. In-situ process is used for bitumen extraction that is located 200 feet below the ground and economically unviable by surface mining. The company has vast land holdings in Clearwater, McMurray, Wabiskaw, Grand Rapids, and Carbonates where thermal in-situ process like SAGD and Cyclical Steam Stimulation, or CSS, will be applied for bitumen extraction. The company estimates that its thermal in-situ areas contain around 97 billion barrels of bitumen initially in place, or BIIP, and have achieved a production of around 0.4 billion barrels. Canadian Natural plans to add around 40,000 bpd to 60,000 bpd every two to three years from the thermal in-situ exploration site.

Suncor has a contingent reserve of around 12.4 barrels of oil equivalent, or boe, from the in-situ production from the oil sands. At MacKay and Firebag, the company uses the SAGD process. The MacKay project produces around 30,000 bpd of bitumen while the Firebag produces around 180,000 bpd of bitumen. In both the projects, the company has 100% working interest. While Canadian Natural lined up a number of projects based on thermal in-situ production, Suncor is using both mining and in-situ process for its various projects. According to Suncor's guidance for next year, it plans to increase production from the oil sands by 14%. Currently production from mining and in-situ process is maintaining a balance, but it remains to be seen how the company will shift to more of in-situ processes, because 80% of bitumen deposits are accessible by in-situ process.

Disciplined operations can lead to financial rewards

Pengrowth has put a major focus on the development of the Lindberg project. My discussion on various aspects of the Lindberg project shows that this project has the ability to generate sustainable cash flows from operations in the coming quarters.

The following table shows that the cash flow from operations in the last three quarters:

Quarters

March 2013

June 2013

September 2013

Cash flow from operations ($ millions)

133.65

198.10

151.66

Operating expense per boe ($)

13.84

15.37

15.54

Click to enlarge

The third quarter cash flow from operations was lower because of the loss of production due to asset disposition. According to the company's plan, it has completed its non-core asset disposition of around $1 billion for this year so there is no asset sale expected through the end of this year. This means that there will be no more production loss due to asset sale, and it can expect a steady production through the end of this year and a steady growth in cash flow from operations.

Second, the company's operating expense has stabilized at $15 per boe for the last two quarters. According to the company's guidance for this year, the full year operating cost should be around $14.88 per boe, which is lower than the company's second and third quarter operating expense. This also means that Pengrowth is expecting to lower its operating expense during the fourth quarter to bring the annual average in line with its yearly guidance. A decrease in operating cost is expected to increase the cash flow from its operations.

In addition, Pengrowth's continuous focus on production growth from the Lindberg project is going to provide a solid basis for increasing cash flow from operations. The company wants to increase production from this project to around 12,500 barrels per day by the end of next year.

Making a mark

Pengrowth may not be as diversified as Suncor and Canadian Natural in terms of its asset base, but its asset in the Lloydminster area definitely has some unique properties, and I discussed some of these above. These small differences in properties are essential and have the potential to differentiate Pengrowth from other players in the Canadian oil sands. I expect the Lindberg project will continue to deliver growth as the project continues to enter its execution phase, and this will deliver growing and sustainable cash flows to Pengrowth in the coming quarters.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.