PennWest: Scripting A Turnaround

| About: Penn West (PWE)

PennWest (NYSE:PWE) is currently focusing on the development of some of its assets to reach a target liquid production of 80% by 2018. The company plans a capital spend of around $269 million for next year in the Cardium district and will increase the capital expenditure to around $800 million by 2018. The current production from this region is around 39,000 barrels of oil equivalent per day, or boepd, with around 56% liquids. The Cardium formation contains resources that range between 6 million barrels of oil equivalent, or mboe, to around 16 mboe per section. In the Cardium formation, PennWest has operations in the Willesden Green and Pembina fields, with more than 600,000 net acres. Pembina is a conventional oilfield with around 9.3 billion barrels of oil in place and around 14% of this recovered. So, the PennWest in the Cardium formation acreage will provide the basis for long term production growth.

Typical initial production, or IP, from a Cardium well is around 150 barrels per day, or bpd, to 500 bpd. This range of IP is in the upper range when compared to the IP of the other tight oil formations in Canada. The other two tight oil formations, which have a higher range of IP rates, are the Montney and Beaverhill Lake. PennWest's per well reserve is around 164,000 barrels of oil equivalent with an expected ultimate recovery factor of around 15% to 30%. The well cost of PennWest in the Cardium formation is in the range of around $2.4 million to $2.7 million. At this level of well cost, PennWest will be able to drill around 105 wells with a capital spend of around $269 million next year. The company plans to drill around 67 net wells in the Cardium formation next year. Net wells is a metric of well count that shows the total number of wells in which PennWest has total and partial interest.

PennWest intends to invest around $2.5 billion into the Cardium over the next five years through 2018, while also deploying around $1.3 billion into the Slave Point and around $620 million into the Viking play. These are the three plays where PennWest is deploying their funds for capital expenditure. Interesting to note here is that the Viking and Slave Point offer superior returns, with an Internal Return rate, or IRR, of 65%-75% and 30%-40%, respectively. Compared to these two plays, the Cardium play has an IRR of around 30%-35%. This clearly indicates that the Cardium formation is going to be the heart of development for the company with a focus on production growth rather than on profitability. The production from the Cardium ranges between 20,000 boepd and 30,000 boepd this year, which the company plans to increase to more than 50,000 boepd by 2018.

Other major players in the Cardium formation are Lightstream Resources (OTC:LSTMF) and Bonterra Energy (OTC:BNEFF). Lightstream is focusing on the development of Cardium formation through its Enhanced Oil Recovery, or EOR, projects. Similar to PennWest, Lightstream Resources is also focusing on the development of light oil resource plays with oil and liquid weighting of 80%, which means oil and liquid will contribute 80% of the total production. Since the oil and liquid production from the Cardium assets of Lightstream is around 71%, the company is likely to focus more on the production from these assets.

The company has 295 net sections in the Cardium. In the Cardium, Lightstream expects to reach an average production of more than 20,000 boepd and plans to develop around 42 net wells with a capital expenditure of around $195 million.

Similarly, Bonterra Energy has a large asset base in the Cardium formation with around 193.7 net sections in the region. Bonterra is also focusing on the development of production of light oil. The light oil and natural gas liquids constitute around 72% of the production mix for the company. So, the Cardium formation play an important role for this company in achieving this production mix as Cardium has a high potential of oil production. Bonterra plans a capital expenditure of around $120 million for 41.05 net wells for light oil and around 27.6 net Carnwood formation wells next year. The capital cost for a Bonterra well is around $2.5 million per well with reserves of around 150,000 boe per well. The well costs of Bonterra are comparable to the well costs of PennWest. With these well economics, Bonterra is expected to be a major player in the Cardium formation and worthy competitor to PennWest.

Asset sales is still the cornerstone for turnaround

To achieve a healthier balance sheet PennWest continues to rely on asset disposals. The first phase of asset sale is already underway ($485 million for 12,500 boepd) and is expected to be completed by the end of this year. The second phase of asset sale, which the company planned for next year, is expected to generate around $1 billion to $1.5 billion. PennWest has highlighted the Peace River Oil Partnership, the Cordova gas JV, its Duvernay acreage, and select non-producing assets as key candidates for the second phase of asset sale. PennWest's plan to divest its non-core asset will generate funds to finance its debt and the operations in core areas.

The sale of assets sale is expected to impact PennWest's current level of production. The company has already reduced its production by 12,500 boepd due to the asset sale this year, and hence it has reduced its production guidance in the range of around 135,000 boepd to 137,000 boepd for this year. Although the company is trying to increase production from its Cardium formation, sale of asset will likely to offset a portion of its production growth.

In addition to production loss from the asset sale, PennWest needs to increase production from its assets in order to replenish the natural decline of its asset portfolio. During the third quarter this year, production decline of the company's asset portfolio was around 5.6%. On annualizing this decline rate, it gives an annual decline rate of around 22.5%. The company forecasts a production output of between 105,000 boepd to 110,000 boepd for the next year.

The proceeds from the asset sale are likely to help the company to pay down its debt. The company's long-term debt has hovered at levels of around $3 billion over the last three quarters of this year. The asset sales that will happen over this year and next year will help PennWest to pay down its debt and help the company increase its financial flexibility.

Growth to be expected

PennWest is focusing on growth of its production in the coming quarters. The company is developing its asset base in the Cardium formation. In line with its production mix target of 80% oil and liquids formation, the Cardium formation is going to be the fulcrum of the company's future production growth. As evident from the discussion, a number of its competitors that are focusing on oil/liquid production are also focusing on this particular Cardium play.

In addition to the production growth, PennWest is also focusing on the divestment of its non-core assets to decrease its debt, which has been high for quite a long time. The asset sale will reduce the production in the coming quarters to some extent, for which the company has reduced the production guidance during the next year. With its focus on core assets and a healthy balance sheet, I believe PennWest is on the track to achieve a turnaround 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.