(Editor's note: Investors should note that PDPYF trades with minimal liquidity. PPY.TO on the Toronto Stock Exchange has better liquidity)
Painted Pony Petroleum Ltd. (OTCPK:PDPYF)(PPY.TO) is a Canadian junior oil and gas producer primarily focusing on natural gas exploration and development in the British Columbia Montney region. It also has a limited exposure to the Bakken oil formation located in southeastern Saskatchewan.
PPY exited 2013 with an estimated production of 9,970 boed (with 86% toward natural gas). It also reported as currently having 3,000 boed 'behind pipe' due to lack of access to natural gas processing facilities.
As at February 28, 2014 it is trading at C$8.54/share resulting in a market capitalization of C$756 million (basic).
2014 Capex and Gas Processing Facilities Expansion
PPY recently approved a 2014 capex budget of $149 million, with drilling and completions representing about 85% of the total budget. Drilling will involve 18 (17 net) horizontal wells targeting upper, middle, and lower Montney formations on the company's 203 section Montney property. This compares with a similar-sized 2013 capital expenditure that involved drilling 14 (10.6 net) Montney wells. A significant portion of the planned 2014 Montney drilling involves delineation activities as a large portion of the drilling will be from existing pads.
The remainder of the capital budget will focus on investment in expanding natural gas processing capacity. Since inception PPY has, at the margin, directed its capital expenditures in favor of building reserves. This strategy has been quite successful with approximately 191 million boe of 2P reserves at year end 2012. The corresponding 2012 2P+2C resource approximates 4.3 Tcfe. These resources represent more than 60 years of planned 2014 production.
However, this exploration success, coupled with its relative (under)investment in natural gas processing capacity, has resulted in an ever-growing number of barrels behind pipe - a condition that has recently throttled their revenue growth. This is not a unique phenomenon as a number of PPY's peers with successful exploration operations also find themselves trying to build and/or rent additional natural gas processing capacity.
PPY has placed a high priority on alleviating its current and anticipated future natural gas processing constraints. Accordingly, the company recently announced a number of capacity-related expansion initiatives. These include: securing additional (rented) capacity with pre-existing third-party operators, capital investment in both new facilities and expansion of PPY-owned facilities, as well as engaging in a scoping study with a third-party mid-stream company for incremental gas processing capacity.
These initiatives would result in the following growth profile of PPY's natural gas processing capacity:
PPY Planned Natural Gas Processing Capacity
New Drilling Technology - Ball Drop
During the summer of 2013 PPY tested a new horizontal drilling technology and shifted from a 'perf-and-plug' technology to a newer system referred to as 'ball-drop' technology. In an attempt to test the technology and get a 'head-to-head' comparison, during the last half of 2013 the company drilled six wells with the ball-drop technology at locations very close to wells that had been drilled using perf-and-plug technology. The company reported recently that both IP30 production rates and P120 day production rates were about 35% higher than corresponding wells drilled with perf-and-plug technology. Wells drilled using the ball-drop technology yielded IP30 rates in the range of 8.0 mmscf/d. In addition, the company estimates that the ball-drop technology reduces the capital costs per well by approximately $700 thousand.
Prior to the fourth quarter of 2013 PPY's base case production forecast assumed 4.7 mmscf/d IP30 rates per Montney well (corresponding to a 6 bcf reserve well). Based primarily on actual production experience, PPY revised its production assumption for planning purposes to 5.8 mmscf/d per Montney well (7 bcf reserve well). This revised guidance forms the basis for most analyst models and represents a 23 percent increase in assumed IP30 production rates versus prior plans.
The 5.8 mmscf/d production estimate per well translates into a forecast 2014 annual production of approximately 11,500 boed, or a 32 percent year over year increase versus 2013. This also corresponds to an estimated 13,500 boed exit rate at year end 2014. Furthermore, with a 32-well Montney drilling program planned for 2015, average production in 2015 is expected to be about 20,500 boed representing more than a 75 percent increase over 2014. This corresponds to a 2015 exit production rate of almost 25,000 boed.
Financials and Valuations
Prior to 2014 PPY has operated in a very financially conservative manner and did not utilize any debt financing. Recently, PPY decided that it would permit the use of financial leverage provided that the debt to cash flow ratio would remain below 1.4 times in 2014 and slightly higher at 1.6 times for 2015. These planned maximum levels are approximately the average value for PPY's peer group.
With the low natural gas prices of the last couple of years, the company generally did not hedge its natural gas market price risk. However, PPY announced in January 2014 that they had entered into hedges at an average price of C$4.00/mscf on approximately 20 percent of their 2014 planned production. (Note that the company utilized a natural gas price of $3.71/mscf for 2014 financial planning purposes.) It should also be noted that PPY realizes a five percent to ten percent premium compared to benchmark Alberta natural gas prices (AECO) due to the relatively high heat content of PPY's natural gas.
In terms of valuation, PPY current trades at an EV/DACF ratio of 9.5 times as compared to 9.0 times for its peer group. Meanwhile, PPY's current EV/boe is about C$4.48 per boe as compared to about $15.50 for its peers. This comparatively very low EV/boe metric is primarily attributable to the rather large disparity between the size of PPY's hydrocarbon reserves relative its current production and cash flow.
Key Things to Watch For During 2014
1)Reserve increase: Their year-end 2013 updated third-party reserve estimation is scheduled to be released on March 4, 2014. All in, 2013 was as good a year as any on the exploration front for the company. It will also be insightful to see what the consultants are using as the average reserve estimate for Montney wells being that the company has guided-up most recently from 6 bcf per well to 7 bcf per well for planning purposes.
2)Continued success with ball-drop technology: As noted earlier, the first six ball-drop wells have IP30 production rates in the range of 8.0 mmscf/d, which is a material improvement as compared to the 5.8 mmscf/d for perf-and-plug wells. If this level of productivity continues through the 2014 drilling program, then the company will likely be looking at incrementally higher production and reserve estimates going forward.
3)Natural gas hedging program: It will be interesting to see if PPY decides to increase the size of their 2014 hedging program considering the recent spike upward in the price of natural gas. Communication of this, should it have occurred, would likely be released during April with their first quarter 2014 financial results.
4)B.C. LNG industry prospects: Last but not least, PPY, as with most natural gas exploration companies involved in northern B.C.'s natural gas play, are anxiously awaiting details of the province's fiscal regime with regards to LNG development. Resolution of this overhang will lead to definitive go/no-go decisions by LNG sponsor companies, which will, in turn, have a material impact on the future financial fortunes and market value of all the natural gas companies operating in the Montney and Horn River regions.
Disclosure: I am long PDPYF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have a long position in Painted Pony Petroleum Ltd. and do not plan to sell my current position nor add any additional positions within the next 72 hours. This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. As such, this article does not represent financial advice. Investors are recommended to conduct further due diligence before committing capital to any investment.