I don’t own much Petrobakken (PBKEF.PK) directly, but I do own a pretty large position through my holding of its parent company, Petrobank (PBEGF.PK). I bought a little bit of Petrobank last June and a lot more last August when the energy sector had a good sell-off.
My reason for owning Petrobank is that I feel the company’s share price reflects only the value of its Petrobakken shareholdings and assigns virtually no value to its heavy oil assets and technology -- which I think are worth at least a 50% increase in Petrobank’s share price and likely more, if it executes its gameplan with any success. I’m not in love with Petrobakken by any means, but I think it is a company with a decent set of assets that more than supports the current share price.
This week, Petrobakken released its Q1 results; Mr. Market didn’t seem to care too much for them, as the share price dipped over 4% to set a new all-time low of $16.28. I didn’t think the results were actually all that bad.
I’ve compiled some notes from the earnings release and from the conference call to try and see what I or Mr. Market might be missing.
Production for the quarter averaged 41,562 barrels of oil equivalent per day and reached over 43,000 per day by the end of March. That is good, as a lack of production growth has been the primary concern with Petrobakken over the past year. The 43,000 barrel per day figure is actually a pretty solid 5% increase from the exit rate at the end of 2010.
I think Mr. Market quickly ignored the fact that 43,000 barrels per day was reached, however, and focused on the fact that April production is forecast to have dropped down to 38,000 barrels per day. This drop is a temporary phenomenon because of spring breakup-related well shut-ins as transportation of oil from single well oil batteries is not possible.
I don’t enjoy the fact that production has dropped back to 38,000 in April, but this is a temporary thing caused by weather and wet conditions. It isn’t lost production and it will be back up quickly once weather permits. So I think Mr. Market should maybe have paid close attention to the 43,000 per day figure being reached and less to the temporary drop in April.
Time Lag Between Capital Spending and Production
In my opinion, what Mr. Market has justifiably not liked about Petrobakken over the past year is that while it's spending a lot of money to drill wells, its production numbers are still coming in flat. However, the good news is that this is an issue that can be fixed. The disconnect between lack of production growth and capital spending isn’t poor production from wells. It is largely because Petrobakken is drilling wells much faster than it's been able to frack, complete the wells and put it on production. So for many of the wells that it's drilled, it's yet to enjoy the resulting production. In other words, money has been invested, but rewards have not yet been received.
How significant is this issue? In the conference call and the press release it give us the numbers:
- 8.5 Bakken wells that are drilled and waiting completion.
- 14 Cardium wells that have been drilled and waiting completion.
- 14 Bakken wells that have been drilled and put on production but at abnormally low rates as they have yet to be fracked.
It should be noted that the wells that are drilled and waiting on completion are in excess of what would be a normal inventory waiting completion. The 14 Bakken wells that haven’t been fracked were waiting on a new fracking method, which has now been adopted.
Now consider that Petrobakken produced on average 41,562 barrels per day in the first quarter. The first month expected production from this delayed production would be roughly:
- 8.5 Bakken wells behind pipe @ 150 barrels per day = 1,275 barrels per day.
- 14 Cardium wells behind pipe @ 175 barrels per day = 2,450 barrels per day.
- 14 Bakken wells not fracked @ 100 barrels per day = 1,400 barrels per day.
That is another 5,125 barrels per day of production that has already had drilling costs incurred and can be brought on quickly with little incremental capital. That is a quick and easy 10%-plus increase in production.
I believe that is why Petrobakken president Greg Smith is comfortable with sticking to 2011 exit production guidance of 46,000 to 49,000 barrels per day.
For the production rates I used above you can refer to the most recent Petrobakken presentation here.
Bakken Decline Rates Slowing
In resource plays that use horizontal drilling and fracking, production declines up to 50% to 60% after the first year, then 30% the year after that and less the year after that. As you get further into developing a resource play like the Bakken and build up a base of production that is a few years old and declining at much slower rates it takes less cash flow to maintain that production. Petrobakken is getting there now in the Bakken and explained so in its press release:
As resource plays mature, they generate excess cash flow and require less capital to sustain production. We are seeing this shift in southeast Saskatchewan, and in 2011 we are reinvesting only 65% of the cash flow to maintain production levels. The excess cash flow from this area is being invested in the Cardium,where we expect to generate most of our production growth this year.
Looking for a Third Leg to the Stool
Petrobakken has a big position in the Bakken in Canada and a big position in the emerging Cardium play (it's the most active driller). For the first time, it let us know it's building more positions looking for a third “leg” to the stool. I’m not sure how I feel about that. I’d prefer that it focus on the Cardium and the Bakken and get those properties producing as advertised. If it's accumulating other acreage very inexpensively, then I’d be more supportive. Here is the detail it provided:
In addition, we have accumulated more than 100,000 net acres on a number of emerging Alberta resource plays. We plan to drill three wells in the remainder of 2011 to test the initial potential of the Nordegg, Swan Hills, and Duvernay light oil plays and one well to test an oil or liquids‐rich gas Montney opportunity. These new plays complement our existing inventory of 2,300 locations focused on light oil and leverage the industry-leading experience of our technical staff who, to‐date have drilled more than 800 horizontal wells with multi-stage fracs.
I really didn’t see much in the press release or in the conference call that surprised me. I expected about 43,000 barrels per day at the end of Q1, which is what Petrobakken reached. The drop to 38,000 barrels per day is a short term issue that is solved by spring ending and has no impact on long term value of the company.
Petrobakken does, however, need to show production growth over the remainder of the year. It spends like a growth company, so that growth had better occur. With 36 wells that are drilled in either waiting completion or fracking, there is some very low-hanging fruit for it to make a big leap towards quickly ramping up production. That growth won’t occur in Q2 due to spring break-up, but should be possible starting in Q3.
Smith was questioned on the call as to whether 49,000 barrels a day by year end (the high end of its range) was still realistic, and he said that it was. For shareholders who bought into this company in late 2009 at $35 (now $16.28) when it was formed, I sure hope that it is.
I have a lot of admiration for Petrobakken CEO John Wright, who took over a $50 million market cap company (Petrobank) in 2000 and has turned it into three companies (Petrobank, Petrobakken, Petrominerales (PMGLF.PK)) with combined market caps in the billions. That admiration allows me to be patient, and I’m optimistic that six months from now that patience will be rewarded.