Penn West Shrugs Off Another Tax Hit

I received an email from a reader asking my opinion on the proposed Alberta oil production royalty hike (as well as cuts to royalties from some mature assets). I've posted my response below:

My opinion is that, long-term, this is noise. I try to avoid investments where returns hinge on an 8 percent tax hike.

Specifically as it relates to Penn West (PWE); they commented on this yesterday when they announced their monthly distribution. It will have no material affect on their current operations and may even help them as some of their current production may benefit from the royalty cuts for mature fields. However, they acknowledged that it may have a negative impact on their Peace River Oil Sands project. But the timeline on that is too far away and the moving targets in terms of the SIFT tax and now royalty hikes make any assessment on impact on revenues, cash flow, etc premature at this time. Keep in mind, Penn West has booked only a small fraction of the possible resource for that project.

Long term, the bull case for oil is strong enough that I'm not overly concerned with this news. Take a look at some of the terms that companies are bowing to in Africa or eastern Europe. In Russia, Total (TOT) has been relegated to a de facto oil service company and are just hoping they can claim reserves on some of the fields they're partnering on.

The oil sands conditions seem generous by comparison. It strikes me that many people are ignoring the actual physical ramifications of ramping up oil sand production in Alberta. The environmental fallout will be significant so be prepared for more government saber-rattling.

But the truth is that any oil investment comes with significant risk. The national oils subsidize much of their domestic energy consumption and are subject to political machinations. The major integrateds can't replace reserves fast enough. The independents can only find oil in places like oil sands or deep offshore in politically shaky regions or weather-prone areas.

You may try to find shelter in the oil-service companies but if you examine them on a free-cash flow and dividend basis, you'll find that you're completely dependent on share price appreciation (aka Mr. Market) for your returns. The boom/bust cycle means that those companies spend a lot of money on CapEx during the good times but cash flow dries up during the bad times. "Owners' earnings" never seem to materialize for the majority of them.

So it's really a case of picking your poison. I'll stick with getting paid 13% for the next 3-4 years and waiting to see how the circumstances play out both for the company and the sector in general. PrimeWest Energy Trust (PWI) was bought out yesterday by the Abu Dhabi national energy company. If you examine Penn West's Peace River holdings, you'll see that they are surrounded by Royal Dutch Shell (RDS.A). Just something to keep in mind.

Comments

[whboyce:]

noigf nal oil gas ????? whats up with this co. ??

2007 Oct 01 09:34 AM

[erniem:]

Bingo. Somebody knows what they are talking about. The oilsands market could be huge, and PWE has significant exposure, huge exposure. And BINGO, the environmental impact and subsequent governmental action when that production ramps up will be huge.. Oilsands are insanely polluting and need HUGE amounts of water to produce, huge amounts of energy, and leave huge amounts of polluted water and sand behind. We talking HUGE..

Now if I were interested in a company to invest in, it would be one that is looking at methods to treat the water and sand tailings.

2007 Oct 01 01:57 PM

[Greg Pinelli:]

PWE has SOME exposure to oil tar/sands...it has booked very modest amounts and will not live or die with its future. It may substantially benefit by the rise in nat gas as its consumed in huge amounts developing tar sands...PWE could well end up filthy cash rich never touching the stuff. Decent article..nice perspective on letting the political vultures work their act and letting Peak oil and gas do its thing.

2007 Oct 10 12:04 AM