Canada's unique geology had led to a development differently from the development of the United States, its southern neighbor. Although there had been many drilling attempts in Canada in the 19th and early 20th century, the country depended on US oil imports until 1947, when the Leduc oil field was discovered. In the subsequent years, many Devonian reef formations were discovered in the province of Alberta and soon the biggest problem of the Canadian upstream company was to figure out a way to move its goods to the United States which soon became the most important customer. This issue of building pipelines has not lost relevance in the last decades, as the debate about the Keystone XL pipeline clearly shows.
The single most important development in the last years in the Canadian upstream industry is the rise of oil sand production. With an increasing price level and more advanced technology, it became profitable to mine bitumen and upgrade them to synthesized crude oil on a big scale. In some of my articles I have already calculated production costs of the biggest oil sand producers in Canada (part I, part II).
Nevertheless, Canadian oil production is not only tied to oil sand. Conventional oil production is still important and in the last decades a number of companies have expanded their activities to places all over the world. Additionally, some Canadian companies are also active in tight oil production in the United States.
In this article I calculate the production costs of a number of Canadian companies. Some of them might also be partially active in the oil sands or US tight oil business. The companies investigated in this article are ARC Resources (OTCPK:AETUF), Arsenal Energy (OTCQX:AEYIF), Baytex (NYSE:BTE), Bellatrix (NYSE:BXE), Birchcliff (OTCPK:BIREF), Bonavista (OTCPK:BNPUF), Bonterra (OTCPK:BNEFF) and Chinook (OTCPK:CNKEF).
The key point for me is to catch the real production costs of hydrocarbons as accurate as possible. For that reason I only consider costs that are directly related to oil and gas production. As the upstream business is a pure commodity business, many companies have bought derivatives to hedge their sales. As gains or losses from that instruments are not directly related to production, I do not consider them directly in my method. Nevertheless, as they might have impact on the future of the company, I mention them if they are significantly high. The same is true for impairments.
Oil is hardly ever produced as pure liquid. Normally it comes as a mixture with natural gas and gas condensate. Although I only consider companies here, that mainly lift oil, they also produce significant amounts of gas. Hence, it does not make much sense to apply costs to the production of oil alone. To deal with this issue the concept of barrel oil equivalent - boe - has been perceived. 6000 cubic feet of gas at standard conditions are about one boe. All costs mentioned below refer to one boe, meaning that are the costs related to the production of 1 bbl of oil, 6000 scf of natural gas or a combination of both. Let's say the price for 1 barrel of oil is around $60 and the price for 1000 scf of gas is about $3. This means, revenue from 1 boe of oil is higher than revenue for 1 boe of gas ($60 versus $18). As there are also fields that only produce gas, this article tends to underestimate the costs of oil production.
Commonly, costs are divided in costs that can directly be related to production (cost of sales) and costs that cannot directly be related to output (overhead). However, many oil companies are also active in downstream and midstream or other economic sectors (e.g. ExxonMobil (NYSE:XOM) in chemical engineering). Hence, I have divided sales, general and administration expenses (SG&A) by total revenues and multiplied it with the revenue of the E&P division to get SG&A for E&P. I did the same for any similar type of cost (marketing expenses, R&D) and for financial expenses. Depreciation, Depletion and amortization, on the other hand, can be directly linked to oil production.
Costs of sales are divided into 3 sub-categories:
- Exploration costs
- Lifting costs
- Non-income related taxes
Exploration costs are costs related to all attempts to find hydrocarbons. This category includes cost for geological surveys and scientific studies as well as drilling costs.
Lifting costs are the costs associated with the operation of oil and gas wells to bring hydrocarbons to the surface after wells (facilities necessary for the production of oil) have been drilled. This figure includes labor costs, electricity costs and maintenance costs.
Non-income related taxes: as production of hydrocarbons is such a lucrative business, governments also want to have their shares. There exists an abundance of different model how the state can profit from hydrocarbon production (profit sharing, royalties, etc.).
It might be, that different companies use different categories for the same type of expenses, but eventually the sum of all costs should be their total cost for producing 1 boe.
The following figure shows the pattern of the cost model:
As I have noticed in one of my articles, that cash flow situation does not look well for the majors. In the long term, a profitable company must be able to generate enough cash flow to cover its capex and to buy money back to its shareholders (either via dividends or share buybacks). Therefore I included operating cash flow and total capex in my data. Operating cash flow and capital expenditure both refer to the whole company. Capital expenditure is investment in assets as well as in subsidiaries if they are not consolidated. This number does not include any subtractions because of the selling of assets. I also add the cash flow companies generated through sale of assets.
Application on 8 Canadian companies
I did not include many Canadian companies in my investigations about 2013's oil production costs. Because of this reason, I calculated only production costs for 3 of the companies in this article. Founded in 1996, ARC Resources is one of Canada's conventional oil producers. The company's activities are focused across Western Canada. Calgary-based Arsenal Energy operates in North Dakota where it produces light oil at Stanley and Lindahl. Additionally the company has assets in Alberta and British Columbia where Arsenal produces medium oil and gas. Bellatrix Exploration focuses on operations in Western Canada's Sedimentary Basin. All the company's assets are located in west central Alberta. As most of its peers, Birchcliff Energy is based in Calgary and listed in the Toronto Stock Exchange. The enterprise has just one core area: the Peace River Arch in western Alberta, where additional to its producing fields, it holds more than 500,000 undeveloped acres. Bonterra gets most of its production from the Pembina Cardium in central Alberta. Other of the company's assets are located in Saskatchewan and in the northeastern part of British Columbia. All of the companies in this article publish their results in Canadian Dollar. As a conversion rate USD1 = CAD1.105 was used.
The results can be found in the table below:
(source: own calculations based on the ARs for 2014)
Liquids do not only mean classical oil, but also natural gas liquids - NGL.
I have also applied my methodology in the following articles:
- 2013's Costs for 121 Companies
- Independents I
- Independents II
- Independents III
- Shale Oil Producers I
- Shale Gas Producers
- Oil Sand Producers I
- Oil Sand Producers II
- Shale Oil Producers II
- Shale Oil Producers III
- Shale Oil Producers IV
- Shale Oil Producers V
- Majors I
- Majors II
- Smaller US Companies I
- Smaller US Companies II
- European Companies
ARC Resources produced more than 60% of gas in 2014. Because of this, realized revenue per boe was relatively low with less than $45 Total costs of sales and depreciation per boe are fairly average. Due to the high amount of output (more than 43 million boe in the last year) SG&A and interest expenses were very low (together less than $3 per boe). Eventually, ARC made a pre-income tax margin of 19%. Other items on the company's balance sheet were a gain on derivatives of $159 million and a loss on foreign exchange of $66 million. Remarkable is, that the company could fund its total capex with funds from operating activities.
Arsenal Energy produced nearly 80% liquids in 2014 (on a boe basis). Its total costs of sales are a bit high, while the company's deprecation per boe is relatively low. Arsenal is only a small producer (1.64 million boe in 2014), but had combined SG&A and interest expenses of less than $5 per boe. However, pre-income tax margin was not outstanding with 15%. Additionally, Arsenal made $15 on derivatives. The company could finance its capex with the combined funds from operational activity and sales of assets.
Baytex increased its total production from 2013 to 2014 by 36%. Both its percentage of liquids produced and its average realized revenue per boe remained fairly steady. There was also only a small difference in total costs between the two years. While costs of sales sunk slightly, this effect was offset by lower depreciation per boe. Below, the line, pre-income tax margin sank slightly from 15% to 13%. However, Baytex was only able to fund 37% of its capex with operational cash flow. The situation of the company was also influenced by a number of other factors: impairments of $407 million, gain on derivatives of $191 million and a foreign exchange loss of $67 million.
In 2014, Bellatrix got nearly 70% of its production from gas. Because of this, the company could only realize $38 per boe sold on average. Combined cost of sales and depreciation were appropriate, while both SG&A and interest expenses per boe were very low for an E&P company that only produced 13.89 million boe in the previous year. Bellatrix achieved a pre-income tax margin of 20%, a rather good value, but could only fund 40% of its investments with the operational business.
Birchcliff produced more than 83% gas in 2014, but realized an average revenue of $34 per boe, as the company got $4.31 for 1,000 scf of gas. Both costs of sales and depreciation per unit are on the lower side of the spectrum. As for most other companies in this article, SG&A and interest expenses per boe are low. Below the line, Birchcliff had a pre-income tax margin of more than 30%, a very good value, not only in Canada, but also worldwide.
Bonavista is the next company in this article that focuses mainly on gas. It kept its total production rather stable from 2013 to 2014 and slightly decreased the percentage of liquids produced. However, average realized price per boe rose by more than $1. The reason for this is the higher revenue the company could realize per 1,000 scf ($3.01 in 2013 versus $3.88 in 2014). Bonavista decreased its costs of sales and its depreciation per boe, but is one of the few Canadian companies with higher interest expenses per boe. With 11% of total revenue, the value is rather high, but still in an acceptable range. Bonavista made $120 million on derivatives and had to impair $271 million.
Bonterra is mainly focused on the production of oil. Therefore it could realize an average revenue of $63.83 per boe. Both cost of sales and depreciation per boe are less than one third of total sales. Together with combined SG&A and interest expenses of $2.5 per boe, the company could achieve a pre-income tax margin of 32%, a brilliant value for an enterprise that only produced 4.82 million beo in 2014. Bonterra could also fund 141% of its capex in 2014 with operational cash flow.
I have already investigated Chinook's costs for 2013. The company decreased its total production slightly, but increased its percentage of liquids produced. Because of this fact and higher average prices for oil, gas and NGL the company realized a higher amount per boe in 2014 as it did in 2013. However, costs in 2013 were too high, resulting in a negative pre-income tax margin in that year. This did not change in 2014. The company still spend more money for each boe produced as it realized. Additionally, Chinook impaired nearly $58 in 2014.
Remarkable about the companies in this article are the low expenses for both SG&A and interest, especially compared to many of the US shale producers. It seems, that Canadian companies have very streamlined overhead costs. They also have either a low debt-to-equity ratio or profit from low interest rates. Additionally, realized revenue per 1,000 scf rose significantly in 2014. These factors might be the reason that they the Canadian E&P industry did well in 2014. However, the cash flow situation is on average not much better than for the US upstream industry, although there are some bright spots.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.