Given the current slow recovery in the oil market (it seems), let's take a look at MEG Energy's (OTCPK:MEGEF) cost profile and corporate break-even. First, let's take a look at MEG's cost profile for the last two years.
MEG Energy - Cost Profile (C$/bbl)
|WTI oil price ($/bbl)||48.80||93.00|
|C$/$ forex rate||1.2788||1.1047|
|WTI oil price||62.41||102.74|
|AECO natural gas price (C$/Mcf)||3.11||4.62|
|Power price (C$/MW-h)||27.48||48.83|
|Net operating costs||9.39||12.06|
|Corporate break-even ($/bbl)||52.35||71.16|
Yes, this is a lot of information. But let's concentrate on a few highlights.
As you can see, the price differential of bitumen versus WTI is getting tighter. This could be explained by the recent completion of pipeline projects. While the differential is there to stay because of different oil quality, the differential might be more constant over time.
Why did MEG's transportation costs skyrocket in 2015? The answer is found in the Q1 2015 report: the company is moving its production all the way to the Texas Gulf Coast because of the completion of the Flanagan-Seaway Pipeline. Also note that rail costs also increased. The change in transportation costs is significant as we can see from the latest quarterly report.
Source: Q4 2015 Report
In return, MEG shall expect a tighter price differential between its bitumen and WTI oil price. The price differential will get back to fundamentals (higher sulfur content and heavier, lower quality oil) as opposed to transportation problems associated with getting the oil sands out of Alberta. It will be beneficial for MEG, and we can already prove it: while increasing its transportation costs by C$3 per barrel, the price differential decreased by C$8 per barrel, which gave the company a price advantage of about C$5 per barrel.
At first, G&A costs also appear to be a little high, but let's compare MEG's cost to Cenovus (NYSE:CVE), another SAGD operator in the oil sands. In 2015, Cenovus had transportation costs of C$6.64 per barrel and G&A costs of C$3.27 per barrel. All in all, Cenovus' figures are not far from MEG's cost profile. Lowering costs is still one of the priorities of the management team.
Corporate break-even is estimated at WTI $50 per barrel. Let's take a look at the few assumptions I made.
- One of the major variables in estimating the corporate break-even is of course the USD to CAD exchange rate. The value of the CAD is deeply influenced by world oil prices. However, based on my model, while the exchange rate is of course a point that makes the corporate break-even lower in USD, it isn't very significant: the lower loonie is compensated by a lower WTI oil price.
- Energy costs are modified according to today's AECO natural gas strip. Current futures predict an average natural gas price of C$1.70 per Mcf this year. Therefore, energy costs are almost cut in half.
- The power revenue will be cut in half.
- The G&A and operating costs are cut by 5%.
- The price differential will remain constant from 2015.
In conclusion, as you can see from MEG's cost profile, the big factor is of course the huge debt load the company is carrying. If it weren't for the financing costs, MEG would be able to break even at WTI oil price of $42 per barrel. The corporate break-even is now estimated at $50 per barrel.
Therefore, it is understandable as to why the management team is trying to deleverage the balance sheet using the sale of the Access Pipeline. This will ease the pressure on the operating cash flow of the company and enhance its cost profile.
The rest of MEG's cost profile is good. Estimated sustaining capital expenditures of C$5 per barrel compares very well to the industry. It could be argued that the true sustaining cost might be a little higher, of about C$7.50 per barrel as we have seen historically for MEG.
Disclosure: I am long MEG.
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