Athabasca Oil Management Not Yet Fried

About: Athabasca Oil Corp. (ATHOF), Includes: MUR
by: Long Player

Cash flow from operating activities topped C$60 million in one quarter.

Rapidly growing light oil production requires very little cash investment.

Despite recent thermal oil production cutbacks, this company generally receives good pricing for its thermal production.

Joint venture partner Murphy Oil is one of the lowest cost producers in the industry.

Cash flow should soon be sufficient to properly service the debt.

When Athabasca Oil (OTCPK:ATHOF) acquired more thermal oil production, management had plenty of work to do to prove to the market that this acquisition was going to work. A previous article had wondered if the company management had gone from the frying pan into the fire. But a funny thing happened on the way to "deep fried" and "burned". Management may have only gotten tanned in the process despite the market reaction to the process. Now it looks like management is well on its way to making this acquisition work despite a lot of Canadian obstacles.

That proof appears on the way in spite of the fact that Mr. Market has given up on the company. A joint venture with Murphy Oil (MUR) provides insurance that this company will have adequate cash flow to service the debt load. This management has been unusually resourceful in coming up with a viable future. Not only that, but cost cutting and decent marketing of thermal production has avoided some major pricing and cash flow issues so far.

(Canadian Dollar Unless Otherwise Noted)

Source: Athabasca Oil Third Quarter, 2018, Press Release

As shown above, the operating netback alone beat the prices many competitors received for their thermal oil. The reason for this is shown below:

(Canadian Dollar Unless Otherwise Noted)

Source: Athabasca Oil Third Quarter, 2018, Management Discussion And Analysis

Very few expected some small thermal producer to largely escape the effects of increasing Canadian pricing differentials. Yet clearly management did just that. Now, there will be some effects in the future as management is materially slowing thermal production in the face of takeaway constraints. Shareholders can expect continued superior pricing performance in the future as management continues to cope with the Canadian headwinds.

Far more important to the future of this company is the joint venture with Murphy Oil (MUR). Management has a carried interest there to sharply reduce capital costs. Right now that carried interest amounts to pure gold in the current operating environment.

(Canadian Dollar Unless Otherwise Noted)

Source: Athabasca Oil Third Quarter, 2018, Earnings Slide Presentation

As shown above, Athabasca has the best of a lot of worlds with this deal. Murphy agreed to the lion's share of expenditures on the part of Athabasca Oil as part of the purchase price. Even though this acreage is in the early stages (because they are still improving drilling targeting, well designs, and initial flow strategies) the rates of return are fantastic. Murphy Oil estimates that those rates of return will allow this project to shortly become self-funding. That means the partners can increase production solely from the cash generated from the production of the project.

The accounting reports to the public expenses. But both managements expect far less out of pocket expenses as cash flow rapidly builds for this joint venture. This is really Athabasca's "ace in the hole". The market is focused on the thermal headwinds and takeaway capacity. But light oil (and condensate) has always been in demand in Canada. Therefore, this oil is very likely to "find a home" cheaply (no long distance transportation needed) over a wide range of industry conditions.

Just in case, investors can bet that Murphy Oil contracted more than enough takeaway capacity at the beginning of the project. That takeaway capacity will get this oil to a better market if that needs to happen. Many of these operators are currently selling excess capacity at considerable premiums and pocketing the difference until midstream capacity catches up with the growing demand. The joint venture benefits from the assured capacity to better pricing. The operator is having a field day offering excess capacity to bidders. In any event, it is clear that this company receives decent prices as a Canadian producer for its products so far.

Source: Athabasca Oil Third Quarter, 2018, Earnings Slide Presentation

The Montney acreage is operated by Athabasca Oil whereas the Duvernay acreage is operated by Murphy Oil. The Duvernay is also where Athabasca Oil has the carried interest. The combined light oil joint venture acreage (not just the Murphy operated acreage) will show rapid production and cash flow growth. Initially the partners will be reinvesting all earnings back into the project. That makes this project a race against time that Athabasca management appears to be winning.

This is excellent for Athabasca Oil because they have about $450 million of United States dollar denominated debt. That debt is currently valued at C$581 million because of the relatively weak Canadian dollar. The joint venture has enough cash flow that both partners appear to be relatively assured of very low out of pocket expenses because the project is on its way to "funding itself". So actual cash needed for the project by the partners will be much less than the original projected cost. Implied with the self-funding is the next step of free cash flow. Hopefully lots of free cash flow when that debt becomes due.

Therefore, when the debt becomes due, this company is projected to have relatively generous cash flows from the joint venture project. Any extra cash from the thermal operations would increase the shareholder value more. Currently the partners project to spend about C$1 billion over four years. The projected return of 100% means a lot of cash for both partners after those four years. If the market likes the joint venture returns, then that debt should be easy to roll over.

Best of all, the continuing well design improvements assure that generous return at successively lower WTI pricing in the future. If Canada can collectively get its takeaway capacity up to the needs of growing production, a lower discount to WTI would also increase profitability even if oil prices do not meet current projections. There are a lot of ways for this company to benefit shareholders in the future with the current strategy.

Source: Seeking Alpha Website November 30, 2018

Interestingly, Mr. Market appears to care about none of the future scenarios. Instead, the focus appears to be on the current heavy oil production cutbacks and the Canadian takeaway capacity issues. Actually, Mr. Market has worried about the acquisition almost from the start. The initial positive reaction of the thermal acquisition really did not last long.

But the company has more than C$100 million cash on hand and unused bank lines. Net debt is less than C$400 million. The latest cash flow shown above annualizes to about C$240 million. That is a fairly comfortable amount for the debt levels shown. Usually diluent expense increases in the first and fourth quarters because colder weather requires more diluent to make the thermal product flow properly through the pipelines. Still, it appears that annual cash flow of more than C$200 million appears well within reach quickly because of the rapid growth of the joint venture production. Therefore the debt load-to-cash flow ratios will become relatively reasonable in the near future.

As noted in the financials and the presentation, the company only pays about 7% of the Duverney joint venture costs because Murphy Oil agreed to pay Athabasca's share of the remaining joint venture costs for several years worth of expenditures. The cash balance of Athabasca could last a long time as long as that carried provision is available. Only about half of that commitment has been spent at the current time. Therefore, the rapid Duverney expansion costs Athabasca relatively little cash. Yet the company receives all the cash flow benefits of a 30% joint venture interest.

The balance sheet looks risky at the current time but that could rapidly change. Preliminary joint venture results are actually far above what Murphy Oil originally projected. A lot depends upon the price of oil and continued joint venture success. Having an experienced operator like Murphy mitigates a lot of risk factors.

The chief risks here are that oil and liquids prices could decline faster than Murphy Oil can improve operating results. That may require the partners to contribute more than budgeted cash to the joint venture in the future to meet the production growth goals. An appreciating Canadian dollar could also hurt results because the company benefits from sales against United States denominated benchmarks. An appreciating Canadian dollar would also raise production costs when compared to the selling prices.

Murphy Oil is one of the lower cost operators in the industry. There is a risk that Murphy could lose that position in the future. That could potentially reduce future joint venture profitability.

But right now the future looks pretty good for Athabasca Oil. That future is brightening right at the time Mr. Market could care less. However, continuing cash flow increases should eventually force the market to change its mind regardless of the ominous industry headlines. This stock is clearly one of the better speculative stocks available in the oil and gas industry.

Disclaimer: I am not an investment advisor, and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I am/we are long MUR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.