In November 2009, Calgary-based Southern Pacific acquired the Senlac SAGD (steam assisted gravity drainage) project from Encana (ECA CN) for C$95M, net of working capital. The project had been operating for over a decade and was primarily used by Encana to develop new technologies and best practices that could be applied to its more significant projects like Foster Creek and Christina Lake (which are now considered among the best commercial SAGD projects in the industry). All of the 20 key field employees who worked on Senlac were retained, providing a wealth of transferable knowledge and experience that are now being applied to the McKay project.
What’s more, as this project was run as an R&D center, its full economic potential was never realized. Southern Pacific is now running it for cash flow. It is producing about 4.5 mbpd at an average operating netback (after royalties, opex, etc) of $41/bbl, which equates to about C$65M in cash flow per year. It has about 11 mmbbls of 2P and 20 mmbbls of 3P reserves. Not bad for a C$95M acquisition. With C$25M of capex earmarked for Senlac, and average production of 4.75 mbpd, free cash flow from this project should be about C$50M (see assumptions below), which will be used to help finance the McKay project. The enterprise value of STP CN is about C$300M (net of C$90M in net cash post equity offering). One could argue that the company is cheap on Senlac’s free cash flow generation alone, which should last at least 10 years.
STP-McKay will be Southern Pacific’s first commercial project in the Athabasca oil sands region. The company in May 2009 submitted an application to the Alberta Energy Resources Conservation Board (ERCB) and Alberta Environment for the development of its first 12 mbopd phase and is expecting regulatory approval by the end of 3Q10 (announcement is expected any day). Typically these approvals (of which there has been plenty of precedent, not just by Southern Pacific but by Suncor and Petro-Canada, which was acquired by Suncor, among others) typically take 14-16 months and we are now at month 17 so it really should be any day.
Phase I’s total project capital cost estimate is C$430M. In April 2010, STP issued 84M shares of stock at C$1.20 per share, raising C$101M in gross proceeds (ultimately enabling STP to graduate from the TSX-V to the TSX in June 2010). This removed the equity overhang related to the McKay Phase I financing, and STP plans to finance the remaining portion through cash on hand, free cash flow from the Senlac project, and a debt financing to be completed immediately following regulatory approval. Bid packages on major drilling equipment and supporting infrastructure are currently being issued, so the company should be able to move quickly upon receiving financing. The current timeline envisions application approval in September 2010, civil construction starting in October 2010, plant construction in December 2010, commissioning in October 2011, and first steam in Jan/Feb 2012.
In June 2010, the company bought out Bounty Development’s (its partner’s) 20% working interest in McKay for C$33M giving STP a full 100% working interest in the McKay project (Phase I and surrounding phase expansion lands).
Management believes that the STP-McKay project is analogous to Suncor’s (NYSE:SU) currently producing, and highly successful Mackay River project, which has steam-to-oil ratios (SORs) that are among the lowest in the industry, averaging 2.5. Both projects target the same bitumen deposit – the McMurray formation. As shown below, STP-McKay stacks up well compared to other currently producing SAGD projects that have been deemed to be quite successful.
With guidance from the company and directly relevant experience from Suncor and Connacher Oil and Gas, I have done what I consider a conservative, but realistic NAV model for STP which aggregates production from Senlac and McKay (Phase I and future expansions), and I come up with an NAV per share of C$2.62. This compares with Tudor Pickering’s NAV of C$3.00, Raymond James’ $2.47 and TD Newcrest’s C$1.66 (the only 3 estimates I’ve been able to find). I assume McKay ramps up to a max of about 40 mbpd by 2018 and Senlac peaks at 4.8 mbpd by 2012. Overall operating netback assuming $80/bbl WTI crude and $6/mcf natural gas works out to about C$33/bbl, with F&D $3.30/bbl and maintenance capex of C$40M. Sensitivities are shown below – clearly the price of crude is a huge swing factor here given the steep differentials and high operating costs of oil sands, so if you are not a bull on crude, this is not the investment for you.
I’ve compared STP to its 2 closest comps, Opti Canada (OPC CN) and Connacher Oil and Gas (CLL CN), and on an EV/recoverable resource basis, the contrast is stark. The market is clearly applying little to no value for the McKay project despite all the positive reserve updates (on 8/19/10 the company upped its Best Estimate Contingent Resource from 256 mmbbl to 489 mmbbl. Total recoverable resources increased 62% from the prior estimate to 667 mmbbl).
Applying the peer group average EV/recoverable resource we get a fair value for the stock of about C$3.45. Assuming the C$300M debt is in place and funds capex the equity value drops to about C$2.55.
Disclosure: Disclosure: Long STP CN