PWE - Penn West Petroleum

[Wilson-TPC]

You think Penn West can get 50k per flowing in US Dollars in this kind of environment?

 

Can you name any other transactions that's even remotely close to these multiples?

 

The non-core asset sale was 43k in Canadian, so 32k US. The whole company today trades around 29k per flowing in US.

 

I'm just trying to understand where the optimism comes from.

[Cardboard]

You do good math on BXE and I like and own that company too but, on PWT it is a different story...

 

Net debt is now around $1.96 billion CAD with this latest sale (and yes it has been adjusted for the exchange rate moving higher since June 30 and them selling their FX hedging gains).

 

Flowing boe/day is now around 83,500 with this latest sale

 

There are 502 million shares.

 

Stock is at $0.72 CAD

 

So current Enterprise Value is $362 million plus $1,960 million or $2,322 million CAD.

 

That gives an EV/boe/d of $27,800 CAD.

 

There are dozens upon dozens of recent deals done at higher multiples than that. They are mostly companies consolidating a play.

 

As Penn West continues selling non-core assets, it becomes less and less distressed meaning that bargaining power goes up. Operating costs are also heading down fast. Nawar was also right saying that this deal was accretive since EV/boe/d came down since they have done it.

 

Can I try to understand where your pessimism comes from?

 

Cardboard

[Wilson-TPC]

Have you calculated the capital efficiency of PWE?

 

Looking at current capex, it looks to be around C$28,000 flowing boe/d.

 

This is why I'm having a hard time getting my head around Penn West. I attached the screenshot.

 

Flowing boe/d metric is measured on several things:

 

1. Operating cost

2. Capital efficiency

3. IP90

4. Reserve potential

5. Production breakdown (oil and gas %)

6. Infrastructure in place

7. Comparable deals elsewhere.

 

If Penn West can sell a non-core asset for C$43K flowing boe/d. What would the Cardium go for? If Cardium goes for whatever, then what would the companies operating in that region be worth?

 

I would like an exact answer on capital efficiency and all those things I mentioned, the 7 points. 

[Packer16]

I am not pessimistic per se but when you can get companies that have better capital efficiency at prices that are at or lower than Penn West why invest in Penn West.  Wilson has mentioned BXE (which is a combination of an asset with comparability to some of Penn West' better properties and on of the best asset in the Spirit River) but there is also Gear, RMP and Bonavista in the WSB and Southwestern and Antero in the Utica/Marcellus.  All of these have much better capital efficiencies and are growing production per share, except Bonavista who is flat. 

 

If you listen to Ken Peak's last interview on Bloomberg he clearly states that low cost is the way to go to reduce risk in O&G as you have no influence on pricing.  He also practiced that it doesn't take alot of folks to do this correctly.  One way to look at the people issue is to calculate production per employee.  Contango has about 250k boe/d/employee.  From list above, I think Gear, RMP and Antero, along with Peyto, clearly fit into the Ken Peak type companies.  BXE is on its way there.  Both BXE and Sothwestern do have alot of employees versus other Peak type companies.  Peyto is very expensive versus the other three but Peyto has a nice track record that the others do not have at this time.  Interestingly enough his three area of investment were offshore GoM, the Piceane in Colorado and the WSB in Alberta, some of the lowest cost geographies out there.

 

Packer 

[Cardboard]

"I am not pessimistic per se but when you can get companies that have better capital efficiency at prices that are at or lower than Penn West why invest in Penn West.  Wilson has mentioned BXE (which is a combination of an asset with comparability to some of Penn West' better properties and on of the best asset in the Spirit River)"

 

There is not a single E&P company cheaper than PWT other than for some juniors. You guys are comparing a company that produces 70% liquids (PWT) with one that produces 70% natural gas. These normally don`t trade at the same EV/boe/d or EV/boe of reserves due to oil being much more profitable (especially light). So, the price of PWT is much lower than BXE with them currently selling at about the same EV/boe/d.

 

Bellatrix Cardium assets are comparable to the average quality of PWT Cardium assets (not the better ones) and I would say below. Bellatrix had some weak assets in the Cardium and with the trend to move to liquids over the last few years, they bought Angle Energy (was the 2nd largest holder in the Cardium behind PWT if I recall well) which had assets adjacent to them in the Cardium to create efficiency of scale. This is not cream of the crop but, all right.

 

On the other hand, BXE has a terrific asset with Spirit River giving it Returns on Capital Employed similar to Peyto and close to Southwestern. This asset, current price and Orange Capital are key reasons why I have money now in Bellatrix. Orange is very important since Raymond Smith has not demonstrated solid capital allocation (note: I had a substantial position in Angle because it was very cheap and kept most BXE shares on the take-over exchange continuing making good money until Smith issued shares in May 2014 for no reason. It was actually his eventual saving grace without him having a clue about it. Also, very glad it made me get out!)

 

I do not know enough about Gear or RMP to make comments but, Bonavista is another 70% gas producer. It is cheap too and can be compared to BXE. Between the two I have chosen to put my money into BXE.

 

Getting back to PWT, this remains a sum of the part with improving core operations. You have in it a hidden Raging River in the Viking and a Whitecap in the Cardium. And they have lots of optionality with many holdings. Operating costs are showing dramatic improvements and as they liquidate more and more non-core assets, this only gets better. Recent slashing of 35% of employees with most at HQ certainly shows attention to reducing costs. Remember this was a fat and mismanaged organization. It takes time to change the culture but, these tough times are allowing for this to happen.

 

Is there risk of permanent capital loss? Absolutely. If oil remains at $50 or below for a year or two, that is a big problem. However, I would say that it is a big risk for most NA producers. Many are hiding now with their hedges or lower debt levels but, they still make no money at these prices and will show declining production if these conditions persist.

 

Cardboard 

[Packer16]

My measure of profitability is net back not whether they produce oil or gas.  I also adjust production to reflect a 15:1 oil to gas price and even here PWE is more expensive than any of the firms I mentioned.  I think there is an advantage to being a junior here as you can focus your resources on high return formations versus spreading your bets around.  IMO the spreading your bets approach will be hurt in this O&G environment.  It works great when prices are rising but not in a declining or flat environment.  If O&G prices go up then PWE will rise more than the other firms I mentioned but I am not making that bet.  The other firms will do well if prices stay put and get some upside if prices rise.

 

Packer

[plato1976]

if a company goes to zero it is not cheap at any price

 

"I am not pessimistic per se but when you can get companies that have better capital efficiency at prices that are at or lower than Penn West why invest in Penn West.  Wilson has mentioned BXE (which is a combination of an asset with comparability to some of Penn West' better properties and on of the best asset in the Spirit River)"

 

There is not a single E&P company cheaper than PWT other than for some juniors. You guys are comparing a company that produces 70% liquids (PWT) with one that produces 70% natural gas. These normally don`t trade at the same EV/boe/d or EV/boe of reserves due to oil being much more profitable (especially light). So, the price of PWT is much lower than BXE with them currently selling at about the same EV/boe/d.

 

Bellatrix Cardium assets are comparable to the average quality of PWT Cardium assets (not the better ones) and I would say below. Bellatrix had some weak assets in the Cardium and with the trend to move to liquids over the last few years, they bought Angle Energy (was the 2nd largest holder in the Cardium behind PWT if I recall well) which had assets adjacent to them in the Cardium to create efficiency of scale. This is not cream of the crop but, all right.

 

On the other hand, BXE has a terrific asset with Spirit River giving it Returns on Capital Employed similar to Peyto and close to Southwestern. This asset, current price and Orange Capital are key reasons why I have money now in Bellatrix. Orange is very important since Raymond Smith has not demonstrated solid capital allocation (note: I had a substantial position in Angle because it was very cheap and kept most BXE shares on the take-over exchange continuing making good money until Smith issued shares in May 2014 for no reason. It was actually his eventual saving grace without him having a clue about it. Also, very glad it made me get out!)

 

I do not know enough about Gear or RMP to make comments but, Bonavista is another 70% gas producer. It is cheap too and can be compared to BXE. Between the two I have chosen to put my money into BXE.

 

Getting back to PWT, this remains a sum of the part with improving core operations. You have in it a hidden Raging River in the Viking and a Whitecap in the Cardium. And they have lots of optionality with many holdings. Operating costs are showing dramatic improvements and as they liquidate more and more non-core assets, this only gets better. Recent slashing of 35% of employees with most at HQ certainly shows attention to reducing costs. Remember this was a fat and mismanaged organization. It takes time to change the culture but, these tough times are allowing for this to happen.

 

Is there risk of permanent capital loss? Absolutely. If oil remains at $50 or below for a year or two, that is a big problem. However, I would say that it is a big risk for most NA producers. Many are hiding now with their hedges or lower debt levels but, they still make no money at these prices and will show declining production if these conditions persist.

 

Cardboard

[jmp8822]

if a company goes to zero it is not cheap at any price

 

What do you think is the probability of it going to zero? How long would that take?

 

Given the uncertainty in oil prices, would you risk 10-percent of your portfolio, with a 50-percent chance of zero and 50-percent chance of multiplying your 10-percent position by 8X? Put another way, if crude settles at $75 in 12 months, PWE might be worth $4+. And if crude is generally higher than today, the stock-to-zero-risk falls in an exponential fashion.

 

Without the probability estimates, we can't easily assess the risk.

 

If anyone has oil price/stock price, etc. estimates, that might allow a more fine-tuning of the valuation.

 

 

[Wilson-TPC]

I think one needs to figure out the exact capital efficiency. Like I said, that's really the key here. This number determines your cash flow in essence. Penn West looks to have a really shitty capital efficiency number given the amount of capex needed just to keep productions flat. I haven't reached out to IR, but if someone knows the number, please tell me. Penn West tells shareholders absolutely nothing in those slides. Useless slides imo.

 

I suggested to Steve at BXE to include the decline curve and capital efficiency figures. I said, "How can shareholders value you if you don't disclose these two metrics?"

 

Penn West discloses only decline for core assets, but not for non-core. That's not cool. Shareholders have the right to know.

[Liberty]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

[jmp8822]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

[Picasso]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

Maybe it should never have been at $75 when every producer and their uncle was able to make the economics work, much less $100.  The best operators are the diversified and low cost ones because this always freaking happens with every commodity.  Who knows where the mean reversion price is up or down.  I don't see how anyone gets these odds right because not only do you need the price to go up, but you need the price to average $75 or whatever for years.  A quick jump in crude doesn't suddenly make the total discounted cash flows much more valuable.

[Green King]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

I think you'll make more money buying oil futures if you want to make a bet like that.

[Wilson-TPC]

The probability of crude hitting anything above 70 for an extended (longer than 6 months) is highly unlikely, as a lot of struggling producers like Penn West would aggressively hedge for the years out.

 

Quality companies like PXD, EOG, and CLR would bring rigs back online, then markets will take that into account and knock down prices. This will create mini cycles as opposed to long term cycles.

 

Watch this video from Zach Schreiber for more insights.

[Liberty]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

Sure. And why do big moves in either direction need to happen any time soon? Prices stayed low for years, if not decades, many times in the past.

 

I think for any commodity, relatively low prices/margins are more stable than high prices/margins (especially true if you adjust for inflation).

 

As someone else has said, if you want to place bets and speculate on price moves, there are options and future markets for that. If you buy stock in a business, I think you should primarily care about the economics of that particular business and what is under the control of that business' management.

 

One scenario that is just as plausible as any other to me (I have no idea what will happen) is that oil prices stay low for a few years, just long enough for mass-market electric cars to come out (200+ miles range for prices in the $20-30K range) and we enter a new era of demand destruction (it'll ramp up over many years, but it'll have an impact at the margin) just a decade after fracking and directional drilling technology has made it quick and easy to tap more wells and flood the market.

 

Food for thoughts.

[jmp8822]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

I think you'll make more money buying oil futures if you want to make a bet like that.

 

There is more leverage in PWE to rising oil prices, than oil futures, based on the cost of the futures, in my opinion. Futures don't give you that much leverage, relatively speaking to PWE. Also, there is some possibility that if all PWE assets were sold, the NAV per share would be more than the stock price.

[Uccmal]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

I think you'll make more money buying oil futures if you want to make a bet like that.

 

There is more leverage in PWE to rising oil prices, than oil futures, based on the cost of the futures, in my opinion. Futures don't give you that much leverage, relatively speaking to PWE. Also, there is some possibility that if all PWE assets were sold, the NAV per share would be more than the stock price.

 

Also, PWT is a managed flyer on higher oil prices, as are the other examples bought by Packer to the thread. 

[Cardboard]

Why aren't all the worried individuals going out and buying: SPDR S&P Biotech ETF (XBI)?

 

It is not commodities so products can be differentiated. The price keeps going up, so the risk to go zero must be less right? Stay with what has worked.

 

Cardboard

[Uccmal]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

Sure. And why do big moves in either direction need to happen any time soon? Prices stayed low for years, if not decades, many times in the past.

 

I think for any commodity, relatively low prices/margins are more stable than high prices/margins (especially true if you adjust for inflation).

 

As someone else has said, if you want to place bets and speculate on price moves, there are options and future markets for that. If you buy stock in a business, I think you should primarily care about the economics of that particular business and what is under the control of that business' management.

 

One scenario that is just as plausible as any other to me (I have no idea what will happen) is that oil prices stay low for a few years, just long enough for mass-market electric cars to come out (200+ miles range for prices in the $20-30K range) and we enter a new era of demand destruction (it'll ramp up over many years, but it'll have an impact at the margin) just a decade after fracking and directional drilling technology has made it quick and easy to tap more wells and flood the market.

 

Food for thoughts.

 

Re: your last scenario.  These companies can turn off the taps along the way and still make money.  It wont happen that rapidly. 

 

The other part of the scenario you present is the consolidation phase.  PWT would end up being eaten by someone much bigger - hopefully above the present share price. 

 

When I think about XOM, SU, BP, pr Chevron I know who will be the leaders on alt. energy.  We saw the same thing happen when the internet was born in the mid 1990s.  There were hundreds of service providers in Ontario.  Now there are two in Ontario of any consequence - Bell and Rogers.  The same will happen in the energy space. 

 

RE: PWT - my total exposure to this company is <2% of my holdings.  Is that a vote of confidence or a flyer on higher oil prices?  If it triples, it pays my expenses for a year.  If it goes to zero it equals the daily fluctuation in my portfolio - on a quiet day. 

[Liberty]

Why aren't all the worried individuals going out and buying: SPDR S&P Biotech ETF (XBI)?

 

It is not commodities so products can be differentiated. The price keeps going up, so the risk to go zero must be less right? Stay with what has worked.

 

Cardboard

 

I don't think the only choices are PWE or XBI...

[Liberty]

Re: your last scenario.  These companies can turn off the taps along the way and still make money.  It wont happen that rapidly. 

 

The other part of the scenario you present is the consolidation phase.  PWT would end up being eaten by someone much bigger - hopefully above the present share price. 

 

When I think about XOM, SU, BP, pr Chevron I know who will be the leaders on alt. energy.  We saw the same thing happen when the internet was born in the mid 1990s.  There were hundreds of service providers in Ontario.  Now there are two in Ontario of any consequence - Bell and Rogers.  The same will happen in the energy space. 

 

RE: PWT - my total exposure to this company is <2% of my holdings.  Is that a vote of confidence or a flyer on higher oil prices?  If it triples, it pays my expenses for a year.  If it goes to zero it equals the daily fluctuation in my portfolio - on a quiet day.

 

It's possible. It was just one of many scenarios. But assuming that the industry as a whole will be rational and will just turn off the tap seems problematic to me. There's a prisoner's dilemma situation going on, and if anything, the coordination in the industry seems to be going down among the big national players, not up.

 

But your scenario is also certainly plausible. But maybe it all shakes out in a year or two, maybe it takes ten, who knows?

[Packer16]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

I think you'll make more money buying oil futures if you want to make a bet like that.

 

There is more leverage in PWE to rising oil prices, than oil futures, based on the cost of the futures, in my opinion. Futures don't give you that much leverage, relatively speaking to PWE. Also, there is some possibility that if all PWE assets were sold, the NAV per share would be more than the stock price.

 

Also, PWT is a managed flyer on higher oil prices, as are the other examples bought by Packer to the thread.

 

I disagree that the low cost O&G firms are flyers on higher oil prices.  Some of these names (all except Peyto) are cheap based upon today's prices and any upside is gravy.  Given their capital efficiency these guys could become the O&G compounders of the future, similar to Peyto today or Contango before the passing of Ken Peak.

 

Packer

[Uccmal]

if crude settles at $75 in 12 months

 

How do you calculate the probabilities of that? Feels a bit like Commodity Price Roulette to me.

 

I agree - that is what makes valuing commodity-based businesses tough.  But if oil can fall so easily from $100 to $45, why can't it rise back to $75+ in 12 months?

 

I think you'll make more money buying oil futures if you want to make a bet like that.

 

There is more leverage in PWE to rising oil prices, than oil futures, based on the cost of the futures, in my opinion. Futures don't give you that much leverage, relatively speaking to PWE. Also, there is some possibility that if all PWE assets were sold, the NAV per share would be more than the stock price.

 

Also, PWT is a managed flyer on higher oil prices, as are the other examples bought by Packer to the thread.

 

I disagree that the low cost O&G firms are flyers on higher oil prices.  Some of these names (all except Peyto) are cheap based upon today's prices and any upside is gravy.  Given their capital efficiency these guys could become the O&G compounders of the future, similar to Peyto today or Contango before the passing of Ken Peak.

 

Packer

 

For that purpose I already hold Arx and wcp. 

[Cardboard]

Regarding oil, this is not a repeat of 1986. Back then Saudi Arabia was producing around 3.6 million barrels a day down from a production above 10 million in 1980.

 

Today they are maxed out. They have no spare capacity.

 

A ton of big projects were also coming on stream back then: North Sea, Alaska ,etc. These were already funded projects and could not be stopped easily and Saudi Arabia wanted to sell 6 more million barrels a day.

 

Where is the comparison today? Shale is already shut and coming down fast. Oil sands expansion will grind to a halt. Brazil is forecasting half or what they were supposed to produce in 2020. Irak has sent notices to majors to slow spending because they cannot afford their share. I guess it leaves Iran or 500,000 to 1 million barrels a day?

 

The other thing that people do not seem to comprehend is that lifting oil once all infrastructure, drilling and completion has been done is very cheap unless you are operating a stripper well that produces 2 or 3 barrels a day. These are netbacks. That is the cost to extract your ready to go production, not your entire reserves.

 

People that claim that oil can be profitably extracted at these prices in NA are crazy. This excludes any capital to get there. Hence higher prices are needed to obtain positive ROCE and the bankers know that. So forget about shale being some kind of switch that can be simply turned on and off: you need people: gone (you think that they will simply sit and wait after around after being fired for months?), cheap capital: gone and profitable projects/land: more and more gone as they are being used up with high grading.

 

You can mark my words, funding will not be available for a long time or only if hedged and on really low cost projects. This can only mean one thing and that is declining supply.

 

Cardboard

 

[Wilson-TPC]

Regarding oil, this is not a repeat of 1986. Back then Saudi Arabia was producing around 3.6 million barrels a day down from a production above 10 million in 1980.

 

Today they are maxed out. They have no spare capacity.

 

A ton of big projects were also coming on stream back then: North Sea, Alaska ,etc. These were already funded projects and could not be stopped easily and Saudi Arabia wanted to sell 6 more million barrels a day.

 

Where is the comparison today? Shale is already shut and coming down fast. Oil sands expansion will grind to a halt. Brazil is forecasting half or what they were supposed to produce in 2020. Irak has sent notices to majors to slow spending because they cannot afford their share. I guess it leaves Iran or 500,000 to 1 million barrels a day?

 

The other thing that people do not seem to comprehend is that lifting oil once all infrastructure, drilling and completion has been done is very cheap unless you are operating a stripper well that produces 2 or 3 barrels a day. These are netbacks. That is the cost to extract your ready to go production, not your entire reserves.

 

People that claim that oil can be profitably extracted at these prices in NA are crazy. This excludes any capital to get there. Hence higher prices are needed to obtain positive ROCE and the bankers know that. So forget about shale being some kind of switch that can be simply turned on and off: you need people: gone (you think that they will simply sit and wait after around after being fired for months?), cheap capital: gone and profitable projects/land: more and more gone as they are being used up with high grading.

 

You can mark my words, funding will not be available for a long time or only if hedged and on really low cost projects. This can only mean one thing and that is declining supply.

 

Cardboard

 

I disagree with several things you said.

 

OPEC does have spare capacity in the tunes of 2.5 million bbl/d to 3.5 million bbl/d.

 

Private equity capital are abundant and on the sidelines waiting for deals, so cheap capital is still there.

 

This is not to say oil production won't decline. It will, I estimate most of the oversupply to get fixed given current pricing economics by the end of 2016. This is not to say that oil will spike back to 100. I think oil will spike, then fall, spike, fall, as market anticipates potential demand from the Permian, Eagle Ford, and Bakken.

 

I think oil might go back to $60-$70 and fluctuate and overshoot.

 

Looking at Penn West's financials, using Q4 2014 numbers, PWE won't be able to keep productions flat giving current prices. PWE operates currently at a ~C$100 million give or take deficiency. So investors have to figure out, even if oil spikes to C$70, how long can PWE last? My estimates indicate 2.5 - 3 years.