Precision Drilling

[SharperDingaan]

 

You have to understand that to do oil/ng drilling successfully, you need at least 4 things to come together:

 

- You need a oil/ng field close to an existing pipeline network, & a (preferably nearby) market at the end of it. If the field happens to be in a 'safer' part of the world you also get a pricing premium for 'security of supply'. Market.

 

- You need bankers willing to lend against variable & depleting reserves. If the formation is porous you can suck up all the oil/ng within maybe a 100 foot radius of your holes oil/ng zone, if the formation is tight its maybe 10 feet. The maximum loan is typically no more than 50% of the estimated remaining oil/ng volume in that 10-100 foot radius around that holes oil/ng zone x the estimated oil/ng price over the expected depletion life of the well, discounted at some risk adjusted rate. Geology & Price.

 

- You need technology. Horizontal drilling puts more hole in the oil/ng zone (increasing loanable reserve) & lets you do many holes from one central collection point (reducing infrastructure cost). Fracturing increases porosity (increasing loanable reserve). Water/gas sequester increases reservoir pressure (increasing loanable reserve). Ability & Reputation.

 

- You need reasonable drilling rates. The lower the cost/hole, the more holes/budget, & the better the odds of getting enough economic wells with a total reserve big enough to at least cover the drilling costs. Strategy, Risk Management, Total Cost.

 

 

WRT to Precision Drilling itself

 

- The GW acquisition has made Precision Drilling a 'top of list name' in the Western Canadian & NA Gulf Coast basins. They have proprietary horizontal drilling capability, & pricing power in that speciality. The speciality results in more revenue/well, but dramatically lowers the development cost/loanable reserve ratio, & is applicable to both on and off-shore drilling.

 

- Their NA market is a 'safe' market & commands an indirect 'security of supply' premium. ie: Tar Sands is uneconomic at current prices but is continued because of its size & the security it offers - the ng to power the extractors comes from the Western Canadian basin, using wells that were in part drilled by PDS. A floor to drilling activity.

 

- They have cut drilling rates & retain sufficient CF to cover their obligations. Other drillers will also be forced out of the business before they will, which will bolster that CF. They are increasing market share because of the value advantage to their technology.

 

- The current industry low is a combination of low prices (reducing loanable reserve) & restricted lending under much tighter conditions. Smaller budgets, excess drilling capacity, & cut-throat pricing on 'simpler' wells that don't require sophisticated technology.

 

 

But look forward a few years ...

 

- If oil is USD 60/barrel on average, Tar Sands will be economic, & loan value will increase by 33% [(60/45)-1]. At USD 75/barrel loan value increases by 67%. More money for drilling, spread over fewer drillers, & at a time when a small increase in the price/barrel rapidly increases loan value.

 

- If CO2 sequesture is the green solution to Tar Sands, resevoir pressure will go up & loanable reserves increase. Even more money for drilling.

 

- The drilling increase will come at a time when PDS is more leveraged than normal, which will exaggerate the early eps & significantly improve CF. CF that has then historically gone to debt reduction to significantly reduce risk. Higher EPS, higher multiples, & rapid pricing growth.

 

 

While the symbol will show up on the Graham screens, almost none of the business strength does.

Don't automatically dismiss the cyclical commodities businesses out of hand.

 

SD

 

 

[kyleholmes]

Sharper Dingaan,

 

Very good post... you are very correct on alot of things.

 

One big thing is the fact that alot of oil/gas companies paid very large amounts to acquire there tracts of land/permits that don't last forever and some are making decisions at the present time to either spend the money or forget about the sunk cost and move on.

 

I know that time is running out on alot of them... and that this is on oil/gas executives minds!

 

Even with the "low hanging fruit" gone so to speak, there are many places left that with enhanced oil recovery techniques people are still interested in going after.

 

Frac Technology/ Horizontal Drilling have opened up previously unthought of reserves. These tight formations now make sense. Just ask Southern Saskatchewan! (Disclosure: I am from Saskatchewan) This is also the reason that price of oil/gas should be higher than is today as the cost to produce is much higher than it used to be to get it out of the ground.

 

An important part of most drilling companies is the variable rate worker situation with no severance or anything else.... they work when theres work and thats it. Is not very hard for this industry to park the rigs in the yard and let them sit.

 

Very simple thesis on a company I like right now which is a drilling/service rig company:

 

Lots of Cash and current assets(that are good!) that will have no problem even if rigs move very little

Quality Rigs- Horizantal, top drive, high high power, very new rig fleet(Small service rig and rig moving companent)

No pension/severance- Laid off 37% of workers in past quarter

Rigs if not being worked essentially don't depreciate(or very little) in real economic terms

Debt- Not large or due for 4 yrs... very managable amount with more available

Smart Shareholders- Own approx 40% of the company

Management Team- They know what there doing!

Works in safe market, with loads of oil and gas reserves still left.... and a declining rig count daily!

Depletion rates on oil/gas wells is quite high in most cases, and finding amounts of additional supply to quench the worlds thirst is difficult as we all know.

 

Mr. Market valuing the rigs at 100 million, when really even in todays market a rational oil/gas man would value the equipment more in the 300-600 million range

 

Lots of cash/ receivables to cross desert, and they are hunkering down which is a smart thing to do right now for them. When companies start replacing reserves again(which they have to or they are essentially liquididating) and capacity goes back up, looking at a very attractive investment. The supply/ demand for oil/ gas is mid and long term positive for a drilling company, even if there is short term pain.

 

Heads can't lose(asset values), Tails win big(earning power)

Very cheap dollar bill

 

Not talking my book or anything, but just wanted to let you guys know of some of the opportunities in this sector with little downside, nice upside type investments... even if oil/gas stays relatively flat and demand starts moving downwards(alternatives, etc.) Not trying to be a sector investing(disagree with this idea) but just have seen quite a bit here where you pay nothing for upside and have protection on downside!

 

Happy hunting!

 

 

 

Extra about drilling companies

 

Better have quality rigs!!! This is vital

 

 

 

 

 

 

 

[Uccmal]

Thanks Sharper, I took some time yesterday to review some of the material on their web site and listen to a recent presentation.  Will be doing further due diligence.  It looks like there will be a lag effect before the stock starts to rocket. 

 

It is interesting to see how the next O&G rally is setting up.  Drilling drops way off, gas poduction in particular drops quickly.  At a certain point the price will start to rise rapidly due to low supply and drilling will come into big demand again. 

 

Thanks for you comments as well Kyle. 

[SharperDingaan]

 

The critical things here are (1) Industry Circle of Competency and (2) Investment Circle of Competency.

A Canadian investor also really can't afford to ignore the O/G sector, & for many that means developing (1).

 

Most folks haven't realized the BS devastation.

1,000,000 bbl @ 60/bbl & 50% LTV produces 30M of LV; a senior coy might typically borrow 2/3 of the LV (20M), a junior might borrow 3/4 (22.5M). The same calc at 45/bbl reduces LV to 22.5M, leaving very little borrow room for a senior & nothing for a junior - & all this before depletion & marginal production cost considerations. Very few funds available.

 

Most folks haven't realized what drill-it-or-loose-it really means.

For many - if they dont drill the leases, the alternative lease write-downs are big enough to adversely affect debt ratios & trigger early debt repayments. Upcoming 2010 IFRS reporting is having an impact, & while depletion/depreciation can fund some of that drilling, you really need new capital (Alta Treasury Board). Robust floor level.

 

Most folks haven't realized what the Tar Sands greening implications really are.

- 40-50% of produced Alta ng goes to Tar Sands. Change the furnace fuel source & this will immediately displace into the market. Extended periods of low & stable ng prices.

- One of the quickest hits is high temp waste oil & plastics inceneration. ie: Burn the garbage, blow air/oxygen into the fuel stream to increase the temp/efficiency, & get paid to take it away.

- One of the best long term hits is nukes in the lower territories. Extremely stable geology, electricity to open up the North & feed the upgrader H requirements. Newfoundland & James Bay all over again.

- Green infrastructure, funded independently, & with very real industry impacts.

 

Lots of opportunities, but it has to be viewed a little differently  ;)

 

SD

 

 

[Myth465]

Does the debt and the purchase of grey wolf not bother you? Seems like Management didnt do a good job of capital allocation.

 

Also what do you think of HP. That was my main go to stock for land drillers due to the quality of there rigs. Offshore its definitely ESV due to the nice rigs, high ROIC and Margins, and no debt.

[kyleholmes]

It is interesting to see how the next O&G rally is setting up.  Drilling drops way off, gas poduction in particular drops quickly.  At a certain point the price will start to rise rapidly due to low supply and drilling will come into big demand again.

 

Uccmal your absolutely right on this... oil/gas service companies can hunker down quite fast in most situations and if they have quality assets, absense of liabilities and a solid financial situation to 'cross the desert' you have a high probability for success.

 

The company I was talking about is one that Marty Whitman owns 22% or so percent and that Carlos Slim is buying pretty much daily(over 4 million shares now) in Bronco Drilling. Forget that they own it and digest the material yourself, but these rigs are incredible for that price, they are financially sound and have an absense of liabilities... not only that really like how the guys who are running it think.

 

Other drilling companies that have some very good management helping them through these tough times-

 

Nabors Industries- Marty Whitman

Diamond Offshore- Tisch Brothers

Ensign Drilling- Murray Edwards (Our western canadian genius!)

Goober Drilling- Leucadia(Not publicly held)

 

Oil/Gas service business is a boom/bust type business that you better build a war chest in the boom, as you are certain that there will be a time coming that your equipment doesn't leave the yard for an extended period of time. Incredible amounts of money can be made though in booms, and it's just a matter of time before prices rise due to supply problems, causing these companies to be running at high capacity again.

 

 

[SharperDingaan]

 

Myth

 

Our intent is only to highlight the opportunity.

While we hold a long position in PDS we would prefer that folks do their own DD, & that we not talk up the book.

 

Overall we see the GW acquisition as being a good thing, but recognize that the timing couldn't have been worse. It'll be talked about for years - but the real value add is the fact that they went ahead with it. O&G is a small community, with long memories -  & like an UW paying out out a big claim, being seen to make good on your commitments (when it clearly hurt) will take you a very long way. Goodwill that doesn't show up on the BS.

 

At todays price the risks are pretty much priced in. If it goes to $35-40 a share, paying $3-5 today really doesn`t matter.

 

Best of luck to you

 

SD

 

 

 

 

 

 

 

[kyleholmes]

If you want to truly understand the oil/gas supply/demand problem I would suggest listening to Mathew Simmons... he has a great book out called "Twilight in the Desert" that I am sure most of you know about.

 

Here is a couple links that I think are important:

 

 

http://www.simmonsco-intl.com/files/Commercial%20Club%20of%20Boston.pdf

http://www.simmonsco-intl.com/

 

Went from wood to coal to oil... not sure what future brings but know that it will not be for awhile and that even with the addition supply brought on from other forms of energy, the declining supply of oil/gas will make it so we need everything we can get! I however don't make macro predictions or invest that way but if you don't have to pay for any of that upside that you think there is a good chance of happening, and you got your downside protected, you got great odds of success!

[Kiltacular]

If you guys are interested in this space, you might also want to check out helmerich and payne (HP).

 

They've got a much newer stable of rigs which work terrifically in horizontal stuff -- they call them Flex Rigs (there's more than one generation).  My take is that they're the last to be stacked.  Company has solid management, in my opinion.  Nothing egregious on options, family run, they've got some reasonably sized stakes in Atwood and SLB which they were selling at when they were 3 times as high.

 

Here's their latest presentation for good, if quick, primer: http://library.corporate-ir.net/library/10/101/101650/items/326418/9CD8C332-6780-492A-A15E-9FBB1EB7BD65_22709_Presentation.pdf

 

kiltacular

[netnet]

My problem with PDS is the debt load, particularly in this environment. 

[JAllen]

The disparity in valuations between the aforementioned companies is huge.  Some of the larger ones that have been mentioned sell at 1-3 times book.

 

I think their contracted 80 rigs should cover their interest (no maturities for 4 years I believe) but I'm not sure about their other fixed costs.

[ValueBuff]

As long as PD can handle the debt load...i wouldnt worry about it. 

 

If we do get inflation down the road, the debt would be a benefit.  Inflationary earnings would pay down the debt quicker as it is static.

 

inflation would make oil higher, and thus more drilling.

[alertmeipp]

The bridge loan is expensive but worst case it will turn into long term debt due in 6 years from end of 09.

[netnet]

I must confess I haven't done a bit of work on this name, but the lender on the bridge is going to allow them to roll it into a term? What kind of rate are they paying on it.  It must be ghastly expensive. 

 

Cursory inspection as to cash on hand seems as if they do not have the cash to cover, so then you have to figure how far down is there cash flow going to go?

[JAllen]

The bridge loan is 17%

 

:o

[ValueBuff]

did they not payoff their bridge loan with the equity issue recently?

[woodstove]

Precision still has a large chunk of the bridge loan, which was intended to be refinanced as LT debt, but they could not get reasonable interest rates (and perhaps terms) for refinancing - comment made in recent presentation that no point to refinancing at 16 pct.

 

Useful info at presentation - audio plus overheads http://remotecontrol.jetstreammedia.com/15947

 

Pages towards end of overheads have current capitalization info.

 

Added in edit- my mistake above, it now seems to me that the capital raise was to retire the Grey Wolf convertible notes, and since there was no debt component of captal raise, the bridge loan amount actually increased.  Presently $235m.

[JAllen]

 

 

What kind of utilization rates/EBITDA forecasts for this year are you guys thinking of? 

 

They need about $150M (assuming ~11% average interest) and have various ways of paying this interest assuming EBITDA plummets.

 

The combined entities are capable of producing $400-700M in run-rate EBITDA but I am trying to be conservative on what I think it will be this year because frankly I don't know.  One has to assume a very very dire scenario for 2009 but it seems like we are in a dire scenario.  The required CAPEX is another cash need and I'm not sure how that should be thought of because they are all contracted for. 

 

So, assuming $150M of interest plus $239M in CAPEX plus ~$20M in G&A they have at least $409M of cash needs for 09'. Some of the maintenance capex can probably be postponed. 

 

How are others thinking about this?

[SharperDingaan]

 

Its better to think of now through Oct'09 ... & then the 2009/10 drilling season.

 

Assume that from now through Oct'09 Capex is 25% of run-rate, with the difference going to debt reduction. The only new-build being horizontal rigs, which should now cost less.

 

Model the drilling season on different rig counts (-20%,+20%,+40%, etc) & different drill rates. Assume a wider P(x) spread for the various options, & that their market share remains constant. Rig count will be driven by oil/ng prices, state/provincial stimulation packages, lease requirements, etc.

 

Then keep in mind that o/g service coy valuations are characteristically volatile because the business can change so rapidly.