The Energy Report: Bruce, the price of natural gas has remained well below $4 per thousand cubic feet ($4/Mcf). How long can junior and midcap explorers and producers (E&Ps) of natural gas keep on going at this rate?
Bruce Edgelow: They're in a better place than they were a year before. The marketplace is—and I'll hesitantly use the word—"enjoying" about a 45–50% increase in prices year over year. This new price is, for the most part, bringing producers back to a break-even or a modest return on cash flow. However, they clearly need a more robust price to generate the returns that the market expects of them.
TER: The spread between West Texas Intermediate (WTI) and Brent Crude prices has narrowed to just a few dollars per barrel. How is that affecting the crude E&Ps?
BE: We've been up over $100 per barrel ($100/bbl) for a while, and healthy crude prices and the narrowing even of the heavier differential price have restored, by and large, a more robust profitability to that market.
If there's one part of the market that is benefiting more from these trends, it would be either the liquids-rich natural gas producers, which benefit from strong crude prices, or the oil sands producers, which are up because the differential is narrowed and crude prices in general are up. Some companies have locked forward prices to make sure that in the next 12–24 months they can enjoy the strip pricing, and I think those market players are enjoying a little bit more of investor interest.
TER: Last January, U.S. oil consumption hit a 16-year low, but it has shot up again this summer. How are E&Ps responding to these signals?
BE: Some companies are hedging to reduce some of the near-term "noise," issues like storage levels, the near-term political climate or the latest economic forecast. But the longer-term market is much more important to a company's strategy.
TER: How is U.S. fiscal policy affecting the investment climate for the junior and the midcap E&Ps?
BE: In Canada, we're trying to solve things in our own space. We're in a capital-constrained environment. It's hard to say what is driving all of that, but when you look at the near-term production gains that the U.S. has enjoyed, like in North Dakota and other fields, the reliance on the Canadian producer has clearly been muted. I'm not sure that I would blame that on fiscal policy, but clearly the overall trend of the U.S. being a bit more reliant on its own reserves is something that we're very mindful of in the Canadian market.
TER: The oil and gas industry is facing a number of technical and environmental challenges, including the oil spill at Canadian Natural Resources Ltd.'s (CNQ:TSX; CNQ:NYSE) Primrose site and controversy over the environmental effects of hydraulic fracturing. In an interview with The Energy Report two years ago, you expressed confidence that technology advances would eliminate many of these challenges. Are you still optimistic about that?
BE: Very much so. We have a continued lens on the environment and yes, the Canadian Natural spill took place. There's been pipeline disruption. There have been incidents around the North American market, including the rail disaster in Québec. Nonetheless, technology is allowing us to do things differently. It's also allowing us to clean things up much more quickly than ever before. We're using different tools and chemical solutions as well as better satellite and Supervisory Control And Data Acquisition (SCADA) reporting to react quicker when spills do take place. We're not sitting idle and unaware. We're doing things today in cleanup and monitoring that would not have been possible five or 10 years ago. From our point of view, the oil and gas space is well monitored, well regulated and the technology is still our dearest and closest friend.
TER: Technology advances have transformed oil and gas development especially in recent years with fracturing of shale beds, but they've also raised the bar for succeeding because of the higher costs. How is this affecting E&Ps?
BE: The higher costs are clearly relevant. However, from a net-barrels-in-place perspective, things that we were able to do for $1.5 million ($1.5M) five years ago are now costing easily as much as three times that. Where five years ago, you might have been able to do six to seven wells for that $10M, now you barely can do three wells, or even just two, including the purchase of the land. We need to have companies that are able to attract larger pools of capital.
We're seeing certain entities with significant management teams that are able to do it. Companies like Tourmaline Oil Corp. (TOU:TSX) or Paramount Resources Ltd. (POU:TSX) are able to raise capital, put together large resource plays and generate the best-in-class returns that investors are looking for. On the intermediate side, Yangarra Resources Ltd. (YGR:TSX.V), another junior, has generated the returns without even an equity raise.
TER: Will juniors and midcap companies have the resources to participate in that smaller field of investment?
BE: Yes, but on a very selective basis. Equity investments in the Canadian public market up to May 31, 2013, weighed in at $1.3 billion ($1.3B) in new capital raised, compared against $3.3B in the year prior—a significant reduction. Of that $3.3B that had been raised, a large concentration was available for less than 10 names. These would be companies that have put together well-respected teams and have a track record of success, a land base and a diverse asset program to generate the returns. The market sees them as capable of generating those results, even with high-cost wells. That trend has not changed appreciably since the end of May.
TER: It sounds like a number of companies are being left out and possibly becoming takeout targets. Is that the case? And, who would they be?
BE: Without naming individual companies, I think there are more companies today on the TSX or the Venture that are trading at or near 52-week lows versus 52-week highs. Even investors on the private side see the need for further consolidation for economies of scale and judicious use of capital. Tamarack Valley Energy Ltd. (TVE:TSX.V) was recently named as an individual company that was looking for a merger candidate—a merger of equals—to consolidate and create a larger base investors would be interested in putting capital into.
We're hopeful that companies will be nimble and proactive because that's what the market is looking for. Those with the capital are telling us they will hold out for those opportunities.
TER: What companies then would be looking to make acquisitions? You mentioned Tamarack—a merger of equals—but perhaps others that are looking to buy out?
BE: Whitecap Resources Inc. (WCP:TSX.V) is one; over the last 12–18 months it has been very strategic either in acquiring reserves or in corporate activity. It has recognized opportunities to make reasonable market offers to companies that may be stalled, and it has been able to entice them, on a share exchange basis, to take the new paper to the old shareholders and achieve some pretty good returns. Again, I mentioned Tourmaline; Mike Rose and his team have been very successful in consolidating their core area and acquiring companies and/or reserves.
TER: For several years, new fields like the Bakken, the Marcellus and the Eagle Ford were being added to the North American oil patch. E&Ps were flocking to them. Is the gold rush over or is there another chapter to be written?
BE: No, through the ongoing use of technology, we're able to go downhole and do things in that region that we've not been able to before. For example, the carbonates within the oil sands basins are the new sources of reserves, and technology allows us to tap into that. If we continue to be successful in booking those reserves through the standard engineering protocol, we may be surprised where we stand one day when they all get added up. There's also a fair amount of work taking place in some of the large reserves that have been active since the 1945s or 1950s, where companies are now going into the deeper reservoir.
We're seeing companies go back into uphole regions that were not accessible before current technology became available. We think we'll continue to see new fields or the resurrection of old ones.
TER: Well completions in the Western Canadian Sedimentary Basin have fallen off quite a bit from their 2006 high. They remain about half of what they were then. Is this now the sustainable level?
BE: Yes, because when you look at numbers of completions, what you need to look at are the initial production (IP) rates. While the number of completions may be down, the IP rates coming out of the completions are significantly different, a multiple of historical rates from three to five years ago simply because of the use of horizontal and multistage fracturing. The new way of drilling and completing will make us very sustainable and more productive. It's not necessarily the number of wells completed, but what we're getting per wellbore, and those numbers are inversely related.
It's an encouraging time in the basin, where the net recoverables on primary production are offsetting the increased cost to do the work. The size of the prize is worth the investment in a lot of cases. But you need to have good well control and understand what you're doing downhole. It's not without its risks, but with the right science team and capital, companies have reaped rewards from it.
TER: What do you see as major challenges and concerns facing the oil and gas industry, and how can the industry address them?
BE: The major challenge is getting a made-in-Canada solution for production, both of natural gas and oil. For example, today there are two very large refineries in the East Coast on the St. Lawrence seaboard, which are currently bringing in North Sea Brent because they don't have access to other crude, and they're paying North Sea Brent prices. We need to get a stronger Canadian base to those refineries for processing. The Energy East Pipeline that was recently announced by TransCanada will be a big part of that solution.
Being able to consolidate and generate more reasonable returns for the shareholder base is another challenge, because a lot of individuals have their wellbeing tied up in an oil patch, and if they become the casualty of consolidation, i.e., they're not employed by the new consolidated company, there is a lack of incentive. A lot of these people are bright, young individuals who still have to establish their net worth and raise their own families. Those are not easy decisions make, if you want to do the right things for your shareholders.
Those are some of the challenges that we're going to be faced with, deciding who should be the last one standing in those corporations and who should be running them and how to create that economy of scale.
TER: To conclude, do you have any favorite companies that you'd like to highlight?
BE: We look at companies that have done really well. We talked about Tourmaline and what its team has done. Paramount has been amazing at putting programs in place. Bellatrix Exploration Ltd. (BXE:TSX) has recently done some really nice joint ventures both on the international and the domestic front to continue to maximize its activity. Crew Energy Inc. (CR:TSX) has been a consolidator, picking up new areas for continued exploitation of the Montney. Yangarra's got a nice little resource play that it's working on. Whitecap has been a real consolidator and has a great team that is capable of doing more. That would just be a smattering of names that we've been looking at and we're quite pleased to see their progress.
TER: That's great. I've gotten a lot out of this. I appreciate your time.
BE: Pleasure chatting with you.
As vice president of the energy group, Bruce Edgelow is responsible for helping to build ATB Financial's energy business and capabilities. His team consists of specialists in all aspects of the energy industry, including: drilling and service, pipelines, utilities, midstream, exploration and production. Before joining ATB, Bruce was a senior Royal banker and has more than 39 years of experience with a focus on the oil and gas industry.
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DISCLOSURE:
1) Tom Armistead conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family owns shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Bruce Edgelow: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Whitecap Resources Inc., Tamarack Valley Energy Ltd., Yangarra Resources Ltd., Paramount Resources Ltd., Bellatrix Exploration Ltd. and Tourmaline Oil Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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