The great AIMco SNAFU - Part Two AIMco is a pension fund investment manager. Like most investment managers, it usually sticks to taking minor stakes in ventures that are initiated and run by outside entrepreneurs who have some expertise in the field. Generally, the hope is that these entrepreneurs will know what they doing and will do what they promised. This has the decided advantage that the investment manager can take credit when things go right, blame someone else when things go wrong and have no responsibility for cleaning up any messes. So when AIMco decided to play entrepreneur in putting Chinook Energy together then they should have also been aware that investors would expect them to still be around when things started falling apart.
Chinook Energy came into being in 2010 with AIMco as its original principal backer. AIMco provided interim financing to put it together and placed its shares among its clients at $3.00 to $3.25 a share. Chinook was subsequently listed on The Toronto Stock Exchange as CKE and made its debut at about $2.42 a share. It is now trading at less the 6c a share.
AIMco has over $100 billion under administration. With only $5 million to show for their original $250 million investment, CKE may now be nothing more than a nuisance best swept out the door as soon as possible. But among the hundreds of ordinary shareholders who bought CKE shares, banking perhaps on the fact that AIMco was behind it, it could remain a significant investment. AIMco is not some basement boiler room outfit. At its roots, AIMco is a department of the Alberta government. The people who work there might hate to admit this, but fundamentally they are civil servants and, despite their smart suits and fancy titles, they are beholden to best serve the public they work for. Investors are entitled to expect that in the process of winding down CKE, AIMco will treat all shareholders with a high degree of respect, integrity and fairness. There should be no preferred treatment given to the folks they might hang out with down at the Petroleum Club shooting cuffs and exchanging golf scores.
AIMco controls who gets to be on the board of CKE. It’s their votes that keep each director in office. It would be one thing if the present state affairs at CKE was due solely to events outside the control of the present board but it was not. Since end 2017 CKE quarterly reports have told a sorry tale of one catastrophe after another - if wasn’t a landslide here, then a pipeline had burst there or a processing plant was down somewhere else. All producers suffered from low Station 2 prices. No question, these factors were all outside the control of the board. But there is one matter that received little if any mention in any CKE reports until Q4 2018. That is an issue that was entirely under the Board’s control and had a significant effect on the profitability of CKE for the past three years and will affect their profitability for the year to come. Egress rights or the advance booking of pipeline capacity required to ship production to the market. This is not just my opinion - CKE admits to it in their Q4 2018 report.
Our operating netbacks decreased during the current reporting periods compared to the same periods of 2018. Given the extent of restrictions to limit our production sold at depressed BC Station 2 pricing, in addition to third party outages, the current reporting periods’ operating netbacks are not representative of the profitability of our operations. These restrictions limited production to levels required by our firm pipeline capacity and processing contracts. The extent of these production restrictions also had the effect of increasing fixed operating costs, on a boe basis, relative to total operating costs.
Securing pipeline capacity rights was universally the most important issue facing Montney producers for the last three years. Read their reports and you see that problem was being recognized in early 2017. Every listed gas producer in Montney, except for CKE, kept their shareholders regularly informed on the provisions they had made to secure future capacity - particularly to Chicago where the prices were significantly higher than Station 2. Among those reporting were CKE neighbours whose production was also affected, to one degree or another, by the same infrastructure failures that CKE had to endure. The significant difference is that CKE neighbours seem to have had the foresight to secure advance pipeline capacity contracts (particularly to Chicago), while CKE apparently did not. The comparative results between Q4 2016 and Q3 2019 growth and operating netbacks should speak for themselves.
| | Storm Resources | Saguaro Resources | Black Swan | Chinook |
| | | | | |
| Production Q4 2016 BOE/D | 13,320 | 12,000 | 14,692 | 3,030 |
| Netback Q4 2016 | 12.93 | 9.80 | 13.63 | 5.21 |
| Production Q3 2019 BOE/D | 18,596 | 17,242 | 23,514* | 2,256 |
| Netback Q3 2019 | 6.84 | 10.96 | 4.43* | (3.65) |
*Q2
It seems that it was not until late 2018 that CKE finally got round to obtain some long term pipeline capacity to Chicago. At this point, they were able to secure, by my calculation approximately 1,600 boe/d. If I am correct on this you will see (if you read on and as the above results show) that this was less than adequate to serve CKE potential production. Add to this they probably had to pay top dollar to get these rights so late in the game.
The Board of CKE cannot blame anyone else for this. The responsibility for this sits squarely and solely on their shoulders. Is this why investors have not been regularly kept informed about this issue?
There is no doubt CKE operations were negatively affected by the failure to obtain these egress contracts. The question then is, how much damage was done? To determine this one needs to how much potential production was shut in and will be shut in from its existing wells. Here again CKE shareholders have, to my mind, been kept in the dark about an important issue. Reading the managements reports investors could be led to assume CKE maximum potential production is about 4,000 to 5,000 boe/d. If investors were to make this assumptionthen they may be wrong. By my estimation it could be double this.
Pararmount, which keeps it shareholders informed on such matters, recently reported averaged gross peak 30-day production of 1,198 boe/d per well from its 11 wells in the Montney. Insofar as CKE 13 (11.23 net) wells in Brierly have hardly been pumped, it would be reasonable to assume the maximum peak production from these wells could be close to 10,000 Boe/d based on their original IP90 projection of 890 Boe/d per well. This would correspond to CKE own projection of peak production of 9,506 Boe/d given in their May 2017 presentation. To this one could add perhaps another 1,000 plus boe/d from the 54 (?) producing vertical wells at Martin Creek - also presumably currently shut-in because of lack of egress contracts. If one values just the Brierly field at $4,500 per boe/d or $4 million per well (both values may be on the conservative side) then the Brierly field alone has a value of about $45 million - or over 22c per CKE share - well above the 6c CKE where is trading now. So why are investors and potential investors not being better informed about this?
By my analysis, CKE has a realistic break-up value of over a $1.00. One of the assets that contributes to this sum is a little known balance sheet item - $357 million of “deferred tax assets” - potential tax benefits to an acquirer of CKE derived from prior losses. Putting a value on this requires a complex and variable analysis - but for this post it could be reasonable to assume a value of 20c a share if CKE is sold as a continuing entity - its shares being acquired (voluntarily or compulsorily) from the existing shareholders. Here is what makes me uncomfortable about this. If CKE is acquired as a continuing entity then the existing directors would probably retain the options rights they have awarded to themselves and management. Each director has 533,800 in options while CEO Walter Vrataric has been awarded almost 3 million. If CKE is taken over as a going entity, then each of the options could worth as much as a $1 apiece depending on how cheaply CKE is acquired. At this time ordinary shareholders might consider themselves lucky to get just 10c a share based on the trading price of CKE for the last 90 days. This would result in the ironic situation that the very people who may have been partly responsible for its problems could stand to reap millions on options that cost them nothing. In contrast, the previous ordinary shareholders would be left licking their wounds and counting the pennies left from the cash they had invested. One day a decision will have to made as to whether the sale of CKE should best be by way of the sale of its component parts separately or by way of the company as a whole. Herein could lie a clear conflict of interest between the interests of the board, who get to decide this, and the ordinary shareholders. This issue needs to be urgently resolved now.
This whole situation with CKE is a SNAFU but it is soluble. Here is what AIMco could do to put matters right track again.
(a) Given that AIMco provided the interim financing to put CKE together in the first place, they could, for a short term, guarantee its line of credit to stop it from falling apart.
(b) AIMco should ascertain that no scenario exists by which members of the board could secure for themselves a financial advantage by agreeing to a takeover of the company instead of the sale of its separate assets. If the is any such potential conflict exists, then the strategic review committee should be replaced by other shareholders including a representative from AIMco
(c) CKE should publish as an Information Circular a making a fully transparent disclosure of all CKE assets and liabilities. This information should be presented so that both in its detail and form ordinary shareholders and potential acquirers would be able to derive at least a rough estimate of its value - both as a whole and in its components .
In my next post I will be writing an open letter to the Chair of CKE, Ms Jill T. Angevine. In this I will ask her some questions about these matters and on several other issues where I believe CKE shareholders could be better informed. If she replies, it could make for some interesting reading. But don’t hold out your hopes. She never replied to my letter of February 28, 2018 asking “what, if any, commitments has CKE secured for pipeline space for 2018 and beyond”
If you are an ordinary shareholder and share my concerns, there is one thing that you could do to ensure that we, the ordinary shareholders, are going to be treated fairly. Write to AIMco requesting they take proper responsibility for this. You can express your own concerns write or just send them a copy of this post. The more people who do so the better the chance they will start focussing on these issues. The head of communications is Denes Nemeth - denes.nemeth@aimco.alberta.ca - or if you are on Linked In you have several more choices. One is Peter Pontikes is Executive Vice President Public Entities - but who knows manages the CKE file. Whoever it is might want to dust it off and start giving it some attention. With only $5 million at stake, CKE might not mean much to AIMco, but let me assure them that it stills mean a lot to the ordinary shareholders, both the lucky ones who got out early and the not so lucky ones still in it.