Kicking Horse Energy Inc. V.CEX

Kicking Horse doing a Saudi Arabia

[Valueinvestor9]

Kicking Horse doing a Saudi Arabia


When the collapse of the oil prices started, in the summer of 2014, everyone noticed that Saudi Arabia was not playing their traditional role of "swing producers", that is varying their production in such a way to maintain reasonably constant prices. Facing a slump in demand, they should have reduced production; but they didn't.

Initially, I thought the Saudis were simply taken by surprise and they were slow to react. But now, with the recent increase in Saudi production, it is clear that they have something in mind. Maybe they haven't engineered the market collapse, but in some way they are riding it.

Though this be madness, yet there is method in it. But what method could there be in raising production just when prices are lowest? Every single textbook in economics will tell you that the market should adapt to changes in demand and offer in exactly the opposite way: facing a reduced demand, production should go down, too. But if you have high debt as with Kicking Horse you have no choice to feed the machine and keep producing. Kicking Horse is like a hamster in a wheel, it must keep running because if it stops it will not be able to pay overheads and its debt.

Of course, as we all know, what you read in textbooks of economics has little to do with the real world. And, in the real world, there is a well known market strategy that consists in bankrupting your competitors by selling below cost. The idea is to create a monopoly and recoup later what the winner of the struggle has lost at the beginning. It is, of course, illegal, but the very fact that there are laws against it, means that it is done. Problem is that Kicking Horse does not have the balance sheet of Saudi Arabia, and it is not going to drive any competitor out of the market.

However, there is a little problem in applying this strategy to the oil market. It has to do with the fact that oil is a finite resource. So, if producers manage to obtain a monopoly, that means they will run out of the resource before the others. Imagine you are an art dealer: would you sell your Picassos at low cost in order to undercut the other art merchants and gain a monopoly? Of course not, what you would obtain is simply to run out fast of your precious Picasso paintings and then leave the market fully open to the others. This is exactly what is facing Kicking Horse, they are depleting their resource at a rapid rate, and at a commodity price that does not yield potentially a profit. Do you understand, that they are just producing the wells to feed the machine. When the oil and gas is depleted then what do they do? Drill some more wells? With what, as they have been just producing at likely a loss. Remember, the Alberta Gov. takes a cut, there is a Gross Override that takes a cut, there a processing and operating fees that take a cut, and then there a management fees and overheads that take a cut. What is left, not likely too much.

So, what are the Saudis doing, exactly? Art Berman suggests that they are fighting against the banks that created the tight oil bubble possible. After the elimination of the bubble, the market might return to relatively high oil prices and maximize the revenues for Saudi Aramco. Problem is that Kicking Horse may not be able to last that long. Talk on the street is that Kicking Horse may be down year on year approximately 50% on net revenue when comparing similar production. The next quarter is coming up and everyone is looking to see how bad the numbers will be.

Berman's interpretation is surely possible, but, as in all these cases, we are looking at governments as if they were "black boxes", trying to understand the inner mechanisms that make them move. This is very risky: just as we see in clouds faces that aren't there, we may see in a government's actions a plan that is not there. Are the Saudis really planning for a long term profit? Or are they simply misjudging the extent of their resources? Are the Saudi’s just depleting a non-renewable resource? In my humble opinion, the strategy is not logical. Long term US producers will reinitiate drilling and production the moment the window is open again. We are in a long term cycle of lower commodity prices, and those companies and countries that have relied on higher commodity prices to survive will definitely struggle. As mentioned in previous blogs, October and November will be telling months in Canada and January and February will be telling months in the United States. Companies with high debt will be subject to significant pressure and likely credit line reduction. Look only to be invested in companies with management teams that have the strength to financing in a challenged market. Kicking Horse has not demonstrated the ability to access capital in a significant way. I will not repeat all the facts that make this company in my humble opinion a higher risk investment, but ask investors to do their own due diligence. Do your homework on this company, and understand the risks.
There are several examples of non-renewable resources having been managed as if they were infinite. Just consider how the North Sea oil was extracted at the highest possible rate when the oil market was experiencing historically low prices. That left producers with declining oil fields when market prices started increasing. It was not a very smart strategy, to say the least.

In the case of the North sea, there was no long term planning; it was just that the long term depletion problem was not understood. So, are the Saudis and Kicking Horse blind to the very concept of "depletion"? That's impossible to say at present. The only certain fact is that age of cheap oil is gone; even though some wild oscillations may make us believe that the good times have returned - but just for a while. When you have produced a well and sold the commodity at a net loss, what would make you think the business model is sustainable.
Food for thought in these challenging times.

For the employee the word of the day is: exactitude