Daily Oil Bulletin posting today Arcan Confident Of Swan Hills Waterflood Potential
By Elsie Ross
With its waterflood infrastructure in place at Ethel in north-central Alberta, Arcan Resources Ltd. is preparing to make the transition from a high-growth junior exploration company to a sustainable light oil producer.
But the transition to a value play from a growth play has not been an easy one for the junior, which is proving up the Swan Hills reef complex, Doug Penner, newly-appointed company president, acknowledged at the company's recent annual meeting. The company's share price has fallen to a 52-week low of $1.53 per share from a high of $7.15 a share in July 2011 as shareholders have expressed concern about debt levels and operating performance and costs.
"Arcan is rich in assets but is not a near term play," he said. "It takes time and capital to develop our properties and there is a lag degree as a result of the waterflood process." In the Swan Hills area, Arcan has 173 (169 net) sections and a drilling inventory of more than 400 potential horizontal drilling locations, with 130 plus wells surveyed and proceeding to license.
Waterfloods, which could increase recovery rates for the 38-41degree API oil to up to 40 per cent from 15 per cent on primary recovery, are the key to maximize the value of the company, resulting in long-life, low-decline assets that underscore a growing net asset value, according to Penner.
The company has made the upfront necessary infrastructure investments in roads, pipeline and injection systems to deliver future reliable production at reasonable costs, shareholders heard.
Deer Mountain No. 2, where Arcan has 9.5 (7.5 net) sections, is nearly fully developed and at Ethel directly to the south the company has received regulatory approval for an enhanced recovery scheme expansion and waterflood implementation is now underway. Arcan has identified 250 potential wells at Ethel and so far has drilled 44 wells. At $90 per bbl WTI, the payout is about one year.
"With any junior company the question is 'Are you building to build or building to sell?'" said Penner, the former executive vice-president and chief financial officer.
Arcan has always been open to approaches, but has been determined to deliver value to shareholders, the meeting heard. "Investors recognize the scope of opportunity in our asset base and they want to see that value recognized," he said. "Above all, therefore, we will not sell this company at fire sale prices."
Over the long term, "we are here to develop that asset and we want to do it right," Penner later told the DOB. "As we continue to do it right, if someone comes with a reasonable price for the value of those assets, then of course we would look at that, but until then we are building to build a good company."
The biggest concern raised with company officials is that Arcan has over-extended itself and that it doesn't have access to capital to continue to grow at the same pace it has achieved to date, he told the meeting.
Arcan's March 31, 2012, net debt to funds from operations (based on annualized first quarter 2012 funds from operations) ratio was 3.6:1.0. However, the major expenditures are behind it and Arcan is implementing a plan to bring its debt ratios back into balance, said Penner.
"Most importantly, we still have financial flexibility that in turn gives us strategic flexibility." Arcan has $130 million drawn on its $200 million credit facility and has two series of debentures with the first due in 2016 and the second in 2018.
The company has been running a process to solicit offers for two of its non-core assets. In addition, it has hedged 2,500 bbls per day of production this year and 2,000 bbls a day for 2013 and 2014.
Arcan also has heard concerns about operational performance, operating costs, downtime, the waterflood process and the company's ability to execute. "Quite frankly, we haven't helped ourselves with our own forecasts of production rates and downtimes," he said. "We haven't achieved our own targets and the market is punishing us for that."
Penner said there remains a great deal of concern about the Swan Hills play performance because of high capital and operating costs. However, "in this regard, we remain 100 per cent confident that this play will show us some value as we begin to reap the rewards of the waterflood strategy," he said. "There has been over 50 years of waterflood use in the field to prove this point as well as independent verification from our reserve auditors GLJ [Petroleum Consultants Ltd.] and our banking syndicate."
The Swan Hills play has been a learning experience for all operators in the region and "we are a lot smarter now than when we started," said Penner. Arcan has taken a number of steps to improve its operational performance and reduce costs, including well costs.
In 2011, Swan Hills operating costs were $21.36 per bbl of oil equivalent but this year they are expected to decline by $9.36 per boe to $12 per boe with the completion of the 18-kilometre Ethel gathering pipeline and the Pembina Pipeline Corporation sales line (a savings of $8.11 per boe) along with the implementation of a pump monitoring system for a $1.25 per boe saving.
Arcan has a 2012 capital budget of between $175 million and $200 million and after an active first quarter in which it spent $106 million, will be moderating its pace and spending within cash flow for the balance of the year.
Plans for the year call for drilling up to 24 new horizontal wells, with up to 30 wells being brought on production. Five wells currently are standing and will be completed and tied in during the third quarter when the roads dry up. As Arcan is budgeting for $90 per bbl (Edmonton par), at a price of $80 per bbl it would drill fewer wells to stay within cash flow.
Production for the year is forecast to average between 6,000 boe per day and 6,500 boe a day.
Arcan had faced land expiry issues at Ethel this year but it now is able to keep nearly all its land for the next year, shareholders heard. The company drilled in the area, and during drilling it also took a number core cutting and samples and other work it normally doesn't do to support a land continuation application, receiving a "very favourable" application.
Board chairman Michael Laffin also acknowledged shareholder concern about Arcan's market value. "While our assets contain significant reserves, they also pose technical and financial challenges," he said. "Arcan has responded to the technical challenges in many ways including investing in infrastructure and hiring some of the brightest technical minds in the industry and our efforts are showing results."
However, financial challenges remain and while Arcan can address some of them such as ensuring it operates within cash flow, "there are others that Arcan will continue to face with the rest of industry," he said.