Surviving in Today's Unprecedented World - What's VII to Do?Surviving in Today’s Unprecedented World- What is VII to do?
In 1986 when I was a boy engineer, we laid off 50% of our staff about one week after the challenger blew up. You tend to remember these events vividly. The dramatic drop in prices unleashed a frenzied scramble to a) keep the lights on and b) cut all uneconomic production. We eventually shut-in about 500 wells and kept up well by well cost analyses for about two years. Given the continued insistence of SA to flood the market the worst is likely to come as forecast by many pundits. I would imagine that every oil company in Calgary and in the US is looking at operating costs, capital expenditures, interest coverage, G&A and contractual commitments (i.e. transportation).
The continued drop in prices has moved us into survival mode as witnessed by Jason Kenney’s recent comments. Thirty dollars WTI has marginally OK, but $23 (at the time of writing) with the prospect sub 20 or even in the low teens is a whole nother ball game in which it is time for really decisive action (unless of course you think the Saud’s will cave. I think not as MBS is trillionaire with total control – money probably means nothing to him. He won’t change his time until he feels his crown and head is threatened. That could take three to six months or more). The problem will then be working off the surplus.
I think the biggest threat to Alberta, and VII is the price of WCS. Currently there is about a $13 per bbl differential. Condy is trading roughly on par with WTI. The problem simply is that at $12 per bbl, it is uneconomic to produce WCS. Fortunately, WCS has a captive market in the northern tier refineries, who are tooled up to run heavy blends. They cannot substitute light crudes quickly or efficiently. When Alberta instituted mandatory shut-in, Mayan blends filled the gap at WTI plus as much as $15.
As in 1986, all heavy oil producers are now in the process of evaluating every well and property and will shut-in expensive production. I’m guessing but we could see as much as 500,000 or more bblpd shut-in. This would have a positive benefit by potentially reducing the differential and allowing the Alberta industry to survive. The knock-on effect to VII (and NVA, Chevron and Encana) would be reduced demand for Condy leading to a differential to WTI of up 15%.
Over the next few months prices, differentials and production will gyrate wildly in the WCSB. Not all companies will survive, especially those with high debt loads per BOE (BTE at 5+ is at risk, VII at $1.90 per BOE is not). But the light at the end of tunnel is that as indicated by TD, the entire market is oversold and under valued based on fundamentals, especially E&P companies. Even SU and CNQ are trading well below book.
So, what is VII to do? As I see it, they have two choices. The first is to stay the course with a $900 million budget with annual production of 182,500 boepd and ride with prices. In this option they risk exposing themselves to a draw on debt. The second is more drastic and cuts capex to $250 million with production averaging 145,000 boe per day (it could be higher with less new production and more vintage production).
What would this look like? In both cases I assume that the first three months of the year are at historical prices ( they should have free cash flow in Q-1) with much lower prices in Q-2 through Q-4 with WTI at $20 and Condy at 85% of WTI ( $25 Cdn), natural gas at $1.45 Nymex ($2.15 Cdn) and NGL’s at $10 per bbl. I include $5.75 per boe for hedges and all-in operating and corporate expenses of $16.25 per boe. In case two I cut back capex to $250 Million which essentially shuts down the capital program. To Summarize following are the relevant metrics:
Metric Case 1 Case 2
Capital ($MM) 900 250
Revenue ($B) 1.57 1.17
Cash Flow Q-1 ($MM) 298 298
Cash Flow Q2-Q4 297 231
Total cash Flow($MM) 584 528
Netback Q-1 ($/boe) 18.3 18.3
Netback Q2-Q4($/boe) 5.82 5.82
Debt draw ($MM) (316) Nil
Free Cash Flow ($MM) (316) 278
Note: each $/boe represents a gain or loss of $49 million revenue in Q2-Q4 in case 1.
Should prices continue their collapse and events unfold as I have outlined in case 2, even though it is counter intuitive, the best course of action to preserve the balance sheet and preserve debt for future use is to curtail all capex past April 1. If prices drop this much, I think the market will reward VIII for taking a bold step. To simply high-grade locations and carry on in low price environment is to waste your most valuable reserves and essentially give then away while piling up debt.
The one good thing about shale resources is that they can be turned on and off quickly. As we have seen from VII it was relatively easy to jump from 150,000 boepd to 200,00 boepd. They can do it again as the resource is there and they can ramp up the number of well drilled as prices recover.
Time will tell if they have the creativity, courage and wisdom to take this bold step rather than carving out small savings by squeezing service providers. At best cost cutting will generate a few million on capital and less than a dollar per boe on Opex. Both Marty and Harvey Doerr were around during 1986 and should be familiar operating in drastic times.
I have been hogging this space lately and would like your comments, as I only offer the bottom up view of an operations engineer who has prepared a few budgets.
PS: Their Alliance transportation can be filled by purchased gas at a profit.