[Editor’s note: To read part I of this interview, please click here]
Based in Calgary as BMO Capital Markets’ oil and gas analyst for Canada, Mark Leggett shares his home province with what’s called Canada’s “trillion-barrel tar pit.” Alberta’s oil sand deposits reportedly contain about 1.7 trillion barrels of bitumen in-place, comparable in magnitude to the world's total proven reserves of conventional petroleum and second in volume only to Saudi Arabia. The catch? It costs up to $25 per barrel to extract oil from oil sands, compared to $2 to produce Saudi crude—numbers that don’t work well with oil at $50 a barrel. In this exclusive interview with The Energy Report, Mark talks about oil sands plays and how today’s oil prices affect them. He says that may not yet have bottomed out, but longer term he sees restored demand growth that will cause prices to climb again. At that point, oil sands production may nudge peak oil’s day further into the future. Global oil consumption stands at about 87 million barrels per day, a figure that—despite recent demand destruction in North America and Europe—will climb as ascendant economies in India and China increase their appetites for oil. Peak oil theorists argue that production of conventional crude is already maxed out, meaning imminent shortages and sharper price spikes; more optimistic experts believe that peak oil’s day—when production of conventional crude reaches its pinnacle—won’t dawn for 20 to 30 years.
TER: One of the companies you follow is NuVista Energy Ltd. (TSX: T.NVA, Stock Forum)
ML: Very disciplined, strong balance sheet. The board is a very, very strong disciplined team. NuVista is in Saskatchewan and Alberta, but they’re trying to take advantage of what’s going on in Alberta because of all the capital that’s been allocated out of the province given higher royalties. So they decided to target a particular area called Wapiti, and they’ve built out a land base there of 110,000 net acres, and they’re targeting a natural gas resource play. And land prices came down because of the royalty announcement in Alberta, so they got their land for a lower price deck.
When we were in the natural gas trough last winter, they were maybe the only company that had access to capital to get a transaction completed. They did a private equity deal with Ontario Teachers Pension Fund, and it was of the view that NuVista was the cream of the crop in terms of a trustworthy, disciplined management team. What they needed to add to their business model was more of these resource plays, longer-life assets, and the Wapiti play is just that. It gives them some internal growth potential, and if they have the multiple to get M&A done, they will also look at that.
TER: So they’re currently producing natural gas, and the Wapiti is an expansion for them?
ML: Natural gas in Alberta and Saskatchewan, and Wapiti is an area within Alberta. It’s a pretty small part of the company right now that represents its growth profile.
TER: One of the companies that intrigues Rick Rule is Oilsands Quest Inc. (AMEX:BQI, Stock Forum).
ML: I’ve just heard of them because they’re located in Saskatchewan, which in the good times had everything going for it—the Bakken light oil play, Potash Corporation and Cameco with its uranium play. Then Oilsands Quest came to the table with maybe an oil sands play. Don’t know if it’s real or not yet, though.
TER: That darn province has it all.
ML: It seems to. But they’re a hard working bunch, so they deserve it.
TER: Any other companies you can comment on for us?
ML: In the general sell-off in terms of the companies, it’s difficult to time the bottom, but the type of stock to pick away at on a disciplined basis throughout the bottoming is Suncor. You’ve got to move up the level of quality and go for the bigger companies. Suncor Energy (TSX: T.SU, Stock Forum) is a very, very strong company that is oil sands pure play. It’s been around for a number of years and has real production.
Suncor is the best operator, and has scaled back capital spending in response to current markets. But it’s these kinds of companies that at some point do reach a bottom, and speculation would be that they can’t stay down so low forever; otherwise someone would maybe take a look at them.
TER: When you were on TV, on BNN, when was it that you did that interview?
ML: It seems like every day is a week long now, so it’s feels longer ago that it really was. It was probably only three weeks ago, but it feels like a three months.
TER: At any rate, you mentioned Husky Energy (TSX:T.HSE, Stock Forum) and Oilexco Inc.(TSX:T.OIL, Stock Forum).
ML: Oilexco has become very topical, and we actually went to a neutral rating on that after they reported Q3, because their lead banker, Royal Bank of Scotland, is having an enormous amount of trouble over in the UK. Oilexco had a $200 million line due January 31. The Royal Bank of Scotland extended 70% of that out into Q4 of next year, so that was good from that standpoint. But crude oil prices are so low it overrides getting the credit extension.
TER: Scary for shareholders, that’s for sure.
ML: Yeah, the stock has fallen off more. We’ll see what happens. It’s a great example of a very successful team that just got caught in the crosshairs of a very violent market.
TER: What about Husky?
ML: More of a stable business. Husky has a low breakeven price on their East Coast offshore production of light oil. They do have some oil sands exposure, and actually went into partnership on U.S. refineries with BP. So they’re more of a stable company that will for sure survive this difficult time.
TER: Do you cover just Canadian companies? How does that work at BMO?
ML: Yes, I just cover the Canadian intermediate and junior groups.
TER: Can you tell investors who may be looking to get into oil companies the value of an oil sands play vis-à-vis the value of, say, light crude? It sounds as if oil sands has a pretty darned expensive extraction process versus light crude, which is more along the lines of putting the straw into the big pool under the ground.
ML: Absolutely. That’s why all the conventional light oil plays were chased first. It’s just cheaper and easier. A big part of the cost component for oil sands is labor. Is it possible for labor to come down very hard to bring down the breakeven prices on oil sands? Probably, but for how long would be the question. Would it be maybe a temporary setback for two years, after which labor prices would just go right back up? No matter who you spoke to around the globe prior to the current credit crisis, they consistently reference tight labor markets.
I guess in terms of the oil sands players themselves, companies that did not have a project off the ground yet will not get it off the ground. For instance, UTS Energy Corp. (TSX:T.UTS, Stock Forum), which is a partner in the Fort Hills project north of Fort McMurray, just issued a press release saying that it would be a multiple billion-dollar project, and they don’t have access to capital to be able to fund it now.
Oilsands Quest? A company like that is very interesting when we’re in the $100 per barrel oil price environment. But now if you do not have an asset base with a real cash flow platform, you’re not going to get from Point A to Point B because you need the capital. So I guess I would segregate the oil sands producers from those that have production and those that just have a project on paper. And then if you have oil players that can hit oil wells at lower breakeven prices—EOG has a very good Bakken play in North Dakota—that kind of play can make money at lower breakeven prices and is not as capital-intensive.
So in this environment right now, picking one over the other, I would say you could go with a Suncor, the top performer within that oil sands play. That being said, though, they’re both having troubles right now. I would suspect that if you’re buying an oil investment, you’re taking the view that prices will recover at some point. And if that means that the demand is coming back into the picture, the oil sands will be needed and revalued and there would be good appreciation there for companies with assets that are producing. So the Bakken and the oil sands both make sense for different reasons.
TER: Has Oilsands been pushed down further because of the production costs than a play like Bakken? Or have they been equally decimated by the market in general?
ML: No, I would say the oil sands companies that don’t have a good-sized scale of operations already producing have been hit a lot harder because of their inability to access capital. The Bakken players have been hurt, but they haven’t been killed.
TER: So what kind of movement in oil prices do you see in the near term?
ML: Likely testing the downside. OPEC meetings in the near term are likely the only catalysts to potentially provide support for crude oil prices.
Oil and gas analyst Mark Leggett joined BMO Capital Markets as an integrated oils associate in 2002. He was promoted to analyst in 2004. Based in Calgary, he covers Canada’s intermediate and junior oil and gas producers. A Chartered Financial Analyst (CFA), Mark previously gained twelve years’ industry primarily at Canadian Natural Resources. An oil and natural gas company that produced about 1,400 barrels of oil a day and had market capitalization of about $1 million in 1989, it has since grown to production exceeding 565,000 barrels per day and an enterprise value of approximately $30 billion. Its first delivery of light, sweet synthetic crude from Project Horizon is targeted for late in the fourth quarter 2008, with startup capacity pegged at 70,000 barrels per day, moving up to 110,000 barrels per day late in the first quarter of 2009. Future phases will see production of 232,000 - 250,000 barrels daily, followed in due course by an expansion to 500,000 barrels. As work continues on Phase 1, future expansions to the project are in the design and engineering stages. The University of Calgary awarded Mark his Bachelor’s of Commerce degree in finance in 1990.
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