The recent trend has been away from spending big dollars on exploration and production or mergers and acquisitions in the oil and gas space, but we’ve seen several deals in recent weeks that confirm that companies are indeed looking to the future.
Suncor Energy’s (TSX: SU, NYSE: SU) proposed buyout of Petro-Canada (TSX: PCA, NYSE: PCZ) is an expression by Suncor’s board and management of real confidence in the oil sands as a long-term play, and CE Portfolio holdings ARC Energy Trust (TSX: AET-U, OTC: AETUF) and Advantage Energy Income Fund (TSX: AVN-U, NYSE: AAV) each have taken extraordinary steps in recent months to make sure they have sufficient cash right now to invest in the Montney Shale Formation.
Canada’s oil sands--estimated to be the world’s largest reserve outside the Middle East--represent a rare opportunity for potential production growth in a non-OPEC country, and the Montney is estimated to hold 28 percent of Canada’s proven gas reserves.
Developing the oil sands economically--i.e., in an environment where crude prices approximate USD100 per barrel again--seems a long way off at this point. And natural gas prices have continued to lag, even as crude has found a stable range in the USD50 neighborhood.
Suncor has already established itself as a leading developer of the oil sands, second only to Syncrude, the partnership of major oils operated by a unit of ExxonMobil (NYSE: XOM). The Petro-Canada deal will also boost the company’s refining capability, a major need for any producer of heavy oil. That should enable it to control costs far more effectively operation-wide, and ultimately increase profitability greatly. Suncor said the merger will save the combined company about CAD1.3 billion a year in operating expenses and provide greater efficiencies in capital expenditure.
Montney’s geology is complex with varying reservoir characteristics and quality. But the magnitude of the prize is potentially enormous. EnCana (TSX: ECA, NYSE: ECA), for example, estimates it has 60 trillion cubic feet of original gas in place on its Montney lands alone, in the same ballpark with its south-of-the-border shale plays, Barnett, Piceance and Haynesville.
ARC Energy Trust began breaking open the Upper Montney formation in 2003, but development only took off after it drilled the play’s first multiple-stage frac horizontal well in July 2005. With a lateral reach of 1,500 meters and five fracs along its length, the pioneering well cost CAD7.9 million and is still producing 1.6 million cubic feet per day (mmcf/d).
ARC recently drilled a 1,900 meter horizontal leg, fraced it eight times, spent CAD5 million, and achieved initial production of 8 mmcf/d. The company reported finding and development costs of about CAD10 per barrel of oil equivalent (boe) at Dawson, a netback of about CAD40 per boe, and total production of about 5 billion cubic feet (bcf), nearly 1 million boe, for each well.
In terms of exploration, tight gas is more comparable to oil sands than to conventional oil and gas. The resource is pretty much known to be there in very large quantities, but the challenge is extracting the gas at an economic cost. The fundamental solution to that problem is coming through multiple hydraulic fracturing of long horizontal wellbores.
ARC Energy, one of the largest, most efficient oil and gas producer trusts, has trimmed its distribution by 40 percent since September 2008. The additional cash saved on the monthly payout, combined with its solid balance sheet, will allow ARC to move aggressively from building its Montney assets to exploiting them. The trust actually boosted its 2009 capital expenditure forecast in the late fall of 2008, even as the global economy and financial system seemed to be falling apart.
Advantage, keen on making a quick dent in its forecast CAD2.5 billion long-term capital expenditure on the Montney, announced its intention to immediately convert to a corporation (subject to unitholder approval) and suspended its distribution this month. EnCana, a new addition to the Canadian Edge coverage universe, has devoted considerable resources to its projects in the Montney.
In this period of uncertainty, companies have to make difficult short-term decisions that could lead to down-the-road cash flow. Suncor’s deal for Petro-Canada and ARC Energy’s and Advantage Energy’s recent moves have been entirely focused on long-term sustainability.
The US Financial Accounting Standards Board (FASB) announced last week that it will allow companies to use “significant” judgment in valuing assets to reduce writedowns on certain investments, including mortgage- backed securities. The International Accounting Standards Board (IASB) will discuss fair value accounting April 23-24.
Canada’s accounting regulator, the Accounting Standards Board (AcSB), will issue its decision on the matter after it can evaluate moves made by US and international bodies. The AcSB is awaiting final word from FASB on its revisions and for information from the IASB conference later this month.
European Union ministers said earlier this month that it’s “critical” that convergence on accounting standards is reached on the continent to ensure the region’s banks aren’t at a disadvantage against US competitors. Of primary concern for the AcSB is that its regulations mesh with international standards. Paul Cherry, chairman of the body, also noted that Canada’s banking system is quite different from the US financial industry.
Canada’s six main banks have taken about USD15.9 billion in pretax debt writedowns since the financial crisis began in 2007, compared to USD916.2 billion recorded by banks and brokers worldwide.
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