Portfolio Update


The first two purchases for the newsletter, Rock Energy (RE-TSX) and Petrobank Energy (PBG-TSX) each announced their first quarter (Q1) results in the last week.  Both met or exceeded expectations, as oil prices were better than expected through March.  Both companies simply continued doing what they have done the last year – find oil cheaply and extract it profitably.

Heavy oil prices in particular remained strong for Rock, making them one of the most profitable junior oil and gas companies, per barrel of oil, on the Toronto Stock Exchange. 

Heavy oil trades at a discount to the “light” oil price that is the one usually quoted in the media. But over the last several months that discount has been smaller than normal, as most of OPEC’s production cuts have been heavy oil – it costs more to produce, so in times of low oil prices it’s the first to go.  Simple economics say that when supply goes down, prices go up, and so has it been for Canadian heavy crude, as it has replaced Mexican and Venezuelan heavy crude taken off the market.

So as the oil price slowly moved up from $38 – $50 through Q1, heavy oil had an even greater percentage rise – as the discount went from 36% to 29% in Canada.  That may not sound like much, but it has turned a traditional lower profitability sector of the energy market into one of the most profitable right now.  And as Mexican production continues to decline, that differential could even get smaller.

Management at Rock got a better price and better production – President Allan Bey said their average 3818 barrels of oil per day (bopd) production beat their own estimates by 150 bopd.  Rock drills small wells – an average of only 40 bopd, but are very good operators.  They get a well producing for about $525,000, or just over $13,000 per flowing barrel.  Rock currently trades for about $21,000 per barrel.

In my initial story on Rock I reported how Tristone Capital out of Calgary said the average buyout of a junior in the last 8 months was at $41,000 per barrel, leaving a lot of room for investors.

These low costs allow them to continue having a recycle ratio of 2:1.  The recycle ratio is the industry’s key measure of profitability – you divide your profit per barrel, or netback, over how much it cost to find that barrel. In Q1, Rock showed a netback of $14 per barrel, and National Bank research estimated  finding costs of $7.  This is what makes it one of the most profitable junior energy companies on the TSX – with these low energy prices, almost nobody is making 2:1 recycle ratios.

Management will drill 8 more heavy oil wells this year, and no gas wells.  Should heavy oil prices continue to be high, Bey says they could increase that later in the year.  But he adds that they are focused on acquisitions, as they are as cheap as or cheaper than drilling.

Investors are only slowly discovering this cash flow story.  Rock’s production is 40% heavy oil, 10% light oil and 50% natural gas.  Natural gas prices remain low, and as most Canadian junior and intermediate producers are more heavily gas weighted, their cash flows are comparatively much weaker than at Rock. Cash flow is definitely helped by a $150,000 credit from the Alberta government for their heavy oil wells.

At Friday’s close of $1.57, the newsletter has a 33% gain from our purchase of April 2 at an average price of $1.18.

National Bank raised their target to $2.30 from $1.75 after Rock released its Q1 report.  Wellington West Capital Markets has a $2.50 target.

Petrobank is our favourite growth story.  It has low cost production, produces mostly oil, and management is technologically innovative. The newsletter bought the stock at $24.10, giving it a 27% gain on Friday’s close.

They had a great Q1 2009 as a couple of their big wells in Colombia came on line.  Like Rock, it is a low cost producer with great leverage to rising oil prices.  It’s the low cost producers who benefit most when oil is at this price level. Production averaged 43,856 bopd for the quarter, almost double over Q1 2008.

Their Bakken play in Saskatchewan continues to give the company some of the most profitable barrels of oil being produced in North America.  Netbacks, or profit per barrel, were $34.68.  By investing in infrastructure (read: pipelines and processing centres that separate oil & gas & other liquids) they dropped costs from over $9/bbl to $6.  With over 550 undrilled locations and a strong balance sheet, Petrobank has the ability to scale development of the field depending on the oil price.  They are increasing the number of wells to 70 this year, and indicated they would go to 120 if the oil price went over US$60/bbl.

Because they consider themselves experts in horizontal drilling and multi stage fracing, they have built large land positions in a couple natural gas plays – Horn River in northern BC and the Montney in central BC.  Their first Montney well came in at 7.5 million cubic feet per day plus 180 barrels of liquids – this is a very strong well.  I don’t see the gas play ever having much impact on the stock because of low prices, but it does show they can drill the play.

In their heavy oil section, they have progressed two plays – Whitesands in Alberta and Kerrobert in Saskatchewan – that we should see some significant production milestone achieved in Q3 that validates their proprietary Toe-Heel Air Injection (THAI) technology that upgrades heavy oil and/or oilsands.  This could be a far-reaching technology as it is much cheaper than existing extraction methods.

In Colombia, through their now-66.8% owned Petrominerales (PMG-TSX), Petrobank has seen phenomenal growth, due to the 7500 & 9500 bopd wells they have hit.  With such large production, these wells are very profitable.  Netbacks out of Colombia in Q1 were $30.18.  The company continues to move ahead on implementing infrastructure in-country that will lower costs, as most oil is now trucked.

Petrobank will be drilling another well in their Corcel field in this quarter, Q2.  Despite being a 47,000 bopd company, a single well at Corcel can still jump production 15-20% if they keep hitting such huge wells.

Financially, it is notable that their main US$250 million convertible debenture, with a strike price of US$28.49, is now in the money (depending on the day). 

Petrobank is growing production, has low debt (around 1:1 debt to cash flow compared to most producers on the TSX that are 50%-100% greater) and is a core holding for the newsletter.


I am focusing my newsletter and my own portfolio in these low cost but growing junior oil producers, with strong balance sheets and proven management teams.