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Does This Man Run The Best Natgas Company in North America?

INTERVIEW WITH PAINTED PONY (PPY-TSX; PDPYF-PINK)
CEO PAT WARD

Shares of natural gas producer Painted Pony have gone from $3-$9 this year–despite Canadian natgas prices trading as low as 65 cents/mcf this year!  They are one of the lowest cost producers, and I think will show the largest percentage increase in both production per share and cash flow growth per share–and that’s what the Market pays for!

That’s the kind of market out-performance I look for when choosing companies to present to my subscribers at our annual Subscriber Investment Summit.  CEO Pat Ward presented in March in Toronto, and he will be presenting again on Tuesday October 11 at our annual Vancouver summit–you can register here: http://bit.ly/learn-lots-make-money

The truth is, we are already full with over 500 people registered–but for some reason, many subscribers don’t come to claim their seat.  So you will likely get in!  Our speakers this year are CEO Ryan Dunfield from Stream Asset Financial Management, who will be talking about the debt markets in Canadian energy, and Dan Tsubochi from the firm as well, giving a macro talk on global energy.

Investors can get a full update from Pat’s presentation on October 11.  But last week, I asked Pat to explain how he and his team set the company up to become such a technical success, and a Stock Market Darling to boot.   Here’s our conversation–and don’t forget to sign up for October 11!

Keith:          Pat, you’ve had a couple of great runs in the stock through really what’s been a bearish gas market. So that’s a hell of an accomplishment.

Pat:             Yes–heaven help us if we got a good gas market.

Keith:          But what really set the stage for what’s happening now? If we went back to that event and moment where you said–hey, we are going to make an incredible natgas producer now–what were you thinking at the time? I guess nobody could have foreseen the incredible improvements in technology that’s happened since you started but when you look back to…for you what was the seminal moment of okay now we can build something big here?

Pat:             Okay I’ll give you some of my story and see if that answers your question. About 4 years ago I guess, as a team here, we have annual strategy sessions and we talked about the evolution of the company and where we’re going and what’s working and not working and who’s working and who’s not.

We had purposely built an oil leg to the company and a gas leg and we really liked our oil assets and were doing a good job, but our stuff in the Montney (the prolific natgas/condensate formation on the Alberta/BC border–KS) was over the top. We knew we had a better resource than 90% of the companies and were getting incredible results and whenever we tried something new it got better.

We looked and said gee–there’s a lot of gas here and we’re finding that cheaper than anybody in the Basin. So if anybody can make money we should be able to make money. Of course at that time the big talk was that Petronas / Progress was going to whack us, Shell was going to whack us, BG was going to whack us and so…

Keith:          When you say that do you mean like.. buy you out?

Pat:             That’s what we thought here that they’d buy us. So we considered those options of you could do joint ventures and all that but we said what if we just built this thing ourselves what would it look like? How can we build this without having to raise unlimited amount of capital we may or may not have access too? How fast could we build it and what would it entail?

So we talked about probably one source of financing would be to sell our Saskatchewan (oily Bakken–KS) assets, make sure we have the right blocks to work on and probably about then we bought our Townsend block (in the Montney.  We bought shortly after that the South Townsend block, we sold Saskatchewan and really got focused on just being a BC natural gas company. When you focus people it’s very interesting because it’s very distracting when you have a multitude of properties and plays and there’s expertise in each one you need to focus on.

So we started saying we’re going to build this thing to last. How big can we go? And so we started modeling and came up with our 5 year plan first and said Wow! we can get to 100,000 BOE (barrels of oil equivalent with natgas to oil at 6:1) per day in a about 5 years and this is how we’d do it. We’d look at the financing and how would our bank line grow with that. What kind of costs? What kind of cost efficiencies we might see along the way? How do we build facilities to handle it, pipeline take away and transportation?

We said you’re going to do things differently if you’re building it to sell versus building it to last.

Keith:          Tell me a little about that. Tell me what some of those things are..

Pat:             You’re always worried about, if you’re building it to sell you’re worried about the guy who your potential purchasers are–what are they going to want? So you’ll say they won’t want us to do a big deal with some mid-streamer (pipeline company) because they may not like that mid-streamer or would like to own their own facilities. Gee you make commitments to a Trans Canada and they may have other commitments. So you’re always trying to second guess what they’re doing.

It’s kind of like getting a pig ready for the sale. You put some lipstick on it but you don’t want to put a tattoo on it because the buyers don’t like tattoos on their pigs.

Keith:          Right.

Pat:             So we have to focus on building it to last and building it as a good standalone company. So that’s what we started working on and there’s a lot of iterations of how fast can it grow. Gas plants, take away capacity. What kind of gas prices do we need? What kind of gas price storms can we handle? That’s when we started down the path of building it.

And if you really look, our 5 year plan has really been a 6 year plan because we slowed down at the beginning because 2013 was a terrible gas year but we’re well on our way now and what we’re seeing is really good.

We’re into our second year of our 5 year plan and that’s basically in the bag.  So we have 3 more years and we’ll reach 100,000 BOE per day and it’s going better than we ever thought. Our costs have continued to tumble, our production performance has continued to outperform what we even thought was possible and so everything’s working.

The only thing that’s been a headwind, as you mentioned at the outset, was a low gas price and it has continued to be poor. But we can survive at very low gas prices, lower than anybody we think and it’s just because of our well performance and our costs.

Keith:          When the industry talks about efficiencies there’s service cost reductions and a true technical efficiency improvements. What would you say is a couple of the top truly technical efficiency improvements the industry has developed that’s really helped the industry lower costs or specifically you?

Pat:             The first one is always–how quickly can I drill my wells?–because time is money. So for everyday we save on drilling we save $100,000 and that’s not a bad rule of thumb. If you look back 3 or 4 years ago our average was probably around 25-26 days and now we’ve drilled some in 13 days. We’re averaging around 17-18 days right now including the liner run, which typically adds 1.5 to 2 days.

So we’ve cut probably close to a million bucks off our drilling costs. Then the next big one was fracking. We zeroed in on a very good frack technique, not that we’re not still experimenting, but we really zoned in and do 90% of our wells with our recipe. That saves us time on fracking now and other improvements. We’re using less water and that saves us money, we’re not using an acid spearhead and that saves us money, but time is the biggest one.

Every day I save fracking I save $400,000. Our average fracks were taking 5 days before and now we’re down to just over 2 days, so there is another million dollars of savings. Those are embedded cost things and never have to go up as far as time. People say what if service costs go up? I said that would be wonderful because that means commodity prices are going up.

Keith:          That’s right.

Pat:             I say we’d make a lot more money, but we’ll still save on these other efficiencies, true efficiencies we’ve come up with and there’s lots of other little ones,  like water ponds. We’re sourcing our water now from surface water that the ranchers have on their land. I was out there yesterday and the one pond is nicely filled up for some 2 weeks of rain out there. They’re on a rancher’s land and we haul the water off.

That one is about 2 miles from a pad we’re fracking from that the well’s on right now…while 2 miles of trucking and sometimes we’d be trucking water from 60 miles away of our fracks. We recycle about 100% of our frack water now. We source frack water from the gas plants which is water removed from the gas and use that water for fracking. So we haven’t taken much water from a stream, river or lake for probably 4 years now.

So it’s those kinds of efficiencies we keep chipping away at. And standardizing our equipment on our well site–our well site equipment used to cost us about $900,000 a well and we’re down to $600,000 per well with better equipment and easier equipment to maintain. So looking at the maintenance and how we do our maintenance and build that into the design of the surface equipment.

The guys are always thinking and coming up with stuff that amazes me all the time. And it’s just that attitude to drive down the costs and be more efficient.

Keith:          When you talk about your fracking recipe I guess for the retail guy they know there is slick water and all these terms but even within that–is it pretty site specific from play to play and operator to operator?

Pat:            So we use a slick water open hole ball drop system 1 tonne per meter, high pump rates and that’s probably the 4 biggest things we do.

The other thing we have is a real sweet spot geologically. We have a highly pressured area…we mapped the Montney Trend all the way as far south in Alberta and it goes all the far north in BC, we truly believe we have a sweet spot. There’s a couple of them. Seven Generations has a really nice spot. They’re a little bit deeper and expensive but they’re higher liquids.

It’s that over pressured nature of the rock where we are and the permeability we start with that gives us the most robust wells. I think RBC just put out something this week and mentioned a bunch of companies. They mentioned Painted Pony and the 7 Generations were pushing up the well performance of the Montney.

We’ve done a study in our area of almost 1,000 wells and we’ve got 9 of the top 10. That reaffirms our belief that we’re truly in a sweet spot and real estate is real estate you can’t recreate ocean front.

Keith:          That’s a great line. Okay.

Pat:             So it’s a combination of all those things that allowed us to do it. What we constantly focus on is the full cycle costs. Someone will say…gee…we have really low operating costs because we own our own plant. Well so what? That’s great to stagnate there and you can make cash flow at very low numbers but if you can’t grow and add production because of your drilling cost and well performance…that’s the difference we’re growing. We’re showing the biggest growth we’ve seen of any company among our industry peers on a per share basis.

People say why are you doing that? I say why are you asking us that? Why don’t you ask the guys who aren’t growing why they’re not? We’re doing it because we can. We set ourselves up and we entered the down-turn with no debt and so we can use our balance sheet now when everyone else is struggling and we’re getting the best industry costs that we’ve seen in 20 years to grow our production. That will be there when gas prices come back. If they don’t we’ll still be making money.

Keith:          So you’re not quite unique but you’re rare. In that entire cycle you had a net cash position a huge chunk of the time.

Pat:             Because we were delineating and exploring and you don’t borrow money when you’re in that phase of a company and that’s where these other guys get off kilter. They need the capital and just aren’t efficient. They ran too many plays, they didn’t build a solid foundation, didn’t get focused.

I think selling Saskatchewan was a very tough decision but we sold it when oil was at $104 a barrel in July 2014. How the hell did we know to do that? We didn’t but I didn’t expect oil prices to get much better and we knew we needed the money so we pulled the trigger. So we entered 2015 with no debt, we had cash. And we didn’t do it by raising a bunch of capital and diluting our shareholders. Every time we raised capital is because we had something we had to do and that would be make an asset purchase or…so we were always very careful about how we raised money.

So we have very few shares out compared to most of our competitors. Our price right now is still not up to the average of the industry. If you believe we’ll be at 40,000 barrels a day or 240 million cubic feet equivalent per day which we will be shortly, very shortly, our stock looks very cheap.

Keith:          You look at the growth that’s happened here and I guess to a certain degree success breeds success. Is it true that with what you’ve been able to achieve you get basically a better quality groups knocking on your door asking to be part of the play and asking whether it’s on the drilling side or services side or the midstream side or even the off take side. Is that something that is true or the business is just all about the numbers and that’s it?

Pat:             I went out to the field yesterday for the opening of the Townsend plant and we stopped at one of our rig sites there that’s been drilling. I said you guys have been drilling for us for a long time. God it’s got to be over 3 years now, this is the Trinidad rig. They said no actually it’s been 5 years now, 5 years. They were asking me are you guys going to keep going. Oh we’re going to drill more wells next year than we did this year so just keep drilling. As long as you’re doing the best job.

We pay our bills on time, we don’t drag we don’t use our suppliers to extend our credit line.  We tell them if we’re going to slow down 2 or 3 wells in advance.

So we treat our partners fairly, contractors well, we have a great relationship with AltaGas and they’re as happy as we are with the plant and getting it on stream and seeing the production and it’s a very efficient modern plant and they’re very happy. We’re talking about the potential for the next expansion already.

They have a pipeline that will take all the liquids down to the Alaska Highway and saves us about 2 ½ hours of trucking and it’s a very efficient system. Plus you’re not driving on slippery muddy roads to get oil condensate and propane butane out.

Keith:          This is a gathering line you’re talking about?

Pat:             No it’s from the plant and it goes right to the Alaska Highway, basically straight east/west of the plant and goes right to the Alaska Highway and saves us trucking time. For a truck loaded with liquids it would take them about 2 ½ hours or maybe 3 hours round trip compared to where they pick it up now where they were having to pick it up at the plant site. So we’re continuing to see our transportation costs drop. They’re putting in a rail terminal because they’re considering building a propane export facility near Prince Rupert and we’ll be tied into that and selling our propane into Asia.

Keith:          Wow. Let’s quickly run through some questions about what is happening now.  In Q2, PPY reported one Townsend plant now reached 50 million cubic feet a day of gas processing, and on course for 150 million by Q4. What’s your timeline here on 150?

Pat:             So 50 million cubic feet of gas per day we added again just this week and so we’re pushing around 100 million cubic feet of gas per  day right now–so that was Step 2. And Step 3–October 1st or so–we’ll add another 50 million a day.  So everything is going fine and like I say, I was up there yesterday and things are humming along. I haven’t had any real issues with the plant at all.  Yes the next 50 million cubic feet of gas per day will be on in October so we’re humming along here and it’s going really well.

Keith:          What future strip gas prices do you think you’re going to grow spending even more? Is there a line in the sand a number that you say if gas can hold 3 and a ¼ for next year then we can go to “x”? Is there a certain price level that’s a trigger for you guys?

Pat:             We think it’s a forward strip as it is and with our hedges in place we can grow as quickly as we can getting both facilities and transportation lined up. You’re really looking, we’re looking 2 to 3 years down the road already.  What we’re seeing is not only are we going to add more processing facilities, but also more take away capacity cheaper than we had ever budgeted for.

The first plant we had budgeted in our 5 year plan–the second phase would be the same cost and it looks like that cost is going to be less than the original cost or less to add the processing capacity. That’s what we’re looking at.

How do we drive down those costs and make more nickels per MCFE? We’d love a better gas price we’d get more cash flow, etc. but we’re going to continue to follow our plan and we don’t see gas prices or forward strips slowing us down at all.

Keith:          You don’t see egress–getting the gas to market–as any issue for yourselves there?

Pat:             Well we got take away capacity well planned out. We’re fine and some expansions to Spectra’s system and to TCPL’s system which we committed to and they’re getting built. Things are fine and we’ll make our 5 year plan we’re very convinced.

What do the next 5 years look like beyond that? I think this year with our budget we’ll talk about 2021. We’ll continue to see ourselves grow and add significant production.

Keith:          Wow. Last macro question, what is the biggest challenge facing operators in the WCSB right now?

Pat:             Governments and taxes I think is a big problem. Carbon taxes…we’re okay in BC… we’re kind of used to it but Alberta is putting a new carbon tax in. We need to get these pipelines, pipelines that go to LNG projects …we’re not getting well priced for our product and it’s hard to compete if you’re not getting a good price. I think that’s probably the biggest thing.

Certainly energy prices themselves are…these are tough times for 90% of the industry. There are companies going broke. We’re very lucky that we have such a good resource and we’ve done a great job and our timing has been good. But the industry needs better prices to ramp up that question you were asking me. That’s what the rest of the industry needs. We’re okay but much of the rest of the industry is not.

Keith:          Got you. Pat–God bless you and thank you so much.

Pat:             Thanks for the opportunity, and see you on October 11.
I hope I see many of you on October 11 as well!  Sign up here!



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