Tag: WCP

Whitecap Energy (TSX: WCP) yesterday announced a $1.9 billion cash ($1.7 billion net of working capital) acquisition of XTO Energy’s Canadian operations, which involves a huge chunk of land and operating assets in the northwestern portion of Alberta, in addition to a gas processing plant. This deal is much more gas-weighted than liquid-weighted.

This deal works for Whitecap if we are in a “higher for longer” commodity price environment. They are acquiring an immediate 32 kboe/d asset at a relatively expensive price, but the lands they are acquiring have very good expansion potential, which they are targeting in 2023. In 2023, they intend to ramping up Capex from $600 million to approximately $1 billion, which means that they will be generating less free cash flow that year than they otherwise would have had they not made this acquisition. However, that would pay off in 2024 and beyond (perhaps when TMX is actually finished, and the SPR drawdown concludes and thus the WCS differential closes???)

However, this flies in the face of the general thesis for most oil and gas companies that they are generally in “maintenance” mode and they will be distributing the bulk of their cash flows to shareholders. In this particular case, Whitecap will be busy paying off the debt from the acquisition and will need the better part of 2023 to get back down to their end of Q1-2022 debt level ($1.07 billion). Specifically they will not be in the open market buying back stock over the next year. They do provide some clear milestones for shareholder returns (at a $1.8 billion debt, they will increase their dividend and at $1.3 billion, they will increase it to a projected 73 cents/share/year – projected at Q2-2023) – which would put them at an approximate 8% yield.

There is now a clear differentiation between companies that are in maintenance mode (spend the capital to maintain production, and then pay down debt and distribute proceeds to shareholders) and expansion mode. WCP is now clearly in the latter category. It works until the commodity price environment goes adverse.

The market has also soured on the deal – Whitecap traded down 6% for the day after trading initially higher. This is probably going to be a disincentive for other companies contemplating expansionary policies.

That said, if the “higher for longer” environment continues, the stock is looking cheap, along with the rest of the sector. But there is this ominous feel of the winds of recession coming, coupled with the potential end of the cycle of the industry.

In terms of valuations, it increasingly looks like that free cash flow multiples aren’t going to get much higher than present values, which suggests that the mechanism of returns for these companies will be in the form of total returns (the cash they will distribute to shareholders, coupled with the impact of open market buyback operations). It will also be very rocky.

The nature of risk has finally returned into the fossil fuel market.

Over the next few weeks, oil and gas companies will be reporting their third quarters and give projections based off of the existing strip pricing.

For gas producers, winter gas prices appear to be headed to around CAD$5/GJ (AECO pricing), while if you can get the stuff onto a tanker and ship it to Japan or Korea, it’s going for about US$35/mmBtu (one million BTUs is about 1.06 GJ).

The spot oil price has also gone up about US$10 since the last slew of quarterly reports.

The first shot that was fired was on October 14 when Whitecap Energy (TSX: WCP) announced its 2022 capital plans and projections. In addition to ramping up production mildly (from 111k boe/d to 122), at a US$70 WTI price (note that spot crude is US$83 as I write this), they anticipate generating $911 million in free cash flow, and this is after capital expenditures and accounting for some idiotic hedges that will result in some considerable losses.

Let’s focus on the $911 million in free cash flow. At the end of Q2-2021, WCP had $1.3 billion in outstanding debt, and a market cap of $4.8 billion. This works out to a 15% return.

Others in the Canadian energy complex have similar metrics.

De-leveraging has been the focus of all of the companies – I suspect they are getting concerned that the banks and financial institutions are going to be pressured to “defund” or put pressures on their credit lines (a “climate surcharge”, etc.). Debt financing can be focused on bond issuances rather than relying on lines of credit.

In the case of Whitecap, as their dividend payout rate is very low, if they keep on their existing track they will be able to eliminate most, if not all, of their line of credit by the end of 2022. Out of the $1.3 billion in debt they have at June 30, 2021, $740 million is bank debt and $595 million are in senior secure notes – $200 million maturing in January 2022, May 2024 and December 2026.

The even rosier news for the industry is the lack of material capital investment in the sector. This gives huge incumbency advantages for the existing players. Traditionally at this phase of the boom-and-bust cycle, you would hear companies pouring billions of dollars in extra capital spending, but companies today are being very cautious. While market valuations would suggest that this pricing level is temporary, I would bet against that. Although prices will never move in straight lines in the short term, the overall trend is quite positive.