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Credit
lines are critical for small- and mid-cap oil and gas explorers. For nearly
40 years, ATB Financial Energy Group Vice President Bruce Edgelow has made it
his business to provide non-dilutive cash for growing energy companies. At
the recent SEPAC Oil & Gas Investor Showcase in Calgary, and in this
exclusive interview with The Energy Report, Bruce reveals some of the
advances changing the bottom line for smart investors.
Companies Mentioned: Calfrac Well Services Ltd. Schlumberger
Ltd. Trican Well Service Ltd.
The Energy Report: When you were speaking with your
friends and clients at the Small Explorers and Producers Association of
Canada (SEPAC) Showcase a few weeks ago, what were the issues they wanted to
discuss?
Bruce Edgelow: In most cases, the comments centered on the encouraging
application of new technologies that have transformed the
resources-versus-reserves landscape. The revised view reflects the idea that
broader oil and gas (O&G) resources may be available for extraction over
time, if enough capital is available. We can now go into a
reservoir and apply different completion processes to take advantage of a
whole new technology frontier. That would be one thing.
Attendees were also interested in hearing more about the service industry's
capacity going forward. How would we manage if both commodities, natural gas
and oil, experienced an uptick in prices? Could we actually fund growth
through the use of services? There's growing concern that the industry
doesn't have enough human capital to deploy on equipment. The services
industry is starting to be really pressured with respect to having the right
people and talent with the right supervisory skills on the drill rigs.
Merger opportunities have also been a hot topic. One
of the notations I made in the presentation was about the size of asset the
equity investor is seeking. In the past, we often talked about 1,000 barrels
per day (bpd) in order to be a starting junior; but now investors probably
need 5,000 bpd with a good management team that has
run both oil-weighted and gas-reserve opportunities.
The other general conversation is the need to grow. We are a fast-depleting
resource industry. On average, we are depleting our resources at
15%–20% standing still—even if we don't show
up. Whether we're public or private, there's a desire to be able to grow
incrementally versus the depletion rate that's taking place. How do you then
grow yourself over and above that and provide attractive returns to
investors? So, some of these are new discussions, but a lot of them are ones
that we have every year because they are ongoing strategic issues.
TER: Bruce, the large gas producers can make about a buck per thousand
cubic feet (Tcf) of natural gas in the $4–$5/Tcf range. But, as you
told the group at SEPAC, summer's going to be a very tough time for juniors.
What are you telling the smaller guys? How do they survive such low natural
gas prices?
BE: We've been in this price regime for the last 18 months, and the
reality is that those discussions have been going on for quite some time.
It's not a change. In this community, there's a lot of patience in terms of
not forcing assets up for sale. By doing so, we would just drag the whole
marketplace down. Collectively, the view is that we are closer to a recovery;
however, we may still have a long way to go. So, we
have been hard at work reducing general and administrative (G&A) expenses
at stranded companies in the natural gas-producer community to attract
expansion investment, even if it's at the margin.
But it's very difficult. Entrenchment creeps in to executive mindsets, which
limits the willingness to sell at a reduced price, thereby eliminating their
jobs at a time when it might be difficult to raise funds and start again.
While we may be closer to natural gas-price recovery, we can't avoid the
reality of a low summer gas environment.
We're touching base with a few of these entities on a quarterly basis just to
make sure that the strategy we outlined 12 or 18 months ago is still underway.
To be honest, it's just a continuation of something that we've been at for
the last two summers.
TER: Are you open to carrying or helping a client through these low
points?
BE: Absolutely, and this is shared across the broader lending
community. I could point to a variety of files, public or private, where
we've hung in there and demonstrated phenomenal support. This is driven by
the reality that you have to put out an inordinate amount of new capital to
offset losses. We can never charge enough to recover an absolute loss on the
debt portfolio.
By cashing-in on a low-price environment, you just create a new bottom or new
low watermark for the price of the reserves. So, if you can provide a sense
of reasonableness to the broader community of being able to work with the
companies through this process, you will forestall any scavenger attempts by
the stronger entities. With a growing sense that we'll start to come out the
other side on natural gas in the next 12–18 months, there's no incentive
for us to create a new bottom.
TER: That brings to mind a question. Does ATB ever take an equity
position in companies, or would that be totally outside your business model?
BE: We have provided a significant amount of
patience and support to a stalled, public nat gas junior over the past two
years. We recognized that cash was dear to the company and instrumental to
growing its reserve base, so we took equity back in payment of fees that were
due to us. In the first case, it was warrants to purchase shares. In the
second case, it was straight out issuance of shares. This structure gave the
company time to develop an oil story. We were cognizant of where cash was
needed, and we took some equity back. That was a new one for us. When I was
at another financial institution, those situations were more common.
TER: The energy-lending business in Canada reached $25 billion by the
end of October 2010. That's up from $14B in 2005—a near 80% increase.
Your firm, ATB, has a $5.3B portfolio, which works out to a significant chunk
of the Canadian energy debt. What accounts for this increase in leverage?
BE: There's probably been twice the amount of equity support over and
above what the debt support has been. First, the balance sheets have been
cleaned up and improved with merger and acquisition (M&A) activity and
equity coming in. So, we've really cleaned up the over-leveraged situation
weighing on the industry prior to 2006/2007 period. That meant the balance
sheets were capable of taking on more debt if it was required for growth. The
fact that we're in a historically low interest-rate environment makes
leverage economical. You can raise debt capital at rates that are less than
what your capital expectations are on the shareholders' side. The cash flow
being generated from the oil regimes has allowed the leverage factors to come
up. So, we're still in a good healthy debt-to-equity relationship. Again,
it's new equity coming into the business that has reduced leverage, allowing
clients to go back into their lines of credit when appropriate.
TER: As a banker, do you think of the juniors and the mid caps as
being in nearly separate industries? How does the due diligence process for
lending vary between these two groups?
BE: To be fair, the only piece that does creep into the smaller ones
is the question of whether the company is concentrated into a single resource type that provides less flexibility than
a larger-cap, mid-cap or senior producer would have. What running room is in
front of them? If they're going to tap out that resource potential, where
might they grow to from there? So, that would be one piece that we'd pay
particular attention to in smaller entities.
TER: Could rising debt in small- and mid-cap companies be indicative
of a bubble?
BE: No, I wouldn't suggest that. If we have a rising debt capacity,
it's because the resource type is in fact capable of managing it. When
clients get to 40,000–50,000 bpd, they have a capacity, they have a
balance sheet and they have an asset base that's considerably varied and diverse.
From that point in time, the leverage is managed through a financial covenant
regime, which historically, would be a debt:cash flow ratio of 3x. That's the
rule of thumb. Junior companies' reserves are expected to support their lines
of credit via a borrowing
base covenant. The lender takes a forward view of production, commodity
prices and burdens, such as royalties and G&A, and lends on a margin of
the net present value (NPV) of this calculation. The larger, more-senior
companies' historical cash flow serves that purpose. So, it's not a bubble,
per se. The reserve-exploitation strategy is being deployed prudently, and
the companies are capable of being lent more money.
TER: Asian demand for oil, primarily from China, is expected to
continue growing at more than 6% per year, and you are forecasting that crude
will remain above $100/barrel (bbl), but choppy over the next few years.
Given that 6% growth in Asia, that sounds conservative.
BE: I would agree. It is very conservative. The reality is that we
have a lot of unknowns. For the first time in a long
time, the OPEC group sitting around the table on June 8, 2011 couldn't come
to a consensus on output. I also question whether China will be the real
demand driver. What about the other
regions—India or Japan, as it rebuilds? I think there's real reason to
be conservative in the approach. Some of us have learned from the past, and
we don't want to race ahead and provide a more opportunistic, or for that
matter, negative view of things.
TER: For the sake of this discussion, assume that crude oil hits
$150/bbl over the next five years. Are you and your group positioned to fund
renewable or alternative energy production?
BE: We are constantly on the lookout in these areas as energy prices
move outside economic boundaries and where, from an economic perspective,
alternative energy would be required. Our organization, in particular, has a
real penchant for staying on top of these opportunities. We attend most of
the alternative energy conferences to find technology that has been proven
and has enough equity support to get through testing and the buildout phases.
We want to provide whatever support is needed to birth these new industries.
It's critical. The changes come quickly, and they are not without risk, but
we are excited about the variety of opportunities. So, yes, $150/bbl oil will
accelerate this process, but these advancements are coming regardless. So,
it's incumbent upon anyone in this business to stay on top of emerging
industries in order to participate at the earliest possible opportunity.
TER: The geothermal industry, in some ways, is technologically similar
to your current industry segments.
BE: Yes, they're significant. If you look at the geothermal technology
being applied, it's been there for quite some time; so, it's not new science.
It's a great time to be optimistic for this business.
TER: I notice that 30% of your debt portfolio
is utilities and service providers. Just from what you said at SEPAC, it
sounds like you're thinking about working with some of these engineering
firms to potentially clean out tailing ponds. This could be very important
for the development of oil sands.
BE: It's critical. That technology has already been tested and is
available to us, but may not be scaled up to total oil sands application
today. There's a great expectation that in three to five years, the tailings
ponds will be a thing of the past and new technology will enable safe
delivery of the waste to a landfill. So, we're paying close attention to
those service providers with respect to the new technology. At $60/bbl oil,
these weren't economical; but at $90–$110/bbl, these are very
economical and are being developed. There is a lot of equity support behind
it. We like to be green, we like to be energy efficient and we'd like to get
rid of the whole tarnish of dirty oil.
TER: Sticking with the technology theme here for a moment and going
back to traditional O&G production, which companies are some of the
shining examples of using technology in an innovative and productive way now?
BE: We've seen a real consolidation in the services business to allow
for economies of scale. I'd be remiss to point out anyone in particular; but,
from a Canadian lens, you could look at the likes of Trican Well
Service Ltd. (TSX:TCW), Schlumberger
Ltd. (NYSE:SLB) or Calfrac Well Services Ltd. (TSX:CFW) on the oil
field-services side.
TER: Great. Do you have any thoughts to leave with our readers?
BE: We think the technology's here to stay. We spend a lot of time
dealing with independent, third-party engineering reports to gather
expertise. The encouragement we're seeing is based on the new methods of
additional recovery—miscible
floods or more waterflood work, for example—that allow us either
to continue to work on fields or go back into wells that have been suspended,
and then apply the new technology. We've seen companies go back downhole
and go from a 20% to a 30% recovery stage.
When you look at the total reserves in place across the basin of the North
American marketplace, with our newer abilities to manage depletion or do a better job of recovery, it is phenomenally encouraging.
These secondary and tertiary recovery methods are being applied today across
more of the resource types than we've ever seen before. Think about the past,
when we pulled some 15% of reserves out of the ground. Now, move that number
to 20% based on new technology. There's phenomenal impact to the entire basin
with no drilling or exploration costs associated. There are no above-hole
costs. It's simply a downhole application. So, there's less capital
expenditure and the impact is significant.
TER: So, if you get an additional 5%, that increases the margin
dramatically?
BE: Yes, just phenomenally.
TER: This has been very educational. Thank you very much, Bruce.
BE: Thank you.
Bruce Edgelow is responsible for the leadership and growth
of ATB
Financial's energy business and capabilities. Before joining ATB, he was
a senior Royal banker and has more than 39 years of experience with a focus
on the oil and gas industry. Bruce is a Fellow of the Institute of Canadian
Bankers, a member of the Calgary Petroleum Club and is a
very active participant in community and church activities. Bruce leads a
team of over 30 energy-industry professionals making ATB's energy group one of
the largest units in Canada. His team specializes in all aspects of the
energy market, including oil and gas exploration and production, drilling and
oilfield services, pipeline and utilities and midstream. Over the past
several years, ATB's energy group has grown to become a significant leader in
Alberta, largely due to its focus on developing highly responsive
relationships.
The
Energy Report
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