COPYRIGHT OF TH DAILY OIL ULLTIN 2016 Junior ector Will urvive The Downturn, ut It’ Likel To Look A Whole Lot Different A triving For ‘conomie Of cale’ ecome The New Norm Y PAUL WLL (/AUTHOR/PAUL-WLL/) – PT. 19, 2016 – VIW IU (/HADLIN/2016-09-19) The elongated and valuation-apping commodit price lump, coupled with the increaed cot of new-era drilling and completion technique, mean the face of Canada’ junior oil and ga ector i changing. And while the parameter that define what a junior compan look like pot-downturn will undoutedl e different than the pre-downturn definition, the ector in’t going awa an time oon. Their rank will dwindle ut thoe left tanding will e larger in ize—oth operationall and in term of market cap. “There i no dout that the low commodit price environment and the high cot of drilling and completing toda’ deep horizontal well will tend to drive operator toward the economie of cale that come with larger ize,” aid Gar Leach, preident of the xplorer and Producer Aociation of Canada (PAC). Gar Leach “I would agree that it’ likel that the population of Canadianowned producer will e fewer in numer ut larger in production cale and with tronger alance heet. ome of that i occurring toda, a thoe operator who are ale to raie capital and have a low cot operating model are uing thoe advantage to acquire aet at attractive price or to continue drilling and growing production even with the headwind of low commodit price.” Patrick O’Rourke, an analt with AltaCorp Capital Inc., agreed that the junior ector i et to hrink and morph a it adapt to changing market condition and new indutr realitie. “I think there’ a role for the junior ector, without a dout. I think that the junior ector i going to evolve and look different than it ha in the pat. There will e le junior plaer than there were. Part of that i the downturn and part of that i the advent in the ort of pla that we’re developing now at thi point in time and the puh toward reource pla and expenive well,” he aid. “Gone are the da when ou could do a friend-and-famil financing round and go and drill a few $250,000 well and prove up omething and tr to ell it. We’re now in a more reource pla development mode where pla like the Duverna require a minimum capital requirement, proal for a junior tart-up, of $100 million ecaue ou need enough capital o that ou can make ome mitake along the wa,” O’Rourke added. “You can’t e living well-to-well in thee pla and ou’re putting a lot of capital at rik—it’ $15 million, in ome cae, on thee well.” Jerem McCrae, an analt with Ramond Jame Inc., aid there are numerou challenge facing maller companie, making it difficult for tart-up to get off the ground or for exiting entitie of maller cale to ta afloat. And even the invetment communit i eing forced to adjut to the new and changing landcape. “There are not a lot of junior analt covering the junior ector ecaue thoe companie are now all kind of a half-illion dollar [in market cap]. The junior ector i not reall there anmore. There are a few companie around ovioul, ut for the mot part the are fewer and farther etween,” he aid. McCrae noted that the high capital intenit of drilling and completion in reource pla like the Montne, Cardium, pirit River and Viking make it all ut impoile for the traditional junior model to ucceed. “Gu are putting in three time a much proppant and three time a much water. There are jut that man more frac tage. The complexit of thee well deign ha ecome much more technicall involved and more expenive. For a junior plaer, where ou need to get a tatitical average from our well reult, ou need to drill a 10 well and if each well cot $5 million, ou need a capital udget of $50 million at a minimum,” he aid. “o to e a junior compan nowada i much more difficult ecaue A, with the complexit and higher frac intenit completion deign that cot more and , i takeawa and egre.” ecaue of their limited ize, and vicarioul financial clout and production capailitie, McCrae aid it’ difficult for maller entitie to ign up for 15-ear take-or-pa agreement for facilitie and pipeline. And with wetern Canadian pipeline capacit limited, maller companie are often left to rel on interruptile takeawa, which i hardl ideal. “We’ve een that the volatilit of interruptile pricing ha een killer. At ome point ou have to pa if ou hip to tation 2 or if ou’re on the Alliance pipeline,” McCrae aid. “o to e a junior plaer and get egre takeawa that the frontline plaer have, it’ jut not poile eing a maller compan.” ruce dgelow, vice-preident of trategic initiative for AT Financial Corp., an indutr lender, agreed that economie of cale have never een more important, epeciall a the current downturn linger. ruce dgelow “Ver few companie are generating cah flow unle the are ver well hedged or large. Ver few junior are generating enough cah flow to actuall how reerve growth and replacing reerve. o I think the igget iue in a down market, and where it continue to e felt, i ‘how can I drive cot out of m uine and where are m economie of cale?’” he aid. “And it’ ver difficult in the junior marketplace to e ale to achieve ucce in thoe thing. And a a conequence, there are not a man ucce torie in the junior marketplace ecaue of it and it’ certainl harder to form a tart-up,” dgelow added. “We’ve known for man ear that the friend-and-famil capital raie ha een gone ecaue the new realit i ou can’t tart a new oil and ga compan with $20 million. That’ not enough anmore. The cot of entr with the new technolog i much higher now.” What’ the new definition of a junior? o what are the enchmark that could e ued to define a “junior” oil and ga producer in toda’ world? “It reall depend on the product ecaue cah flow eing generated on 10,000 oe per da, for intance, a predominantl oil producer i conideral different than a 10,000 oe per da drer ga compan in term of cah flow. I wouldn’t a it’ apple-to-apple on that 10,000 oe per da rule,” AltaCorp’ O’Rourke aid. “At firt it eem like a nice and imple ea little rule. ut I think it’ more aout market cap now. Anthing le than $500 million in market cap i proal what we’re conidering junior at thi point, and then micro-cap i kind of elow $250 million.” dgelow agreed that it’ difficult to come up with an accurate definition a to what contitute a junior compan. “There are rule of thum, more than anthing. M claim to a certain extent would e we’ve got a factor of 10. o a numer of ear ago ou could tart up with a 500 arrel a da operation and take it and doule it and o on. The notion wa how man people do I need to run m compan, and when it get to e too man and too expenive, I’m going to ell the uine,” he aid. “I the new threhold 5,000 now with the capacit to go to 10,000 oe per da? It ver well ma e … I would think that might e the new realm. You do need to proal have 5,000 a da on the wa to 10,000, and ou need the taff and expertie to e ale to do that. It’ a different cope than it ued to e, that’ for certain.” And that increaed cope and the financial wherewithal now required to compete mean that conolidation will likel rampup and corporate and/or aet ale will continue to e part of the urvival trateg going forward. “Now that oil price have tarted to firm omewhat, ou’re going to have ank tr and put more companie together. I do think that’ going to happen,” aid Ramond Jame’ McCrae. “What ou ma alo ee i a [larger companie] tr to high- grade their land the ma take advantage of ome of the junior plaer that ma not have een their tock reound a much a the more liquid name. A a reult, ou could ee ome junior plaer reolve ome leverage iue dipoing of ome of their undrilled land, or jut e taken out completel,” he added. “One other thing i no CO want to e een elling at the ottom of the market. o that could e the one thing that prevent more tranaction from going through. ut at the end of the da, if there can e omewhat of a win-win ituation and ome kind of pin-out, thoe are the tranaction that we could ee more and more of.” Privatel peaking PAC’ Leach aid that ome recent financing, acquiition and going private tranaction indicate that private equit continue to “have an appetite” to upport Canada’ junior and intermediate ector. “Man oerver have commented that there are illion of dollar looking to finance the right opportunitie in North America,” he aid. “Whether that i pulic penion fund mone, U..-aed private equit or our own Calgar-aed invetment firm and capital provider, there eem to e recognition that opportunitie can e found here in Wetern Canada, which i encouraging for the future of our junior and intermediate ector.” McCrae aid going the private route i “definitel an option” ut that thoe with the cah are looking for argain-in deal. “I know there have een a lot of private equit fund that have come to Calgar, hopped around and have looked at different companie tring to take advantage of the depreed commodit price environment and ome depreed valuation,” he aid. “ut thee private equit gu are tring to reall, reall not pa a lot. The trul want to get thee thing almot out of ankruptc. The were not ale to get a lot of deal done ack earlier thi ear, ut ou could tart to ee a few more here a the tart to come to the realization that the need to pa up a little more if the want to get a deal done,” McCrae added. O’Rourke aid going private can make a lot of ene for ome companie who are currentl operating under the pulic model. “We’ve een ome companie [like Yoho Reource Inc. - DO, Jul 19, 2016 (http://www.dailoilulletin.com/article/2016/7/19/oho- reource-going-private-tranaction-led-one-/)], go private a of late. It reall ultimatel come down to the trateg of the uine and in ome intance it make a lot of ene for the compan to ecome private,” he aid. “If the compan ha a reource that’ going to take a little it more time to develop and the’re not looking to have to report on a quarterl ai and how growth progre on that front— that it’ going to e a little it more poradic efore the ecome a nice pulic entit—then eah, it make a lot of ene to go private,” O’Rourke added. “ut the troule with eing private i the cot of capital to privateco i higher than it i for pulic companie.” PAC and it continued evolution Leach noted that PAC aw the greatet change in memerhip well efore the collape in oil price. During the period tarting around 2007, the aociation aw a tead hrinkage in the numer of companie with the peritence of weak natural ga price driven the U.. production urge due to the hale production revolution. “In 2007 Canada wa home to over 40 per cent of the world’ pulicl traded oil and ga producer, mot of thee were emerging and junior producer lited on the TX and TX Venture exchange. That population of pulicl traded companie ha hrunk draticall along with changing capital market entiment that favoured larger companie and the greater role plaed private equit,” Leach aid. “Throughout thee ear we alo aw a hift to larger-cale memer at PAC a a wave of conolidation rehaped the junior ector. In fact, it wa our oervation of thee trend that prompted u to implif our name dropping the word ‘mall’ from the name of the aociation a few ear ago,” he added. “ince the downturn tarted in 2014, encouragingl, our aggregate memerhip numer eem to have tailized and we are ver pleaed with the memerhip roter we have toda.” PAC (formerl the mall xplorer and Producer Aociation of Canada) ha een around for more than 30 ear. In fact, a Leach point out, it wa founded in 1986 at the ottom of the 1980’ oil price lump. “o we have een thi efore. Canada’ junior and intermediate ector continue to e ver reilient and o are we,” Leach aid. “PAC i in olid financial hape and we plan to e around long into the future. At leat long enough to outlat all the people who tell u the oil and ga era i over.” Leach i adamant in hi elief that Canada need a “thriving population” of Canadian-owned companie to develop the “full pectrum of reource opportunitie” availale in the Wetern Canadian edimentar ain. “Whether thoe companie are laeled ‘emerging, junior or intermediate’ producer i not terril important,” he aid. “The ke from PAC’ perpective i that Canada continue to e a place where Canadian can tart up companie that go on to uccefull participate in the ownerhip and development of the energ reource we have in Wetern Canada.” CTION: FATUR (/CTION/FATUR/), MARKT INTLLIGNC (/CTION/MARKTINTLLIGNC/) CATGORI: DRILLING (/CATGORY/DRILLING/), FINANC - INVTMNT (/CATGORY/FINANCINVTMNT/)
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