The Energy Report: In the United States, we're hearing a lot about banks refusing loans due to fear of regulators or a possible double-dip recession. Is loan capital currently available to the junior E&Ps?
Bruce Edgelow: Yes, we are delighted to say that in the Canadian banking environment, the E&P space is as open as it's ever been. Just to give you a sense of deal flow, our organization, which represents 8% of the total loans out to the E&P marketplace since April 1 of this year, has concluded 65 new increased participations in the E&P space, totaling just a bit over $800 million (M). We're $200M short of $1B of new commitments to the E&P space, and that's simply from April 1 to September 6. There are another 46 transactions that we've done for $400M in the drilling and services space. Our organization has put out more than $1 billion (B) of new commitments, and we represent about 10% of the business. I would suggest that because of our market niche, we may be the leading edge on that information. But at the same time a lot of those are syndicated pieces, and you could get a sense that there's a healthy lending regime that is supporting Canadian juniors.
TER: About 15% of your $5.3B loan portfolio is in drilling and services. That seems to be a lower-risk area to me, so why not more? Your stake in these deals isn't equity, and you don't really have a huge upside on your higher-risk loans the way an investment bank or venture capital firm may have.
BE: The number 15% has a direct correlation related to the consolidation that's taken place. We've probably seen 25% of the players in this business get consolidated as people aggregate horsepower, equipment and services to be able to provide these services across the North America platform. So there are not as many players. Those that are fairly large and integrated have been able to go to the bond markets to raise additional capital through the issuance of high-yield notes having maturities of anywhere from seven to 10 years. They've sopped up a lot of the liquidity available to them, and that has paid down a lot of the bank's exposure.
Our loans are not as utilized in that space because of the fact that there have been ample sources of capital available to them from the bond market. And those would be clearly to the larger names like Precision Drilling Corp. (PD:TSX), Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX)—companies like these that are integrated across both platforms—Canada and the U.S. They have good fracking equipment and horsepower and are doing a variety of different services across the different basins. So among them all, those companies have probably raised easily in excess of half a billion dollars of long-term debt that has paid down their conventional senior notes. So that's one anomaly that we would point to, that they're getting their capital elsewhere. So that's part of the issue that has arisen.
TER: They have high margins, they consolidate and they have easy access to capital.
BE: They have had. That market has backed up a bit since the first of August, and we're waiting for it to reopen. Prior to that point in time, there was fairly ready access to those large, integrated oilfield services companies.
TER: Bruce, a joint venture (JV) can clearly help a junior explore for energy and at the same time derisk it a bit. Do you ever play matchmaker for companies so that they can form JVs? Do you attempt to find drilling partners for the small guys?
BE: The answer to this is a robust yes. We're not yet fully integrated in our shop to be able to do this on a fee-for-service basis, but we have so many opportunities in front of us that we actually keep a database and track opportunities as to who's buying and who's selling or who would like to be a joint venture. We try to have those partners speaking together. I think that's commonplace. There are others who will do this on a fee-for-service basis and ask others to provide bids for farm-outs. We often see that function performed through Sayer Energy Advisors and a variety of other players in that space. But on a quiet basis, our firm is doing this all the time. We're trying to put people together because it is all about those that have risk capital and those that have good plays but are constrained on capital. We're trying to put these people together on a regular basis.
TER: What about the M&A matchmaker side of the business? You can derisk a loan by introducing a struggling company to a larger company.
BE: We do that on a regular basis. We have a 19.9% interest in a capital markets firm called AltaCorp Capital Inc. It is setting itself up in this space where it will have an acquisitions and divestitures (A&D) group that will look at formal A&D assignments. So we will, on a formal basis, provide that lead-in through some of our clients who want to do that on a more broadly based bid process, et cetera. But on a quiet basis, we are constantly seeking those individuals who are opportunity rich. For example, they may have less capital but lots of opportunity. They may be selling assets, or they may want to further develop assets. Alternatively, we may have companies that have recently divested assets and have lots of cash and opportunities available to them and are looking for specific play types or are looking to expand in areas that they've got.
TER: Your forecast for natural gas suggests a return to the $6–$8/Mcf range prior to the winter of 2013. I'm assuming that you don't make loans to junior explorers based on what you think the price of energy may be in 12–18 months. From what you're seeing right now, can the juniors make money with natural gas in the $3–$5/Mcf range?
BE: Given the fact that we've been in this regime of low prices for at least the last 24 months, if not longer than that, the sole natural gas producer has learned to survive on $3.50–$4/Mcf gas. The real question is whether they're making enough to replace reserves. We don't think, on a full depletion basis, that they're actually being able to replace reserves. They are paying heat and light and managing to keep things going, but they've been hard-pressed to grow their business in this current environment of low prices.
The benefit in most cases is that the clients have had access to cash, whether it's joint venture money that's come in from other people or whether they've had access to lines of credit. So they have been able to grow their businesses from other sources than cash flow. We're seeing most of those survive by those means. I would agree with your earlier comment that we're not lending on the supposition that we're going to have an increase in natural gas prices until it actually happens.
TER: The WTI and Brent Crude spread is wider than ever. You have said that this dramatically lower WTI price reflects oversupply in the U.S., but there was a significant WTI-Brent spread when gasoline was $4/gallon, Brent was at $124/barrel (bbl) and WTI was at $114/bbl back in May. So, why this large spread?
BE: There are a variety of factors that play into it, and I've checked with our traders. We do have a bit of a landlocked situation with WTI at Cushing, Oklahoma where our crude supplies are, and we've seen a trading anomaly come into play here, and there may not be a supply differential that would match the price differential. We have North Sea production that is coming off. We have Libya production that is coming offline. There are other political factors that have happened in the last six to 12 months that have taken some of the foreign oil offline, and yet, we've not seen a reduction in that WTI and Brent Crude spread. In fact, in certain cases, it's widened. Our analysis would lead us to believe that it is not based upon physical production or physical traders, but rather it is a financial trading anomaly that's moved into the marketplace. Those are players that are, again, not fundamental on supply-demand but players who have the ability to move contracts and make a market all unto their own. There are certain trading tools that are being used that have been detached from the physical reality, and they have momentum all unto themselves. It's hard to understand it at times.
TER: It sounds like there's something of a bottleneck at the Cushing hub, and that people trading the spread are creating an artificial valuation.
BE: It has a volatility all unto itself that would lead one to believe that there is a trading anomaly taking place that's beyond the physical side.
TER: You've devoted more than a little of your diligence to analysis of the environmental lobby. How significant are these environmental worries? Are they significant enough to hurt the smaller E&P guys that you do business with?
BE: Our view overall is that the industry is well policed on environmental matters. There is an environmental lobby all unto itself that may have certain agendas that it wants to have captured. But with respect to the actual day-to-day running of the business, there is a large environmental application and oversight that is done both at the federal and at the provincial levels, and we think that the industry is well policed.
I believe technology advances are giving us great reason for optimism with regard to environmental concerns. We'd like to believe that in three to five years the tailing ponds at the Syncrude-Suncor will be a thing of the past. By that time, new refining techniques will have eliminated the need for reclamation- or settling-pond processes. We are optimistic that environmental issues around fracking are going to be well managed as a result of technology advancements. The industry will survive well past my generation and others as a result of technology advancements in lock-step with the need to continue to produce.
TER: It sounds like these technology advancements represent investment opportunity. Are you involved in any of these?
BE: We're encouraged, to say the least, by the new opportunities coming about in the space. We'll hear about them more as they grow in size and stature, but these are sustainable processes that have been long-sought in the industry, and we're quite encouraged by some of the things we're seeing.
TER: I understand that you have some interest in the carbonate reservoir plays. The market potential looks amazingly large. More than 60% of the world's oil and 40% of the world's gas are being held in carbonates. How big is this market?
BE: Our expectation is that the carbonates could rival the size and breadth of what we currently have in the unconventional oil sands to date. If we take a look at the non-mining oil sands plays on record and booked in the oil sands area of Central Canada, the carbonates, with the exception of maybe two plays most recently coming to the forefront, are not currently booked in those reserves. It's our understanding that as the science is unveiled, they may match the existing non-mineable oil sands reserves, the volume of which is significant.
TER: What opportunities are there for public investors in the carbonates?
BE: We've recently seen Athabasca Oil Sands Corp. (ATH:TSX; ATI:Fkft) come to the marketplace with an offering that speaks specifically to the carbonates. A couple of others in the adjacent areas have recently released reports and done some equity offerings based on the carbonate potential. I think that those are just the tip of the iceberg.
TER: I presume it's cost-effective.
BE: Very much so. If we consider a $75/bbl or an $80/bbl oil price floor, we're led to believe that that is quite an economic platform to produce those carbonate reservoirs.
TER: And, of course, as we've seen with all the newer technologies, costs tend to go down dramatically over time.
BE: I think you're right, if we look at shale's initial extraction process and cost, those costs have come down with volume, science and time. I think you're very fair in your assumption that as you amass more volume, you'll have better economies of scale.
TER: Are there other companies that deserve special attention or mention?
BE: We think Cenovus Energy Inc. (CVE:TSX; CVE:NYSE) is one that continues to receive high marks from the equity investing community as a company that has size and is playing across all different types. It's often touted as the top pick. It's a spinout from Encana Corporation (ECA:TSX; ECA:NYSE). Tourmaline Oil Corp. (TOU:TSX) is one that's recently come back to market. It has a team that has been there in the past and has come back out into the public domain. That's appearing on many companies' top picks list. There have been some companies—Spartan Exploration Ltd. (SPE:TSX) and Tamarack Valley Energy Ltd. (TVE:TSX.V) in the junior microspace that have recently caught some people's attention. Those are just a few of the names we're following.
TER: I've enjoyed speaking with you very much.
BE: Thank you, George. I appreciate your time today.
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 40 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.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Bruce Edgelow: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.
Bruce Edgelow: Yes, we are delighted to say that in the Canadian banking environment, the E&P space is as open as it's ever been. Just to give you a sense of deal flow, our organization, which represents 8% of the total loans out to the E&P marketplace since April 1 of this year, has concluded 65 new increased participations in the E&P space, totaling just a bit over $800 million (M). We're $200M short of $1B of new commitments to the E&P space, and that's simply from April 1 to September 6. There are another 46 transactions that we've done for $400M in the drilling and services space. Our organization has put out more than $1 billion (B) of new commitments, and we represent about 10% of the business. I would suggest that because of our market niche, we may be the leading edge on that information. But at the same time a lot of those are syndicated pieces, and you could get a sense that there's a healthy lending regime that is supporting Canadian juniors.
TER: About 15% of your $5.3B loan portfolio is in drilling and services. That seems to be a lower-risk area to me, so why not more? Your stake in these deals isn't equity, and you don't really have a huge upside on your higher-risk loans the way an investment bank or venture capital firm may have.
BE: The number 15% has a direct correlation related to the consolidation that's taken place. We've probably seen 25% of the players in this business get consolidated as people aggregate horsepower, equipment and services to be able to provide these services across the North America platform. So there are not as many players. Those that are fairly large and integrated have been able to go to the bond markets to raise additional capital through the issuance of high-yield notes having maturities of anywhere from seven to 10 years. They've sopped up a lot of the liquidity available to them, and that has paid down a lot of the bank's exposure.
Our loans are not as utilized in that space because of the fact that there have been ample sources of capital available to them from the bond market. And those would be clearly to the larger names like Precision Drilling Corp. (PD:TSX), Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX)—companies like these that are integrated across both platforms—Canada and the U.S. They have good fracking equipment and horsepower and are doing a variety of different services across the different basins. So among them all, those companies have probably raised easily in excess of half a billion dollars of long-term debt that has paid down their conventional senior notes. So that's one anomaly that we would point to, that they're getting their capital elsewhere. So that's part of the issue that has arisen.
TER: They have high margins, they consolidate and they have easy access to capital.
BE: They have had. That market has backed up a bit since the first of August, and we're waiting for it to reopen. Prior to that point in time, there was fairly ready access to those large, integrated oilfield services companies.
TER: Bruce, a joint venture (JV) can clearly help a junior explore for energy and at the same time derisk it a bit. Do you ever play matchmaker for companies so that they can form JVs? Do you attempt to find drilling partners for the small guys?
BE: The answer to this is a robust yes. We're not yet fully integrated in our shop to be able to do this on a fee-for-service basis, but we have so many opportunities in front of us that we actually keep a database and track opportunities as to who's buying and who's selling or who would like to be a joint venture. We try to have those partners speaking together. I think that's commonplace. There are others who will do this on a fee-for-service basis and ask others to provide bids for farm-outs. We often see that function performed through Sayer Energy Advisors and a variety of other players in that space. But on a quiet basis, our firm is doing this all the time. We're trying to put people together because it is all about those that have risk capital and those that have good plays but are constrained on capital. We're trying to put these people together on a regular basis.
TER: What about the M&A matchmaker side of the business? You can derisk a loan by introducing a struggling company to a larger company.
BE: We do that on a regular basis. We have a 19.9% interest in a capital markets firm called AltaCorp Capital Inc. It is setting itself up in this space where it will have an acquisitions and divestitures (A&D) group that will look at formal A&D assignments. So we will, on a formal basis, provide that lead-in through some of our clients who want to do that on a more broadly based bid process, et cetera. But on a quiet basis, we are constantly seeking those individuals who are opportunity rich. For example, they may have less capital but lots of opportunity. They may be selling assets, or they may want to further develop assets. Alternatively, we may have companies that have recently divested assets and have lots of cash and opportunities available to them and are looking for specific play types or are looking to expand in areas that they've got.
TER: Your forecast for natural gas suggests a return to the $6–$8/Mcf range prior to the winter of 2013. I'm assuming that you don't make loans to junior explorers based on what you think the price of energy may be in 12–18 months. From what you're seeing right now, can the juniors make money with natural gas in the $3–$5/Mcf range?
BE: Given the fact that we've been in this regime of low prices for at least the last 24 months, if not longer than that, the sole natural gas producer has learned to survive on $3.50–$4/Mcf gas. The real question is whether they're making enough to replace reserves. We don't think, on a full depletion basis, that they're actually being able to replace reserves. They are paying heat and light and managing to keep things going, but they've been hard-pressed to grow their business in this current environment of low prices.
The benefit in most cases is that the clients have had access to cash, whether it's joint venture money that's come in from other people or whether they've had access to lines of credit. So they have been able to grow their businesses from other sources than cash flow. We're seeing most of those survive by those means. I would agree with your earlier comment that we're not lending on the supposition that we're going to have an increase in natural gas prices until it actually happens.
TER: The WTI and Brent Crude spread is wider than ever. You have said that this dramatically lower WTI price reflects oversupply in the U.S., but there was a significant WTI-Brent spread when gasoline was $4/gallon, Brent was at $124/barrel (bbl) and WTI was at $114/bbl back in May. So, why this large spread?
BE: There are a variety of factors that play into it, and I've checked with our traders. We do have a bit of a landlocked situation with WTI at Cushing, Oklahoma where our crude supplies are, and we've seen a trading anomaly come into play here, and there may not be a supply differential that would match the price differential. We have North Sea production that is coming off. We have Libya production that is coming offline. There are other political factors that have happened in the last six to 12 months that have taken some of the foreign oil offline, and yet, we've not seen a reduction in that WTI and Brent Crude spread. In fact, in certain cases, it's widened. Our analysis would lead us to believe that it is not based upon physical production or physical traders, but rather it is a financial trading anomaly that's moved into the marketplace. Those are players that are, again, not fundamental on supply-demand but players who have the ability to move contracts and make a market all unto their own. There are certain trading tools that are being used that have been detached from the physical reality, and they have momentum all unto themselves. It's hard to understand it at times.
TER: It sounds like there's something of a bottleneck at the Cushing hub, and that people trading the spread are creating an artificial valuation.
BE: It has a volatility all unto itself that would lead one to believe that there is a trading anomaly taking place that's beyond the physical side.
TER: You've devoted more than a little of your diligence to analysis of the environmental lobby. How significant are these environmental worries? Are they significant enough to hurt the smaller E&P guys that you do business with?
BE: Our view overall is that the industry is well policed on environmental matters. There is an environmental lobby all unto itself that may have certain agendas that it wants to have captured. But with respect to the actual day-to-day running of the business, there is a large environmental application and oversight that is done both at the federal and at the provincial levels, and we think that the industry is well policed.
I believe technology advances are giving us great reason for optimism with regard to environmental concerns. We'd like to believe that in three to five years the tailing ponds at the Syncrude-Suncor will be a thing of the past. By that time, new refining techniques will have eliminated the need for reclamation- or settling-pond processes. We are optimistic that environmental issues around fracking are going to be well managed as a result of technology advancements. The industry will survive well past my generation and others as a result of technology advancements in lock-step with the need to continue to produce.
TER: It sounds like these technology advancements represent investment opportunity. Are you involved in any of these?
BE: We're encouraged, to say the least, by the new opportunities coming about in the space. We'll hear about them more as they grow in size and stature, but these are sustainable processes that have been long-sought in the industry, and we're quite encouraged by some of the things we're seeing.
TER: I understand that you have some interest in the carbonate reservoir plays. The market potential looks amazingly large. More than 60% of the world's oil and 40% of the world's gas are being held in carbonates. How big is this market?
BE: Our expectation is that the carbonates could rival the size and breadth of what we currently have in the unconventional oil sands to date. If we take a look at the non-mining oil sands plays on record and booked in the oil sands area of Central Canada, the carbonates, with the exception of maybe two plays most recently coming to the forefront, are not currently booked in those reserves. It's our understanding that as the science is unveiled, they may match the existing non-mineable oil sands reserves, the volume of which is significant.
TER: What opportunities are there for public investors in the carbonates?
BE: We've recently seen Athabasca Oil Sands Corp. (ATH:TSX; ATI:Fkft) come to the marketplace with an offering that speaks specifically to the carbonates. A couple of others in the adjacent areas have recently released reports and done some equity offerings based on the carbonate potential. I think that those are just the tip of the iceberg.
TER: I presume it's cost-effective.
BE: Very much so. If we consider a $75/bbl or an $80/bbl oil price floor, we're led to believe that that is quite an economic platform to produce those carbonate reservoirs.
TER: And, of course, as we've seen with all the newer technologies, costs tend to go down dramatically over time.
BE: I think you're right, if we look at shale's initial extraction process and cost, those costs have come down with volume, science and time. I think you're very fair in your assumption that as you amass more volume, you'll have better economies of scale.
TER: Are there other companies that deserve special attention or mention?
BE: We think Cenovus Energy Inc. (CVE:TSX; CVE:NYSE) is one that continues to receive high marks from the equity investing community as a company that has size and is playing across all different types. It's often touted as the top pick. It's a spinout from Encana Corporation (ECA:TSX; ECA:NYSE). Tourmaline Oil Corp. (TOU:TSX) is one that's recently come back to market. It has a team that has been there in the past and has come back out into the public domain. That's appearing on many companies' top picks list. There have been some companies—Spartan Exploration Ltd. (SPE:TSX) and Tamarack Valley Energy Ltd. (TVE:TSX.V) in the junior microspace that have recently caught some people's attention. Those are just a few of the names we're following.
TER: I've enjoyed speaking with you very much.
BE: Thank you, George. I appreciate your time today.
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 40 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.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
DISCLOSURE:
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Bruce Edgelow: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.
