A detailed look at our Montney coverage universe.
Patrick O’Rourke, CFA 403-539-8615
Returns on Capital Drive Energy Equity Returns
In our view, the Montney-levered stocks that deliver the best returns to investors tend to be those with the best returns on capital. This is why our key drivers for stock selection are (1) PDP NAV growth and (2) capital velocity.
Inside the report we explain these concepts and their importance on equity returns, as well as their key determinants, which are asset quality, ability to get product to market (egress), and the ability to access capital. At times there can be exceptions to this approach, most notably for the asset capture/exploration and monetize strategy (prior notable examples of success in this business model are Kicking Horse Energy, Celtic Exploration, and Progress Energy). That said, generally the key to exploration success is putting together a package of assets that is highly coveted by companies seeking assets with high asset quality and egress potential.
Drivers of PDP NAV Growth & Capital Velocity
We look to identify companies that have the assets of the highest quality and depth of inventory. Half-cycle well-level economics and profitability are defined by revenue in relation to costs. Revenue is framed in terms of IPs, decline curves and EURs, and the value of the product stream (commodity mix). Cost structure relates to both operating cost-per-unit of production (often defined by choices in capital allocation to facilities development), and the capital cost structure of wells. Fundamentally, we evaluate how quickly a well pays out, or returns the capital invested to investors, and then what the remaining value of the particular well is.
Egress begins at the wellhead and ends at the point of sale. The market access problems of the WCSB and the need for infrastructure development in the Montney, both on the liquids and the gas front, are well documented. We look for business plans that maximize revenue received at change of custody while minimizing the cost to get there. Additionally, good managers of their assets will often diversify end markets in order to mitigate idiosyncratic product market risk.
Businesses are built upon, and investor returns are conceptually predicated upon, the eventual return of capital. Access to capital is therefore critical to any resource play producer. Capital available for investment primarily comes from the cash flow provided by current assets (recognizing that all E&P resource assets are declining in nature if we take a neutral commodity view), bank credit capacity, and access to term debt and equity markets.
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