Argent Energy Trust: Third Time’s a Charm?

Argent Energy Trust was the third cross border trust to IPO back in August of 2012. I initially wrote about AET back in October when the trust was drilling its first two Eagle Ford wells. At the time, the production profile pointed to ~4,000 boed in 2013. However, following new acquisitions since then, the new guidance now calls for 5,500 to 5,600 boed for 2013.

The trust grew its production pretty quickly capitalizing on its high share price. The stock price held up much better than its peers since they did not register any production misses so far – unlike Eagle Energy Trust and Parallel Energy Trust. So all they had to do was to raise money and purchase new properties accretively – and they did it twice since launching.

Let’s face it, launching a trust that returns more than 10% yield right off the bat is not sustainable. The acquisitions were the right thing to do as you increase the scale of production underpinning the sustainability of the distribution.

The trust’s portfolio of oil and gas producing assets are located mainly in Texas. The beauty of starting a new oil and gas company from scratch is that you get to pick where you want to be installed.

And Texas is a great place to be in.

For one, you have no pipeline constraints or discounts to worry about. Since they’re in southern Texas close to the Gulf Coast refinery markets they don’t even have to worry about WTI pricing since they get Louisiana Light Sweet (LLS) pricing for their oil. So when WTI is at $90, they’re selling their production at $95-$100 per barrel.

premium LLS pricing

The beauty of LLS pricing!

Texas has been producing oil since the 1880’s; the assets acquired are mostly legacy conventional oil production with a low decline profile.  The annual production decline rate is at around~18%, that’s an amazing rate compared to some resource plays- recall Pinecrest Energy had estimated its decline rate at 40% in the first year of production following its now defunct combination with Spartan Oil.

In the junior space, the cross border trusts (excluding Eagle Energy Trust at -10%) have outperformed ALL their Canadian based E&P dividend paying companies. In fact 80% of those are in the red so far this year – the beauty of the web based oilandgas analysis tool is that it helps you generate  a “big picture” snapshot of the market.

YTD performance as of March 19 2013

YTD performance as of March 19 2013

Argent offers a lower yield than its peers but there’s a good reason behind it, it’s in a better financial shape. But at ~10%, the distribution is still very generous so let’s see if it’s sustainable in 2013 by running the following scenario:

  • 2013 Average annual production of 5,500 boepd (72% liquids)
  • Average realized natural gas price $3.30/mcf NYMEX
  • Average realized price $100/barrel for oil (~$90 WTI)
  • Capital expenditures of $41.0 million

The basic payout ratio comes out to 64% while the sustainability ratio ends up at ~115%. A premium DRIP is planned and the company anticipates a participation rate of 25% this year. That’s a reasonable assumption; a 25% DRIP participation rate brings the sustainability ratio below 100% to 99%.

Excluding DRIP, a sustainability ratio of 115% results roughly in a $12 million deficit. So in theory, if no investors sign up for DRIP, the amount can be easily absorbed as the company has $45 million unused on its credit line.

The company has some excellent hedges in place for 2013, 60% of its oil volumes are hedged at $90 WTI or better. Natural gas prices have YTD averaged ~$3.30/mcf so I’m reasonable there as well. Using the low end of the guidance at 5,500 rather than 5,600 boed, the debt to cash flow ratio is 0.7x.

The trust currently has an inventory of more than 170 drilling locations or around 12 years’ worth of drilling. The Eagle Ford accounts for 95 locations. The last 2 Eagle Ford wells reported an IP30 rate of 350 boed , not great given they cost $7.5M a pop – more than expected. But thanks to a shallower decline profile so far, each well is estimated to recover about 300,000 boe, still economic at these numbers.

The Eagle Ford inventory is based on a 4 well per section spacing .But it has the potential to double since some industry players have been testing 10 wells per section. Overall, the inventory is bound to rise as there will be more acquisitions to come.

But a strong share price is a prerequisite for new acquisitions. This means their execution until then has to be flawless. No misses will be accepted by the market as we could see a repeat of the Eagle Energy punishment.

This is obviously the biggest risk along with the global price of oil. Even with the hedges, I expect the share price to be sensitive to oil price volatility.

Third time’s the charm with Argent? Could be, but only when they bring their sustainability ratio BELOW 100% excluding DRIP altogether. They will need more acquisitions and flawless execution to achieve this milestone. So far so good for Argent so the potential is definitely there.

What do you think of Argent Energy Trust?

3 comments to Argent Energy Trust: Third Time’s a Charm?

  • Kris

    Hey Mich, Was wondering what your current thoughts are on the big “down draft” in Argent recently. I am thinking it may be getting “over” beaten down and looking like a good risk reward investment (i.e. high risk and high reward… at over a 16% distribution!)
    Also, are you going to take another look / do a comparison of the Canadian Energy Income Trusts, I have really enjoyed reading your analysis but much has changed since some of these were written.
    Thanks
    Kris

    • Mich

      Hey Kris,

      Good to hear from you!

      I haven’t looked too closely into AET but I suspect this is a repeat of the scenario we saw with EGL. I agree with you this is high risk/high reward as something is definitely bothering the market.

      I’ll be taking another look at the income trusts soon. Need to finish a couple of side projects and will be back in action!

      Cheers,

      Mich

  • Kris

    Thanks for replying Mich,
    I decided to buy in when it dropped below $6
    I don’t really understand why it is down so much (I would not have thought the recent drop in Target price by 3 big banks would cause this much damage) but I decided the Risk / Reward ratio was good enough for me. I expect/hope after Year End Results are released on March 4 there will be more clarity as to what is driving the price.
    Looking forward to you 2014 review of the Income Trusts.
    Kris

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