There’s a reason behind the weakness in price for shares of Parallel Energy Trust and I don’t believe it has anything to with it being a “natural gas” trust responding to record low natural gas prices or having its dividend in danger. The answer lies in the last operational update that was released a few days ago:
Parallel had forecasted an exit rate at December 31, 2011 of approximately 4,350 boe/day; however, production was impacted by below-forecast results from some of the dual lateral wells drilled and the abandonment of one well bore.
The production hiccups that were reported have pushed the stock right into the penalty box. Parallel PLT-UN.TO 0.78 [+0.08] missed their 2011 exit rate guidance by a significant 350 boe/d raising a red flag on production going forward. Moreover, the last 3 of 4 wells drilled in Q4 came out with disappointing production rates. What happens if in 2012 a significant amount of wells budgeted for IP30 rates of 40 boe/d end up at 25 boe/d?
To be fair with Parallel, the type curve will not be hit by every well a company drills, production results will be statistically distributed above and below the curve. Furthermore, these last 3 well results should not be indicative of the whole field where the company has 189 drilling locations. Until the whole field is drilled, there’s no telling with a high level of confidence what its production capacity is per well. This is where the company went off-road in its news release, instead of explaining to the market that these results are not necessarily indicative of future well performance they simply threw in a “the distribution will not be impacted” line. That obviously was not enough…
Given that natural gas prices have been tumbling, what is the status of the dividend for Parallel Energy Trust? You might have noticed that I used quotes in my “natural gas” label above and there’s a good reason for it. Only 33% of the trust’s production is actually dry gas so a substantial fall in natural gas prices won’t have a serious impact on cash flow. Having said that, let’s review the sustainability of Parallel’s distributions in light of the new 2012 guidance which was revised lower to average between 4,200 and 4,500 boe/d using the following assumptions:
- 2012 capex: $16.5M
- 2012 average production 4,300 boed (67% liquids)
- WTI oil price of $95.00 covering condensate production
- $58 per boe for natural gas liquids
- Natural gas price at $2.50 /mcf
Please remember that this capex is growth oriented and not for maintaining current production at 2011’s exit rate of 4,000 boe/d. The company may choose to maintain current production instead of increasing it relative to 2011 levels which would require much lower expenditures. Furthermore, this model assumes PLT is entering 2012 with 4,300 boed in average production which is not true; expect 2012 results to differ as the company grows its production on a quarterly basis before reaching its targeted average production.
While the company went with $100 oil WTI and $3.00/mcf I decided to be slightly more conservative especially with natural gas prices wiping the floor in 2012. Thanks to its liquids weighting, the company should be able to realize a cash flow netback of about ~$25/boe which is very good for a “natural gas” producer in this environment. However, the sustainability ratio (total payout) comes out to about 130% only to fall substantially to the 80% level thanks to a 60% participation in DRIP generating $21M per year. The proceeds from DRIP largely cover the capex and the company would even have money left to reduce the debt or to fund new acquisitions.
At least for 2012, the dividend is safe, the asset has a great decline rate and while the outstanding debt is annoying it’s manageable which brings us to what’s really at stake here: operational performance. In the last news release, the company focused on the sustainability of its distributions when in my opinion it should have also focused on defusing the charge those well results carried. The penalty box is deserved based on the performance issues and on the fact that the company is only able to cover its distribution with the help of the DRIP proceeds. Parallel needs to bring its sustainability ratio closer to 100% excluding DRIP proceeds. Obviously, this is were results come in, drilling wells with IP rates at or above the type curve ensures less capital spending is required to reach the production guidance. It should be easier to do now that the type curve has been lowered to an IP rate of 40 boe/d.
The year is still young and it’s not too late for Parallel to address its shortcomings, the company should be reporting year end reserves as well as an operational update sometime this month. This is an opportunity to infuse some confidence back in the stock particularly if its latest well results come out alright. The company reported a good chunk of operational hiccups for 2011; the CEO should keep this in mind when writing the next news release.
What do you think of PLT?