Paralell Energy Trust: Distribution Sustainability in Danger

Last time I discussed Parallel Energy Trust, WTI oil was above $100 per barrel and the company was realizing a decent percentage of WTI for its condensate and NGL production. However, following its last Q2 report, the company is making a lot less money on its liquids production which combined with operational issues are undermining an already fragile dividend.

Due to lower commodity prices, Parallel PLT-UN.TO 4.25 [-0.05] lowered its production guidance 4% for the April 2012 to March 2013 period from a previous guidance of 7,300 to 7,700 boe/day down to 7,000 to 7,400 boe/day. The company will be drilling 37 wells during this year vs 44 wells originally planned.

Furthermore, operational issues seem to plague the company on a quarterly basis. In Q2, the company drilled 6 out of 11 wells which severely underperformed at 15 boe/d rather than the type curve of 40 boe/d. The company had drilled these wells on its Sneed field and will be drilling the remaining wells on its Carson field which has less variability in results.

In Q3, the company will be losing up to 3,000 boe/d of its productive capacity for a six week period. The curtailment is due to regulatory testing requirements at a third-party owned and operated pipeline. While the operator believes testing should be completed by late September, there’s a risk production loss could be for longer than anticipated.

On the commodity prices side, even though the company does not produce any oil, its liquids are priced based on WTI oil. NGL (Natural Gas Liquids) pricing has been under pressure for the past few months due to oversupply in PLT’s area of operations. Prices have tumbled from 47% of WTI in Q1 to 43% of WTI in Q2 and are currently averaging less than 40% of WTI. In Q3 of 2011, NGL was selling at more than 60% of WTI. PLT expects NGL prices to improve in 2013 once the oversupply issue is resolved.

The company estimates its total payout ratio at 140% using a WTI oil price of $95 and NYMEX natural gas at $3.30. The risk to the dividend lies in the price of oil; $95 is not conservative at all especially knowing that its liquids production generates the bulk of cash flow. We saw a few weeks ago how quickly oil prices can correct. If the company is in pain now with a POR of 140% based on $95 oil, it will only get worse if WTI hits $80 again in the near term.

parallel energy trust revenue 2012

A drop in WTI prices will be deadly for PLT.UN

The company’s hedges will soften the blow of lower commodity prices and $40 million in undrawn credit line can help as well. But its the 75% DRIP participation rate that is currently covering the shortfall and bringing the total payout ratio below 100%. But over the long run, it has the negative effect of being dilutive. Paying the distribution from debt or DRIP proceeds is simply not sustainable.

The dividend may not be in danger in the meantime, but the clear and present danger to the distribution will cap the stock price. Any change in market sentiment will punish the stock severely based on high debt to cash flow and an unsustainable distribution.

Finally, the ingredients for a change in sentiment can be found quite easily: from Europe coming back in the spotlight this September, passing by the US elections in November to the looming US fiscal cliff. There’s no shortage of events that will make sure PLT’s share price will see much lower levels before it gets to see a higher one in my opinion.

What do you think of PLT?