SecondWave Petroleum Joins the Walking Dead

No, SecondWave Petroleum did not join the cast of The Walking Dead drama series on TV. As of its last operational update it is clear the company is walking dead as it can no longer realize meaningful production growth. This leaves SCS with the one and only hope of being saved through a buyout.

SecondWave is mainly focused on the Beaverhill Lake play which hosts an estimated 2.5 billion barrels of original oil in place. Its BHL wells initially produce at up to 5,000 bopd before declining sharply in the following weeks. Drilling those wells is not cheap, up to $6 million apiece not counting on the cost of building the necessary infrastructure.

The company now has a total of 35 gross (16.4 net) Beaverhill Lake light oil wells in Judy Creek with the following average approximate light oil IP rates per well:

  • 30-day IP 500 bbl/d
  • 60-day IP 283 bbl/d
  • 90-day IP 219 bbl/d
The fact that we have a type curve here means the play on its acreage has been significantly proven thanks to those 35 wells drilled so far by the company.
secondwave petroleum bhl

The Beaverhill Lake players

As one of a few junior producers with a significant land base in the play, SCS got its 15 minutes of fame culminating in failed take-out negotiations earlier in 2012. The high capital spending associated with the play quickly took SCS from hero to zero. A look at the latest quarterly report reveals an over-leveraged balance sheet with covenants violated.

SCS is another junior producer that got trapped on the dreaded treadmill forced to limit its spending to cash flow going forward. Production guidance was reviewed lower down to 2,200 boed from 3,500 boed. The company has already exhausted leverage by using up all its credit and more. It is guiding for a 5-10% increase in production from cash flow.

The problem is the market no longer believes management and companies with slow or no growth are in no way rewarded. The annualized cash flow for 2,200 boed comes out to about $30 million. According to management, they will be able to increase production by 5-10% next year by drilling from cash flow. The drilling will be focused on the sweet spot area to maximize returns. Operating costs and drilling costs have been trending lower, but that’s not a miracle formula to resume growth.

So let’s assume a 5% growth for next year which puts the annual average production at 2,300 boed (80% liquids) in 2013. It is best to go with the lower end of the guidance since management is not the operator and because their credibility took a hit since they established a precedence for missing. Our scenario will use the following commodity price deck:

  • Edmonton Par at $85/barrel for light oil
  • AECO at $3.30/mcf for natural gas

The end result is roughly $32 million in cash flow. This means that the company will be able to pay down a whopping $2 million on its debt. That’s less than 2% of their outstanding debt if they exit the year at the lower end of their $110-$112 million range. The company’s debt to cash flow will remain high at 3.5x. In my opinion, upside will be almost non-existent and limited to a tide lifting all boats event (not a lot of those lately.)

With the prospect of capital gains largely off the table, getting bought out is the only hope left for the company. The fact that Crescent Point is the JV partner makes this outcome inevitable. In fact, I believe SecondWave Petroleum is ripe for the takeover. That’s based on Crescent Point’s acquisition of Reliable Energy earlier this year. Crescent Point was a 25% JV partner on REL’s Manitoba acreage and owned 19% of REL. Crescent Point moved in for the kill when Reliable Energy’s production got stuck at 1,000 boed.

That would be the optimistic scenario…the pessimistic takeover scenario would be a la SkyWest Energy where the company gets consolidated for peanuts.

I believe  the optimistic scenario has better chances simply because there’s a major shareholder behind SCS, Brookfield Bridge Lending Fund Inc.  They own more than 50% of the shares. They have every reason to keep the company afloat and ensure it finds a decent new home for a realistic price. SecondWave SCS.TO 0.00 [N/A] might be sitting on tons of oil but that doesn’t impress the market simply because there’s no money to extract it. At this point, it’s simply a bet on a take-over which will most likely materialize one day.

What do you think of SCS?