Twin Butte Energy: Setting Up for a Heavy Oil Contrarian Trade?

Twin Butte Energy was one of a few dividend paying stocks able to afford its dividend. On top of it, it was able to pay its dividend from producing heavy oil rather than high netback light oil production. But in its last update, TBE reported operational??challenges that impacted close to 1,000 bopd last week. The stock lost 18% even though management made it clear spending will be adjusted to stay within a 100% payout ratio protecting the dividend. This could be an opportunity for acquiring a dividend paying stock in anticipation of a recovery in heavy oil prices in the second half of the year.

Twin Butte TBE.TO 2.30 [+0.02] experienced performance issues in December and January attributed to the cold on one of its properties. It’s not just any of its properties; it was at Primate (Western Saskatchewan), a signature property responsible for more than 3,000 bopd in 2012. The company lost around 900 bopd of production at Primate as water cuts increased substantially.

While the company is deploying remedial efforts to address this issue, it did the right thing by reviewing its guidance. The spending budget was cut from $110M to $85M and previous guidance was reduced from a mid-range of 19,300 to 17,400 boed (84% heavy oil, 5% light oil & NGLs and 11% natural gas). TBE might be able to restore some lost barrels at Primate but at this point it remains unknown.

Heavy Oil prices have seen RECORD differentials in December and early January. It was selling at more than $40 discount to WTI. Prices improved recently with Western Canadian Select quoted over $66 barrel. Differentials are expected to narrow in the second half of the year on new refinery demand coming online for about 180,000 bpd of heavy oil. That’s not to forget new pipeline capacity coming on line and increased rail capacity out of western Canada.

pipeline expansions 2013

src: Enbridge & Baytex Energy (click to enlarge)

Although there has been a few voices talking about a contrarian trade in heavy oil, there are many variables associated with pricing so let’s focus on the hedge book for 2013. TBE has between 30% and 47% of its heavy oil hedged at $76 WCS for the remainder of the year which should help protect its cash flow.

So where does the new guidance put the payout ratio? Let’s take a look using oilandgas-analysis for our 2013 scenario:

  • Average production of 17,400 boepd (84% heavy oil, 5% light oil & NGLs and 11% natural gas).
  • Light oil at $80 CAD
  • Natural gas at $3.00/mcf
  • Heavy Oil at $60 WCS

While $3/mcf is realistic for natural gas,the price for light oil is conservative right now. The price for heavy oil is the key here and $60 is a pretty realistic number given the hedge book and the current price. This results in a payout ratio of 106% and an all-in payout ratio of 100% including DRIP.

tbe payout ratio 2013

generated by

These are actually some great numbers since our commodity price deck is not??far-fetched??at all. On the contrary, if heavy oil prices recover by $5, the payout ratio drops to 91% excluding DRIP. The company has $205M drawn on a $280M bank line leaving the debt to CF in our scenario at 1.6x. ??

Remember that these are ballpark numbers but they give an excellent snapshot of the company’s financials in 2013. In the near term, investors need to get over this uncertainty at Primate and get used to the lower production guidance. A??successful??remedy or explanation of what happened at Primate would reduce the risk to production going forward. Looking at the big picture, if the outlook improves??for heavy oil pricing, this will bode well for TBE and other heavy oil companies like Rock Energy and Palliser Oil and Gas. I think TBE is the most likely acquirer of both companies since it’s been on a consolidation spree at Lloydminster in 2012.

Getting paid to wait is a bonus when you’re in a contrarian trade. This is where personal risk tolerance comes in, what is your outlook for the price of oil and especially heavy oil? ??I personally think the fundamentals are there for a sustainable price in the $85-$95 range for WTI. The call is really on the outlook of heavy oil prices, will differentials worsen before they get better? That is the question. For 2013, I believe pressure to the downside should be limited on the stock as TBE’s management will do what it takes to protect the dividend and the balance sheet. The debt is currently reasonable and the production weighting offers a free call option on a recovery in the price of heavy oil.

What do you think of TBE? What is your outlook for Heavy Oil’