Cardium Oil Stock Valuations: Have We Seen The Peak?

Aftermarket on Wednesday March 17, one of the Calgary oil and gas boutique securities firms, Peters & Co., issued an updated Cardium report - which in a nutshell said

1. They estimated decline rates on wells were higher than expected (meaning the production levels of the wells dropped faster than expected)…
2. …which means operating costs are higher as costs get amortized over a smaller production base…
3. …and once you factor in the very high land costs recently paid by some companies, the break even on "full cycle", or all-in costs, in some of the Cardium plays (and there are several) were up to $75/bbl in some cases.

What this means for investors is that it's quite possible the next few buyouts could be done at a lower valuation than the most recent three (Berens Energy, Result Energy and West Energy).

The Peters report rightfully pointed out that the Cardium data set is STILL so SMALL (only 35 wells over a huge area - the formation stretches 1000 km) that these results could be dramatically revised - up or down - in the next quarter as even more wells come onstream.

One big revision potentially happened today, Monday March 22, as Bellatrix Explorations (BXE-TSX) announced a boomer well of 910 barrels of oil equivalent per day (boe/d), in their Willesden Green Cardium play (81% oil, 19% natural gas).  There was no mention of how long the duration the production test was - 12 days, 12 hours, 12 minutes - investors don't know.

This would belie the Peters' report conclusion - but Bellatrix also noted that two Cardium wells hit only 100 boe/d, which is 50%-60% of average IP (initial production) rates in the Cardium so far.

Between the Cardium being SO popular, this negative report and my strong profit position, the Oil and Gas Investments Bulletin portfolio locked in profits of 60%, 70% (over 2 months) and 172% (over 6 months) on its remaining Cardium positions in the first two weeks of March, not including the West Energy take-over.

How future valuations will be affected, only time will tell.

As background, through the second half of 2009, analysts quickly moved the new Cardium horizontal well play up to #2 on their comparison of profitable plays in the Western Canadian Sedimentary Basin (WCSB) based on some initial well results. (Other plays (or formations) include the Viking, the Lower Shaunavon, the Bakken, the Pekisko etc.)

The market started smoking "hopium" and quickly convinced itself that with improvements in completion techniques (fracking), the Cardium economics could approach the Bakken, and that production levels would be consistent across every acre of Cardium lands.

Stocks started to fly upward.  Then we saw three take-overs in the Cardium in the first three months of 2010 - Berens Energy, Result Energy and West Energy (which was in the OGIB portfolio).

When analysts backed out their estimates of the value of the production in those buyouts, they came up with some very high guesses as to what the value of the raw Cardium lands were for the acquiring companies. (And of course, it was to their benefit to have that # be as big as possible, so they could put the spin on that the rest of the Cardium players still had lots of room to move…)

That caused stocks like Vero Energy and Bellatrix in my portfolio to fly up and up, and I took profits on the day West Energy was taken out - which so far, was very, very close to the top.

The Peters report said that from the limited number of wells to date, first year declines are 65%-80%.  Using a hypothetical example, if a well has an Initial Production (IP) rate of 200 bopd in the first month, in one year it will only be producing 40-70 bopd.

They estimated the break-even price per barrel on the play - depending on which part of the Cardium - was $58 - $66 on a half cycle basis.  Think of that as meaning just the operating costs, and not including or amortizing in land costs.  As comparison, the Bakken break-even price is more like $40.

And once land costs are included - especially at some of the land prices being paid recently, up to $4 million per section - the break-even price goes up to $75/bbl.  There is precious little profit margin there!

(This is similar to what happened in the US shale gas plays.)

As an example, the report estimated full cycle economics in the East Pembina part of the Cardium - at $4 million per section land value - having only single digit return at US$80/bbl.

The Cardium has usually been ranked by analysts as #2 in profitability of the WCSB plays.  The Peters report estimated the median return of the 8 reservoir plays to be 44%, and the horizontal wells at Garrington in the Cardium were dead last.  The Garrington well profile (how long it will produce at what rate) was downgraded 15% by Peters, the most of any Cardium play.