Athabasca Oil: Big Improvement, But Still Risky

seekingalpha09-14

Distributing 100% of free cash flow to shareholders instead of repaying debt is risky.Thermal earnings are much more volatile than the unconventional business.The new joint venture with Cenovus Energy...

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As a thermal producer, this higher cost producer is finally getting costs down as production climbs to levels that allow for more savings. But the policy of distributing 100% of free cash flow to shareholders rather than repaying that debt is something that should make potential investors pause. Thermal producers rarely exist long as independent entities. The major reason is that thermal production is a fairly expensive proposition. The earnings are fine when the industry commodity prices are at current levels. But thermal is a discounted product. That discount can easily widen during a downturn (even with the new pipeline expansion project now operating) to wipe out cash flow. Therefore, the risk of this investment has to be above average, and it will need constant attention \"just in case\". Earnings The earnings summary is shown below. Note that during the current environment, cash flow and really earnings are in good shape. (Note: Athabasca Oil is a Canadian company that reports using Canadian dollars unless otherwise noted.)   Athabasca Oil Summary Of Quarterly Results (Athabasca Oil Management Discussion & Analysis Filed With Sedar Second Quarter 2024) Earnings are up nicely, and management has some good operational progress to report as well. As is typical with the thermal business, cash flow is now healthy and easily handles the debt load. What may help is management appears to be significantly decreasing at least some of the operating costs per unit. Long-term, shareholders will need to see how much of those cost savings prove to be permanent. However, thermal earnings are far more volatile than is typical of the unconventional business. If the discount to light oil happens to widen during a downturn, then there may be a need to shut-in production to prevent negative cash flow. However, the debt still needs to be serviced, no matter the industry conditions. Currently, management is handling this contingency by keeping a large cash balance on hand. The hope is that the cash balance will last through the business cycle until prices recover. Personally, I would prefer to see the net cash position grow. The Last Article The last article emphasized the new joint venture with Cenovus Energy (CVE) to produce light oil. This comes after the partnership with Murphy Oil (MUR) some years ago obviously fizzled. Depending upon the view of an investor over the past events, that may make the current partnership more or less able to deliver the long-hoped-for light oil production to assure decent cash flow during cyclical downturns.   Athabasca Oil 2024 Guidance (Athabasca Oil Corporate Presentation August 2024) Right now, the thermal production is far larger than the light oil production. Therefore, any cyclical downturn could potentially prove to be challenging for this discounted product producer. If management can increase the percentage of light oil produced, then cyclical industry downturns will not be as challenging in the future. The last partnership did not achieve that goal. Therefore, one has to ask what the new partnership has going on for it that the last one did not. Duvernay Energy This partnership is off to a good start with a big percentage increase in volume from a very low starting point.   Athabasca Oil Summary Of Joint Venture That Is Duvernay Energy (Athabasca Oil Corporate Presentation August 2024) The partnership began with a fair amount of money. That money will go towards establishing a base production that should enable growth if the acreage meets expectations. This benefits Cenovus in that the project (at least for now) does not move the needle but yet, any cash made is a benefit to the company. More importantly, the company does not have to spend any time on this because Athabasca Oil will operate the project. Hopefully, all goes well in the future. As noted before, Athabasca, for its part, badly needs light oil production to assure a cash flow source during cyclical downturns. The small amount of production is definitely significant to this company, and any growth will go a long way towards making future downturns tolerable. Thermal Oil Cost Savings As shown below, management attributes the cost savings to the energy part of the operating expenses.   Athabasca Oil Leismer Operating Cost Savings (Athabasca Oil Management Discussion And Analysis Filed With Sedar Second Quarter 2024) To the extent that the energy savings are a result of climbing production, then those savings will be permanent. Over the years, management has made good progress bringing the costs down. But the WTI breakeven remains fairly high because of the discount between the value of thermal oil and the light oil represented by the WTI benchmark. There is hope that the startup of the Trans Mountain Pipeline (expansion project) would \"soak up\" some supplies and provide a smaller discount to the WTI pricing. That would, of course, lower the breakeven if this type of producer could assume smaller discounts in the future. However, generally, this industry has very poor production discipline when a price increase comes along. A smaller discount is effectively a price increase received for the product produced. Therefore, any reduction in the discount is likely to prove to be a temporary thing. Summary Athabasca Oil is in good shape as long as commodity prices remain strong and the industry optimism about the discount holds. However, management would be smarter to build a larger net cash position while the good times last. The thermal industry often has a huge challenge to get through cyclical downturns when the thermal sales price discount to WTI pricing often widens. Even with the start of the Trans Mountain Pipeline expansion project now carrying more product to be exported, that may well prove to not be a permanent solution because the industry has a very poor record of production control when prices improve. The breakeven point for thermal oil tends to be high when expressed in WTI benchmark terms because that discount widens during cyclical downturns. The net result is that many of these companies get acquired by an integrated company that can upgrade the production to value added products to avoid that discount. Athabasca Oil does have a partnership with Cenovus Energy to gain sufficient light oil production to assure a reasonable cash flow during cyclical downturns. However, until that happens, this has to be regarded as a speculative strong buy that needs lots of attention and is probably more suited to traders as a result. Risks Any upstream company is subject to volatility and low visibility of commodity prices. Thermal producers like this one have the additional issue that the discount to light oil pricing often expands during cyclical downturns. This often results in shut-in production to prevent negative cash flow until prices recover. But then a cash source is needed to service the debt load. Right now, management is resolving the issue with a net debt position that should probably increase. That would enable far more debt to be repaid while maintaining a very strong cash position. Giving 100% of free cash flow is a risky proposition that management has embraced due to the characteristics of thermal production in a downturn. The loss of key personnel could materially set back the company in the future.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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