Late December marked the arrival on the scene of Cardinal Energy [CJ – TSX]. The $247.5 million public fundraising effectively changed the landscape in Southern Alberta. Now, the dividend-issuing Cardinal is not only increasing its production at its Bantry property, but it’s impacting the fortunes of smaller junior companies in the vicinity.
For junior producer Hemisphere Energy [HME – TSX.V] the impact was felt almost immediately, as they had a new neighbour in the area where not so long ago they were watching others leave.
“Cardinal moving into our area is a pretty significant piece of information for us. That’s still new to us,” says Don Simmons, President and CEO of Hemisphere. “The market is really liking their story, and so far their whole game plan that they’ve shown is to vacuum up Southern Alberta oil assets.”
Hemisphere had made a strategic acquisition late in the fall, just before Cardinal hit the scene. The pickup was its second Southern Alberta asset, called Atlee Buffalo. A personal favourite of Simmons for over a decade, the Atlee Buffalo property brought a unique opportunity that went unnoticed under bigger houses.
“Atlee Buffalo had been buried in big companies for a while now,” says Simmons. “It was in Dome, Conoco, and Pengrowth for years. Yet no development or capital was really spent on it.”
“We specifically target pools, like Atlee Buffalo, which we mapped just under 50 million barrels of original oil in place in the two pools that we wanted to purchase. There have been about 2 million barrels taken out since the mid 70s. So we see that most of the pools in this area can recover 30-40% of the original oil in place. This one has recovered 4%. Why?”
ATLEE BUFFALO LAND MAP - SOURCE: HEMISPHERE PRESENTATION
It’s a good question. Part of the reason is that production drop-offs were just left unattended. Whereas an effort by one former owner (Crestar) saw that problem mitigated by drilling a horizontal well and the installation of a special progressive cavity pump (pcp) that prolonged the production life of the wells.
“We’re running our economic models of an Atlee Buffalo horizontal well coming on at about 55 bbls/d producing for about 8 years, and producing about 75,000 barrels,” says Simons. “But then you look at when Crestar put another new pump on when the well looked like it was finished, and the well went on to produce another 40,000 barrels.”
Hemisphere originally entered the region by purchasing its Jenner property from exiting Twin Butte Energy [TBE – TSX]. On Atlee Buffalo, they were able to obtain the property from Pengrowth Energy [PGF – TSX] for $3.35 million. Now, they believe if they apply their horizontal drilling experience, install the proper pumps and implement a pressure maintenance program, they have the ability to perhaps more than triple the resource.
“We are very comfortable saying that we can move the 4% recovery up a lot. Even ten percent would be a significant increase for our company,” says Simmons.
“That’s only moving it to a 14-15% recovery. But, if we can move that to a 30-40% recovery, that’s a huge increase.”
Thus, from a Cardinal perspective, a company of its size may have bypassed a property like Atlee Buffalo just like Conoco and Pengrowth did. However, after a group like Hemisphere buffers a nice shine onto the project and gets the wells pumping at a far more consistent rate, then the whole operation looks more enticing.
To top it off, heavy oil differentials these days are in their favor. They’re at approximately $20 per barrel between Canada and the US, so any price above $90 is indeed workable.
Unlike unconventional plays, Hemisphere’s Atlee Buffalo and Jenner projects stand out as prudent in terms of the economics. Jenner wells cost $1 million to drill and complete. Atlee Buffalo wells are $1.2 million. With each well drilled, the team becomes more comfortable with the terrain, and can shave down the costs more.
On Jenner, the group is already 12 for 12 in drilling success. Now the company has recently announced the completion of its first drilling program of 2014, which includes one Atlee Buffalo and two in Jenner. Should the group match its previous success, it’ll be a very respectable 15 for 15.
Financing such efforts is a lot easier when the economics are the way they are on Atlee Buffalo and Jenner. Conservative recycle ratio projections on Atlee Buffalo are 2.5x, with an IRR of 74%.
“We’re cashflow positive on any given month. After all the bills are paid, we clear about $500k-$750k depending on oil prices,” says Simmons. “With that we could then drill a well every two months. So, 6 wells a year you’re self funding.”
“We would be self-financing every well right now, but can’t self-finance fast enough for rapid growth. So since we are focused on drilling throughout 2014, we’re looking at a 7-10 well program financed through cash flow and our existing line of credit.”
PREVIOUS PRODUCTION CURVE FROM CRESTAR'S WORKOVERS AND NEW PUMPS.
In the meantime, the market awaits the results of the three wells drilled this January; Especially on Atlee Buffalo, where a drilling success there could set off an avalanche of drilling. According to Simmons, the company would need to drill at least 50 wells there to capture the potential resource.
From a market standpoint, there is indeed a logical growth and success story. This young, aggressive management team could continue drilling away and growing their production steadily for quite some time.
But today’s investor needs to know there’s an exit strategy in place. This time last year, it didn’t look like there was going to be a lot of outside interest in the region. Cardinal’s entry changes that.
Prior to Cardinal’s December IPO, it was apparent that none of the majors in the area were going to be getting their budgets approved for unconventional assets. Mid-cappers like DeeThree Exploration [DTX – TSX.V] which are still working the Alberta Bakken are the exceptions to the rule.
Dividend paying larger juniors, such as Cardinal need feeder stock. Assets like Atlee Buffalo work in these types of situations, and draw Cardinal-type companies to takeout targets like Hemisphere.
Should the Cardinal team look to further hone its focus onto its Bantry assets, Hemisphere instantly becomes one of the most likely takeout targets in the vicinity.
Aside from a handful of smaller private companies, and a much earlier stage First Mountain Energy [FMX – TSX.V] also nearby, Hemisphere is alone in its peer group.
Already, Hemisphere has significant infrastructure in place. Last year’s $2 million upgrade on the company’s main facility in Jenner not only is set to improve production possibilities for their wells already on production, but it also has space for more.
“There’s significantly more room in our battery to move more fluid,” says Simmons. “We can focus and drill another 2-4 wells at Jenner to keep that growth going there.”
Hemisphere has access to more than 35 sections of land in Jenner. On this property it has a growing inventory of low-risk development drilling locations and medium-risk exploration prospects. At this point they have between 25-30 offset locations.
With two fronts to tackle, Hemisphere has a clear path to growing its resource. Increasing its recoverability looks to be straight shot, especially if they implement the pcp pumps that Crestar did successfully in the past.
Should they continue to grow at the rate that management is aggressively seeking, it could only be a matter of time before the Cardinal-sized buyers start kicking tires. As well, successes such as Cardinal’s (which has gone from a $10.25 IPO to an approximately 30% gain within one month) could also bring bigger players back to the area in search of production and exploitable reserves.
By. G. Joel Chury