Penn West Energy: More Questions Than Answers

I have more questions than answers after Penn West Energy Trust's Q1 2008 earnings release.

2008 Q1 highlights (all figures C$ unless otherwise noted):

• Operating cash flow came in at $367M vs. $296M YOY. However, taking into account the Vault and Canetic acquisitions (and the 51% share dilution accompanying them), OCF per share came in @ $1.02, down 18% from last year. Free cash flow (FCF) fell 42% from a year ago to $0.24 per share. With declared dividends of $1.02, PWE’s “standardized distributable cash payout ratio,” aka dividend/FCF ratio, was 4.5. Inverted and translated, this means the company’s available cash after capital expenditure necessary to keep the company running as a going concern covers only 24% of declared dividends.
• The company’s balance sheet deteriorated slightly in Q1. Goodwill jumped to $2B (13% of total assets) as a result the aforementioned acquisitions. The current ratio slid from 0.62 to 0.58 and long-term debt ballooned to $3.6B from $2B YOY. Total liabilities as a percentage of tangible assets came in at 121%. Subsequent to Q1, the company issued an additional ~$510M of notes to pay off bank debt so I’d expect to see little net debt added as a result of this transaction.
• Revenues more than doubled to $982M. Net income decreased to $78M, down 19% YOY. Earnings per share was 46% lower at $0.22. The company’s hedges really weighed down results on the income statement. PWE registered netback margins of 59.4%, up imperceptibly from 58.9% & 58.7% margins of YOY and from Q4 2007 respectively. This is despite a 37% increase in aggregate sales price and the hedges in place do not account for all of the gap.
• Management raised funds flow 2008 guidance to $2.7B - $2.9B, due solely to raising the baseline prices for oil & gas.

In my last posting on PWE, I put the company on notice, so to speak. The company’s Q1 report did little to ease my concerns.

Operationally, the company experienced some setbacks with a worker death and a pipeline leak during the quarter. While I don’t think they are in danger of becoming the next BP (BP), these incidents, in conjunction with some of the issues they had last year (such as the Wildboy plant fire), suggest management needs to tighten the ship a little on operations.

The company’s free cash flow is trending the wrong way. I am not sure if there are seasonal factors affecting FCF but the company is well off historical ratios of revenue-to-cash-flow conversion. The company has begun emphasizing “funds flow,” which adds back asset retirement obligations and non-cash working capital, over OCF/FCF. Unless the company also pays “non-cash” distributions and capital expenditures, color me skeptical of this measure.

I asked investor relations for some color on the usefulness of this measure as opposed to measuring cash and received a cut-and-paste response from their quarterly report. Adding to my doubts, I scanned through previous earnings releases for funds flow and could not find that term (”funds flow”) in any reports until Q3 2007. I admit some slack on my part for not noticing it at the time (actually, I mistook “funds flow” as synonymous with OCF, much like their “standardized distributable cash” term is basically FCF), but at this point, I’m dubious about using this figure to assess the stock.

Daily production of 192k BOE per day came in below pro forma guidance of 195k - 205k BOEpd but I would expect this number to gradually ramp up as the new acquisitions are fully integrated.

COO Murray Nunns joined in his first conference call and de-emphasized the Seal/Peace River plays, though he did set preliminary projections of 10k - 15k bpd in select Seal locations with the potential for 40k bpd over 5 years using low-intensity steam injection. He reeled off a whole slew of new plays which had not been previously discussed but unfortunately, did not give any substantive details (such as projected reserve potential, timelines, etc.).

This highlights an increasing frustration for me as a unitholder: The company’s investor communications are poor. The company regularly mentions their millions of unexplored acres, growth prospects, etc. but rarely mentions what their organic reserve replacement ratio is, possible resource figures at these millions of acres, i.e. the true nitty-gritty of resource investing. Management spends much of their time talking about their money-losing hedges but little time talking about their crystallized growth opportunities (maybe they don’t have any?). They’ve diluted unitholders by 51% from last year to acquire Canetic and Vault but haven’t told unitholders why they did it. What properties were they so excited to get their hands on? Where is the potential for value creation that justified these transactions, especially as they’ve admitted that synergy/consolidation potential is limited? When can unitholders expect to see resource conversion on this acreage and at what rate? These are the things I feel management should be talking about.

Unfortunately, investor relations did not provide any clarity on these issues. Apparently, the new plays mentioned by Nunns are already accounted for in current proved reserves (571 mmboe). I guess it is a question of how efficiently the company will be able to exploit these resources.

I also asked them a simple question: What was Penn West’s organic reserve replacement ratio? I found their answer unsatisfactory but reproduce it below for the reader to judge:

As an actively managed Trust we do not have a limited life. We are naturally keen to replace oil and natural gas liquids reserves. We can do so through: acquisition - buying companies and assimilating their proved reserves; or organic growth - including revisions to existing reserves estimates based on new information, extensions to existing reserves, new discoveries and improved oil recovery rates. In terms of Proved Reserves, as at the end of 2006 it was 379 mmboe, and as at the end of 2007 the Proved Reserves was 561 mmboe.

I was directed to page 6 of the Q4 2007 earnings release. Excluding Canetic and Vault, Penn West registered replacement ratios 81.5% of proved and 98.5% of proved+probable reserves to production. Excluding acquisitions, these “organic” replacement ratios fall to 38% and 40.7% proved & p+p respectively. Note that “discoveries” account for only 7% of this organic p+p replacement or 1.3 mmboe of 18.5 mmboe reserves added against 2007 production of 45.5 mmboe. With figures like these, it’s no mystery why the company doesn’t go out of its way to clue investors in but frankly, it speaks negatively of management’s integrity.

At this point, while I am not selling completely out of my position, I have reduced my position by a third, registering gains of roughly 30% in little over a year. Part of the impetus for investing in oil companies is for the leverage on the oil price. PWE has badly lagged the oil bull run, remaining below its post-Halloween-massacre high around $36 even as the price of oil and gas have ran to record highs and the US dollar to record lows (which boosts the price of foreign-listed stocks).

While PWE is in little danger of going out of business, there may be better ways to play the energy market without PWE’s apparent operations and management risk. If management cannot deliver more dynamic exploration results and improve communications with the marketplace, expect this underperformance to linger and the opportunity costs of lagging in such a raging energy bull market are too high.

As I finalize this post, Penn West has announced another acquisition, this time of Endev Energy for C$125M.

Disclosure: Long PWE

Comments

[paultaut]

I fully concur. Management leaves a lot to be desired.
The only good thing I can say about it is the unexplored acreage, and hope someone buys it, before it finds another way to lose money.

[samco]

Management does't seem to give you much.
However, you're a guy with any ax to grind with PWE.
I'm holding on to mine.

[Jack Yetiv]

Management has just changed, so I think it's fair to give Nunns a little bit of time to get his feet wet before he communicates his thoughts.

I do wonder, david, why you did not ask questions on the conference call. Only three questions were asked, so there would have been plenty of time for you to ask questions.

I have some questions for you:

1) What will happen to the key metrics if funds flow is $2.8 billion, rather than the $2.1 billion they were previously predicting?

2) This funds flow figure is based on oil at $107 and gas at $8.50. What will happen to the funds flow and the other metrics if oil averages $120 and gas averages $10 this year?

3) In your previous article, you thought the dividend payment was in danger and I disagreed. Do you still feel the dividend is in danger, and if not, what did you learn in the Q1 report that changed your mind on this issue?

4) How do netbacks of $40.57 per BOE (what they reported in the first quarter) compare to other Canroys and other oil companies?

5) Are there any positives to this company, and if so, what are they?

6) Given everything you know, what is a reasonable percent return an investor can expect by the end of this year (ie, two more earnings reports)?

7) Have you figured out why funds flow PER UNIT (not absolute) increased from $1.44 per unit in Q4 to $1.76 per unit in 2008 Q1 while at the same time operating cash flow per unit decreased?

Thanks is advance,

Jack

[F. H.Hartford]

Dear Mr. Bui:

[Jack Yetiv]

David, one last question. Given that the hedges seem to be the biggest issue for you, have you looked at the sensitivity analysis and concluded what impact the hedges will have in the rest of 2008?

What about 2009?

Jack

[F. H.Hartford]

Dear Mr. Bui:
Sorry about that I hit the wrong button.
Have you ever tryed to contact the "investor relation" department of Pennwest? Website is pennwest.com or 1-888-770-2633 they should be able help you with your questions.
Also mcdep.com is an oil and gas income stocks website they will be able to help with income stocks etc.
quantumonline.com is also another free website for insormation.
I have enjoyed the income of "pwe" sence Jan. 2006.
I hop this will help you and your fellow workers
F.H.Hartford

[Georealist]

This is, to say the least, a biased and not very informative article..in spite of its plethora of statistics and "analysis." For those of you...and apparently we are in the majority since PWE shares have been steadily rising for over 4 months, more reasoned about PWE consider the following...
1. Funds flow was a diluted per unit of 1.74 (incl Canetic and Vault)
2. Production is up to 192,000 boe per day..and ALL FUTURE OIL/GAS WILL BE MUCH MORE PROFITABLE BECAUSE THE CEASELESS RISE IN OIL AND THE LARGE GAIN IN NAT GAS
3. Light oil production is up substantially..this is worth noting since this is easily the most valuable type of oil and commands the highest price
4. The long term debt of 3.6 billion will be overwhelmed by higher production at higher prices..that 160% debt increase will prove to be minor in 2 years.
5. In spite of much increased production and the melding of new structures and resource into a single entity operating expenses are only 9% higher..that hardly sounds like poor management...
6. The distribution is steady thru July at which time I predict it will be raised....

Mr. Bui, in most of his articles, fails to take anything like a strategic perspective on any investment he writes about..I'm not sure he even understands the very substantial moat a safe haven provider of a diminishing resource has.
Of course...what do I know..my return on PWE has only been 27%..Mr. Bui certainly has any number of less worrisome investments in mind that top that...

[K. Argenta]

I'm holding on to my stock. PWE is not in good shape. But give them time to take the broom out of the closet and do a little house cleaning might help put them back on track. Giving the reason for not exploring new tracts of land,ALASKA is still the last frontier we have left,without all the pollution going on in the lower 48 states like we have now, give them time and they shoud clean up there act,I hope?.

[badbernanke]

Nice objective report. This raises may of the same issues that have concerned me about PWE. It does not read as a hatchet job, so I am a little surprised that people react so negatively and personally to a iteration of facts. However, that seems to often happen when someone has an investment they are "personally invested in" questioned. They take it as a personal affront to their own wisdom in choosing the investment rather than investigating the facts themselves.

[drooyrich]

Dear Author, could you please investigate also in the position of the other Caroys namely HTE ? Thanks

[jotenn]

One thing neglected in the above comments...PWE's great dividend. I bought it pre Halloween, and bought more over its decline so I am now about even. But when I consider the dividends, I have made a reasonable return. think I will hold on.

[herbnerho]

I'd be interested in some Canroy's in info appreciated you guys really dig into the info. Great job! herbnerho

[WindyCityDave]

Since I've now read two opposing views, I would like for the author to respond to Jacks questions. Thanks!

[Davy V. Bui]

A couple of points:

1) Maybe I'm too long-winded so people don't read to the end, but as I state above, I am still long the stock. If I have an axe to grind, it is most assuredly not to lose money. My beef with management would be to improve unitholder value, pure and simple.

2) Georealist -- If you think my posts are so inept, why waste time reading/commenting on them? There are plenty of authors on SeekingAlpha that I skip over. But thanks for at least providing some analysis behind your trolling insults this time. In response, I would say that, as an investor, it is disappointing to get "peak oil" right but not make much money on it. I'm not sure why this is hard to understand.

Here is a chart of USO (the oil futures ETF), PWE (both NYE & TSX), & CHK, another stock that I follow closely. It is dated near my entry points for both positions (around Feb 2007):

www.enlightened-americ...

I think USO may have some tracking error but it is still up over 100%. The spot price for WTI was hovering around $50 - $60 at the time and I don't remember where nat gas was -- probably around $6-$8 on Henry Hub. USO is +114%, CHK is +84%, PWE is +14.5% and PWT.UN is -4.5%, not including dividends. From this, it's obvious that Penn West has badly lagged the oil bull, even if you include 15% for dividends. It's also obvious that all of the capital appreciation was due solely to the Canadian dollar strength, as shown by the 19% spread between the US and Can listed stocks for Penn West. If you did the work, you'd also see that PWE lagged other energy trusts like PGH, AAV and even PDS. So if you want to criticize me for picking a lousy stock when I could have just bought the commodity and saved myself the trouble, that's valid and something I'm already asking myself. But I'm not sure where you're coming from -- the facts are the facts.

Now I guess there's a chance that PWE could catch up, which would mean big returns from here and that leads me to Jack Yetiv.

Jack, I don't listen to conference calls live. In fact, I prefer to read transcripts whenever possible as it saves me time. I also try to find companies with good management so I don't have to worry about listening to conference calls live. For example, I still haven't reviewed the results from Agnico-Eagle (AEM) yet.

You can find my previous research, including my entry write-up, on PWE here:

www.enlightened-americ...

As you'll see, I've had many positive things to say about PWE. My original premise was based on a few main positives, all of which are weaker now:

1) The company was covering its dividend solely from free cash flow, which is sustainable.
2) While the company was fairly valued at the time based on its booked reserves, we were getting Peace River, Pembina for free with a massive 1B barrels recovery potential.
3) The management was solid and had a good track record.

As you can see from the quarterly updates, management's performance was poor. And contrary to your statement, I don't care about hedges (or the income statement) all that much so I didn't knock them for poor earnings or the big tax hit but I do care about missing production targets, poor exploration results, etc. After all, management has no control over the price of commodities but much control over operations and that's how I try to judge them. I think we have difference of opinion here. I read your 2 write-ups of PWE and it's clear to me that we approach it very differently.

You seem to be betting on commodities prices. While I think that prices are headed higher long-term, I haven't a clue where the oil price is headed over the next month, 6 months, year and everytime I try to guess, I get it wrong. For example, I thought that oil would pull back heading into winter, as it traditionally has, but then the dollar tanked and we went to $100 oil in the off-season.

I'm looking for fundamentally undervalued companies, where if the price of oil falls back to $80, the stock is still a good value. For instance, Talisman Energy a few months ago (yes, I wrote that one up too) was a good value at $16 because its assets were undervalued even if the price of oil dropped some. Obviously, if oil goes up, the stock is better value.

Also, I think you may be missing something important with your focus on the next few quarters' earnings. The market cares more about future growth, not today's results. For resource companies, that means replacing reserves and keeping costs down. Take a look at ExxonMobil which has reported record earnings and the market doesn't care. Why? Because they can't replace reserves faster than depletion. If you are investing in an oil/gas company, one of the primary concerns should be reserves replacement, especially with peak oil.

As I detailed, PWE's reserve replacement was piss-poor in 2007. They are basically buying reserve replacement. As you mention, oil prices are high so buying oil is very expensive. When PWE buys Endev Energy to replace production, they are buying oil at a high price. That isn't creating value, IMO. The company's implicit admission that Peace River isn't happening anytime soon was a big blow to growth plans.

Finally, FCF in Q1 2008 covered 24% of the dividend, which is worse than last quarter. FCF, by definition, is the cash left over after you've paid out what's needed to keep the business going (not growing, going). You can't keep paying unitholders 2-4x more money than you have indefinitely. You can see this by the big increase in debt.

I haven't a clue about funds flow because I honestly don't know what it represents or what it's good for. So you tell me why funds flow is a better representation of PWE's financial reality than OCF/FCF. Cash is king and there's a reason why. If I didn't make it clear previously, I think this switch to funds flow is fishy and suggests they are trying to paper over deteriorating results. They never used it before and not all trusts use it (take a look at PGH). But if you decide to change your metrics, at least be upfront about it and not sneak it in and hope no one notices.

I gotta wrap this up but keep in mind, I'm still long the stock. I hope I'm wrong. In fact, I'm still betting that management will clean up their house a bit -- just a little less confident than before. If I was bearish on the stock, I would sell my whole position. But as an investor, I try to be informed about all of the risks I'm exposed to and PWE's risks have climbed a bit.

[cliff gill]

Roger Conrad lists it at a buy and he is almost never wrong.

[steve Ward]

A rising tide lifts all the boats. Higher commodity prices pulled all the trusts and the E&P's out of the september 07 to March 08 doldrums.

New management has clearly de-emphasized the oil sand and tertiary recovery plays and are now empahasizing conventional oil and gas step out drilling and pure exploration. All they have now are pilot projects at Pembina and Swan Hills and they arn't on stream yet.
PWE's new management has changed the goals and they maybe in the process of changing the model itself. And for me that is the big unknown.

[Myth454]

Davy has a solid point and you guys should read his article. It has changed my thoughts on PWE. For Q1 PWE didn't cover its dividend and basically had to fudge the numbers.

Funds Flow is not Cash Flow. It takes into account sales in assets and changes in working capital. For Q1 PWE couldn't pay its dividend from its operating profits and buried it in the accounting.

PWE #s pulled from the 10Q

Cash flow from operating activities - $367
Increase in non cash working capital - $251
asset retirement expenditures - $14
Funds Flow - $632

Distributions Declared - $382
Capital Expenditures - $278

----------------------...

They couldn't cover their dividend from a quarter with record prices. How much of that promised 2.8 billion is changes in working capital and asset sales. We were told to expect maybe $500 million in non core asset sales. So maybe $800 million is not operating cash flow.

----------------------...

I am long PWE and am very disappointed, PWE is 40% of my assets. It is still dirt cheap, if they make 2 billion this year in cash flow its still great for a $15 billion dollar company. When the hedges roll off they should hit 3 billion as oil increases. But its not the 3 billion we were told to expect this year.

[steve Ward]

Dave, as far as Pwe's response to shareholders, I agree with you that they are not very forthcomming. I posed the question to PWE's IR on the new Canadian Safe Harbour Rules limiting the amount of capital PWE can generate for further acquisitions. I simply asked how much if any capital can PWE use for further acquisitions. Here is the reply:



Good morning Mr. Ward,

Thank you for your question and your interest in Penn West. There exist many factors (many of which are confidential), however, in the past we were able to raise capital via a private placement basis in the United States with the issuance of notes with an aggregate principal amount of US $475 million last May. Penn West has historically used a combination of assumed debt and stock to finance its aquisitions. Our recent acquisitions of Petrofund and Canetic were both completed on a stock-for-stock basis. The goal is to acquire assets that are accretive to reserves, production, and cash flow. Penn West evaluates both corporate and asset acquisitions and have a 15-year track record of adding assets which are financially beneficial and operationally complementary.



Regards,

OK, fine but how much more can PWE raise for future acquisitions inder Canadian Law?? They never answered the question.
The "confidential&quo... worries me.

[StonePony03]

My appreciation to the posters here, that take the board seriously, stay with the subject and have informed comments. A rarity on other boards, that are mostly a waste of time. I'm long 500 units this trust and considering adding to this.

[enviro111]

After reading David's initial post and his responses, I'm impressed with his work and analysis. It seems credible to me. The bomb throwers on the board offer little in the way of rebuttal.

I'm made some money on PWE - bought in at $26 and collected a few dividends. I firmly believe in Peak Oil, but was surprized by the rapid ascent of oil prices in recent weeks. My work has the Peak Oil year in 2008, so perhaps the rise is justified.

It seems not only are PWE's properties mediocre, but so is its management. During Peak oil, long term hedges are a NO - NO! Better to keep it in the ground than sell it cheap.

Also, the Alberta royalty structure is now a killer for PWE earnings. Although David doesn't mention it in his blog, I think it is the real factor keeping PWE down.

I think I'm going to sell and move on. Looking at Peyto . David or anyone have any analysis?

[AlpineButtercup]

Thanks for a great website and great comments! This is my first time writing, but I've been listening for awhile. I've just finished my first Financial Accounting course at university, and I've been listening and reading about income trusts for awhile. I have a few questons...

1. AET.un talks about all the DRIPs and how that allows them to have distrubutions that don't affect cash flow and they can have higher payout ratios with comfortable cash flows. Management in Calgary is a small club of old boys... and they just all know how this works and don't offer much to the public in the way of information. It's true. I think this might be what their new "free flows" are referring to... any thoughts?

2. It's break-up up north and there can't be a lot of drilling or develpment until summer or freeze up again next winter... As far as reserve replacement goes, everyone is criticizing them for buying all this land. Are they using the land rights as a way to store cash? The tax rules for income trusts have them distributing all the profits, so they could store cash in land and then they can sell it to Exxon or Imperial or Petro-Canada when they need to prop up cash? Sell it off saying that they are divesting non-core assets or something? If oil stays high, then they eventually drill it? I've been watching PD.un... It seems like everyone is getting ready to move, but not yet. The oil patch seems to be reorgaizing it self. They have to figure out how to change from trusts into something else. Everyone on BNN talks about the tax pools that have been built up, but Encana has also just announced a split of the oil and gas. It seems that reorganization is going on. The environmental regulations are pushing for more carbon capture... and gas flaring regulations. To stop the gas flaring they need more pipelines closer to these swan hills, pembina, and seal fields. The roads are far too muddy to get a truck in most of the time. To get at the Peace River oilsands, they need to wait for the nuclear energy plants in Peace River to be built. I don't think regulators will allow another Ft. McMurray oilsands development. It will have to be insitu with steam. That takes infrastructure. Which alberta doesn't have and doesn't have the labor to build. How to sit on cash? Buy land and rights? Good payouts while waiting for these things to sort themselves out. How can you see whether this is in the numbers? True or not true?

[steve Ward]

Canadian money managers are out of most of the Trusts save for Crescent Point, Vermillion, Baytex and Canadian Oil Sands Trust. It seems only the Americans won't give up the ghost on these investments.

To Alpine Buttercup, keep it up, you're getting smarter. Yes the DRIPS are dilutive and provide a false cushion on the dividend. And spot on about the oil sands and tertiary recovery conditions in Alberta. If you don't have production already on oil sands or completing for production within 18 months, like CNRL, OPTI etc., it will be dead money for thre investors.

As far as the "good ole boys" go, I think you are on to something.Notice that all the Capital and debt went to conventionaloil and gas acquisitions and not oil sand or tertiary developments. The currency that PWE used was the high dividend that is why they paid almost no premium for the last 3 trust purchases. Management of the purchased trusts like those hefty dividends too. So they went with it and sold it to their shareholders. I bet Murray Edwards and the rest of the Good ole Boys arn't in the DRIP.
They are taking the cash and running and the rest of the Canadian Investment Community knows it.

[Whisper OnThe Wind]

I'm still keeping mine.

[leumas]

Here is a pasted information on "standardized distributable cash", which, I assume, is what "funds flow" means. To make a long story short, I think the management's use of "funds flow" in q1 was acceptable as the unusual increase in non cash working capital was a non- recurring event, possibly related to the merger. Inferring from this information, suggesting PWE's dividend might be in danger seems to be way off the mark, in my opinion.

<<The calculation of standardized distributable cash is, in all material respects, in accordance with the recommendations provided in the CICA publication Standardized Distributable Cash in Income Trusts and Other Flow-Through Entities: Guidance on Preparation and Disclosure. Standardized distributable cash is not a defined term under Canadian generally accepted accounting principles ("GAAP") and does not have a standardized meaning prescribed by GAAP. Standardized distributable cash is defined as cash flow from operations after non-cash working capital items, less: net capital expenditures; restrictions on distributions arising from compliance with financial covenants restrictive at the time of reporting; and limitations arising from the existence of a minority interest. Net capital expenditures represent all capital expenditures incurred during the reporting period. >>

It certainly is true that PWE needs to improve on its operational performance, in terms of operating cost, reserve replacement efficiency, etc.. But the management did a right thing in acquiring other depressed Conroys( albeit using its depressed stock as currency), before the current run up in energy prices, through dumb luck or not. Bulking up size, without huge sacrifice in terms of per share boe production or reserves, was a right move as size seems to matter in the current environment.

[AlpineButtercup]

Hi there,

Steve Ward, thanks for your kind response. I'll keep looking through all this info. I just have another question... as I'm still getting used to all these metrics. I just can't see how buying land is a bad idea. And leumas, you mentioned "without huge sacrifice in terms of per share boe production or reserves". Leumas, you also found the information from CIDA... Does anyone know if they have already counted oil sands proved and probable? (Sorry if my language is not very sophisticated) Alberta has had traditional seismic over every meter of it... and most places have been looked at two or three times. I don't think traditional seismic picks up oil sands reserves though. I think it focuses on pools. It was only last year or so... when the US started recognizing oil sands reserves in the accounting. If they bought (are buying) all that land and are planning to do gravity, radiometric and magnetic arial surveys so they can officially recognize oilsands reserves... have they already included that... and I just can't see it yet? In reading all these annual reports and websites I still don't understand things well enough. That would make sense with no premiums on the last acquitions... and not paying high prices for oil reserves that haven't even been recorded yet, but they know are there.... They have a 100 years of oil drilling data and low success rates in the beginning years because the will didn't frac right or was full of sand.

[leumas]

I understand that very minimal amount of reserve is counted from PWE's Peace river oil sands asset. That is because of strict rules enforcing the designation of "proven" or "probable" oil reserves. To be classified as 'proven' reserves, the oil has to be ready to be pumped out, with all the infrastructures in place.

The 6 to 7 billion bbl mentioned in the potential of the Peace River oil sands is OOIP(original oil in place) ---- far from real reserves. The quality of this oil sands assets appears to be good because this would not require 'mining' to extract, relatively easier to approach.

It is of note that PWE seems to have a rather conservative reserves figure considering the fact that "proved" reserve is more than 75% of the P+P("probable&quo... plus "proved"), much higher than other companies' figure.

[steve Ward]

The basic argument here is reserves vs. cost of dividend distribution. Reserves are indeed excellent, most including or especially georealist talk up the reserves.

The second argument, equally as correct, is the distribution from cash, is it currently or in the immediate past been covered by net cash. The answer is no.

As long as oil and especially gas remain high, PWE is a good bet for a capital gain even from these levels.

And just maybe, the Good Ol Boyys know what they are doing, milking all the money they can out of depleting assets, it is a viable business option.

PWE's future growth hinges on more asset acquisitions, where the IR department won't give us a straight answer, higher oil and gas prices or eventual and timely development of the vast amount of land base PWE owns with the hope alot of new stuff is out there.

The unconventional lands are virtually in limbo at this time and will not receive the necessary huge amount of cash because PWE's IR stated the word "accretive" in regards to reserves, cash flow and production. The oil sands do not fit PWE's IR dept. description at all.

There is nothing wrong with buying land cheap as long as something is on it. That's the question the Canadian analyst's are asking PWE and they are not getting an answer.

[Jack Yetiv]

Steve Ward--just wondering, how do you know what questions the Canadian analysts are asking PWE, and what answers are being given?

Would it be worthwhile formulating some specific questions to which we want answers and send them directly to Nunns?

Jack Yetiv

[Bullpasture]

I have really enjoyed following the forum discussions on PWE made by both Jack Yetiv and Dave Bui along with all the comments made by various readers. It has been most enlightening to discover the different ways to approach both the analysis and emotional preference criteria used for decision making. I had seriously considered investing in PWE (and at one time had a small position) but recently I have chosen to place all my royalty income investment in Enerplus Resources (ERF). I do not have the skills to critically assess all the financial data available for these two organizations. But I have tended to acccept David's argument that for some reason, PWE executives are somewhat evasive in providing clear strategic goals, identifying reserve replacement, and "dancing" around accounting numbers. Part of the reason I was initially focused on PWE was the prominent attention that Kurt Wulff gives it at his McDep.com web site over the years. He has strangely been silence with regards to ERF yet he has been providing data on this particular canroy for many years. I have followed the data for ERF on his site and compared it to both PGH and PWE that he has provided over the years. As a result, ERF looks extremely consistent and when I read in detail the material they provide on their web site and all released performance and presentation material with their considerable explanations, I simply felt that over the long haul, ERF makes a better case for future commitment to high income generation no matter what the future tax situation brings.

As an additional note of interest, TheStreet.Com rating website provides a ranking grade for the 7 canroys currently traded on American stock exchanges as ADRs. They recently acquired the Weiss Group who has a fine reputation for evaluation of stocks and banks, etc. using accounting information. As a result it was interesting to see that ERF carried the grade of B-, the highest of all 7 canroys, while PWE caried the grade of D+ with a sell recommendation! FYI, the remaining 5 canroys were rated as: BTE C-, AAV D, HTE D, PVX C, and PGH C........................ Hope this dialog keeps going and I would like to hear what both Jack and Dave think about ERF.

[jjason]

I came back to finish the comments and sold 100% ( 1,889 units ) of PWE on May 21st.

Here's why:

1. All the Canadian income trusts were hitting new highs or nearing new highs.
2. I found that PWE now has over one billion dollars in goodwill on the balance sheet
3. There were more "unknowns" in the 1Q 08 report (unaudited, I believe) then I was happy with. I am not a forensic accountant and I tend to prefer GAAP rather than some other form of accounting...especiall... if the other forms of accounting are used repeatedly.
4. I firmly believe that earnings per share mean something. If you take a look at eps data on Zacks.com, you will see a few quarters where PWE had lower eps. In fact, in the quarter ending June 30, 2007,the net loss per unit was $185.2 million. I think that this number included tax pools but how does someone know this if they haven't a clue how Canadian trusts are being operated. To most folks, negative EPS is, well, negative EPS. So to the average guy/gal, negative eps means the company has lost money. I know, I know it's funds flow that matters, eh?
5. I booked a small profit equal to the 15% distribution for the next 12 months. If Jack is right and PWE goes to $50 bucks than I have an opportunity loss. If Jack is wrong then I may buy PWE again for less money.
6. I saw on May 21st that PWE offered an 18+ percent premium for another firm. More dilution. It's a trend. ( I owned CNE and PWE pre merger and voted against the merger ). Remember that goodwill I mentioned...It was on CNE's balance sheet!
7. Back to the tax pools...I don't like putting money aside for future taxes in 2011 and incurring losses now. Maybe I'm dumb and don't understand the accounting rules for tax pools but what do I care about taxes payable in 2011. That, to me, smells.
8. I also learned that some of the guys were making out like bandits on the monthly distributions. Andrews owns 118,975 trust units, Brown owns 188,540 units and Brussa owns 303,415 units. You can do the math at $.34 per month per unit. And these guys get a salary and other bennies too! Overpaid executives?

Hope I wasn't too boring. Just my opinion. Do do your own DD. Good luck with your investment. We'll see what happens.

[Georealist]

By the By..Bui.. On April 23rd when you last bd mouthed PWE it was around $30 and change..since then it has gained..on a a total return basis..OVER 25% including the dividend...but, as we know, you are long PWE.so that excuses what??? Your inept analysis???
So those who buy into your hedging nonsense..I own but I don't like...I have heart palpitating diubts..but I own...so What???

[steve Ward]

Hello Jack,

Instead of posing the question to Nunns, why don't we ask the analysts themselves. Afterall, none participated in the 1st Q CC. Also, at that time a majority had a hold on the stock.

[steve Ward]

Jack,
Get a straight answer out of PWE on the number of shares per month, anually averaged; add that to the number they paid out in non drip distributions. It isn’t pretty.
At current prices, you will probably see an increase to 600 million in cash flow. But all of it over 2.5 billion is going to pay down debt. I don't think that is bad.
For 2009, any increase in projected cash flow, according to management will go to development drilling and exploration, then debt and only then to an increase in distributions.

Bui is right, current production trend is downward. Management knows they got to solve it. Their solution is viable, it is all step out drilling, secondary and tertiary recovery. The latter two are expensive and getting more costly thus lowering ROI in comparison to primary production.

Additionally, Nunns states that in 2 to 3 years development drilling will be reduced from current 66 percent of budget in favor of more exploration drilling. This is an E&P model, not a Trust model.

Secondary and tertiary recovery coupled with exploration all takes time. In that time line, PWE's production flat lines and drops. High and higher oil prices pulled PWE out of the tailspin. Higher oil prices may continue to do so. It would offer the investor a chance to get out and that is good.

Is the current dividend safe, probably for the next 4 to 5 quarters. However, PWE's own Board doesn't vote to guarantee dividend but for only 3 months at a time.

The hard fact is, most people are buying PWE for the dividend and cap gains are icing on the cake.
Historically, that has never been a long term reason to hold.

My conclusion: PWE's dividend coupled with the DRIP simply isn't "honestly" covered. Increasing amounts of cash will be needed, really big amounts, to initiate drilling in the "resource" base which is now "unconventional&q... in every sense of the word.
Other than higher oil prices, where does the money come from? Oh, say about 1 billion plus currently being paid in the dividend.

If PWE engages in the E & P model she will need the accompanying financial structure to go along with it.
Currently you have a CEO talking up an E & P model but the finances are based on a Trust

I see a conflict and I think so do the Canadian analysts

[steve Ward]

Jack, in the first sentence of my above reply I meant to say, get a number per month, averaged yearly for 2007 and 2008 on the number of shares in the DRIP and add that cost number to the dividends being paid in cash.

[casey00001]

I can understand the concern about the non-drip payments being made but how is that any different from US Companies giving Stock Options to their executives? Also US Accounting practices up until recently (and maybe not even now) did not make a company carry those options as liabilities on their books. Just because they are a trust does it really make them that much different than a corporation? I would see Pennwest reincorporating in the US if Cananda doesn't get their act together.

[J Mueller]

So let me get this straight. You guys are pissed because PWE was short about $20 million dollars to cover their cash flows? They also spent about $40 million more in capital expenditures than they said they will. Do you realize that the average prices rec'd were about $7.90 NG and $85 Oil?

They also were short 10 days production form the 2007 acquisitions as they didn't close until Jan 10.

It should be very interesting to see Q2 earnings. I say Q2 Net Income will be close to $1.00 a share. If their Capital Budget comes in at $240 million and pay out $380 million dividend they will have around $170 million to pay down debt.

I still show that funds from operations will be around $3 billion this year if the current prices hold.

I'm with Jack. $50 by year end!!

[steve Ward]

I never had so much fun. Mention PWE at a cocktail party and you get one new friend and one enemy, no matter your position.

OK, mea culpa, DRIPS and employee compensation isn't bad at all. My boo boo.
In fact I think PWE at these oil and gas prices, at least until the summer Olympics are over, will generate slightly more than 3 billion. so why am I down on PWE..
Only higher oil prices have pulled it out of the share tailspin.

As far as what PWE is going to do with anything over 2.5 billion; in Nunns' own words it goes like this:

For 2008, pay down 500 million in debt.

For 2009:1, Increase stepout drilling, development drilling and exploration

2. Paydown more debt. No specific number given

3. Maybe increase the dividend, "a little"

Gentlemen, one thing I keep harping about and no one speaks to: Nunns himself says that the model will look more like an E&P company in 2 to 3 years
E &P's require more money, coupled with the statement from Nunns that they want full CO2 for their legacy assets from a single supplier per asset, no more joint suppliers. That costs alot of money as in pipelines. Tar sands, oil sands, even more money.
Another big problem that no one knows the answer to until they spend a billion or so and that is 4.1 miilion unexplored acres. Nunns states in 2 to 3 years that is where they are headed for 66 percent of the cap budget. That is a good thing. But why wait that long?
But Bui is right when he says balance sheet is worse (2 billion in Good Will is not something to forget about) and production is headed in the wrong direction. That's why they hired Nunns to be CEO, he is a geologist. They will be licky to maintain BOED at 200m to 210m for the next 5 years.
The future for the whole company lies in the oil sands and the 4.1 million acres and more towards the 4.1 million acres for the immediate. They simply can't do all of that on 1 billion cap budget a year and meet their 2012 deadline on tertiary recovery for the legacy assets. a year.

The irony is that if PWE cut the dividend entirely they would have at current projections 6 billion additional in funds over 5 years, currently that would give you 100 to 150 thousand a day in oil sands production alone at current costs. Or put the 6 billion in the 4.1 million exploration acres where the ROI would be higher still.
To heck with the dividend, where is the production growth?

Jack, the Canadian analysts look at 3 things
1. Production Growth
2. Production Growth
3. Production Growth

Canetic and Vault have not provided any yet. Don't get mad at me about your divedend not being increased, blame Nunns, he laid out the priorities.

I like PWE as an E & P, not as a Trust. The day it gets rid of the dividend is the day I buy it. The day PWE plows that bountiful cash flow into increased production is the day PWE shareholders see share gains per ayear greater than the dividend yield, but based on production increases, not just higher oil and gas prices.
That's making money.

[Jack Yetiv]

I spent 3 hours last night carefully re-reading PWE's recent quarterly report, and am still doing some more research, all which I will post as an article. I believe my article will address most of Bui's criticisms, and will show that the (funds flow MINUS capex) figure is an entirely legitimate and very useful metric to decide (1) sustainability of dividend payments, and (2) calculation of what is left over that can be used to increase dividend, fund more E & P, etc.

Steve, you are mistaken in assuming that I want the dividend increased. I DO NOT. If the stock reaches $50, the dividend yield will be 8.2%, which is perfectly adequate, matching BTE's dividend.

I believe Nunns was TELLING US he is moving to the E & P model, without abandoning a still pretty decent dividend yield.

I think that after paying down some debt (and not necessarily the whole $500 million), they will aqlso use excess funds to increase E & P. Just to keep their word, they will increase dividends "a little" (say 5%), but that's only an extra $20 million per year whereas current prices will bring in an extra BILLION dollars per year compared to 2007. That kind of cash allows a whole LOT of E & P to be done with cutting OR eliminating the dividend.

Recall too that there are some real savings that can be achieved from the acquisition of Vault, Canetic and Endev--back office operations can be merged and run more efficiently. I believe you will see SG & A expenses per barrell go down in the rest of 2008.

Finally, in 2008, they will probably get rid of some non-core properties at a substantial premium over what they paid for them, and THAT money can then be used to do more ROI'ish E & P, or for acquisitions that fit their core competencies better.

Jack

[steve Ward]

Jack, maybe we are arguing how many angels can sit on the head of a pin. Maybe nunns is trying to "thread the needle" so to speak, raising enough cap ex to stop declining production and maintain a dividend at current levels.

Oil price plays a significant role in all the above, in cap ex and dividend. I have serious doubts about production remaining stable after in fill and stepout drilling is completed. I have serious doubts that in-fill and stepout drilling can eliminate the decline at all.

I'm not arguing the cash being generated, at these prices PWE should do 600 million over the 2.5 billion cap ex and dividend budget. I'm arguing PWE and its shareholders would be far better off with a model that resembles Crescent Point Energy Trust, where strong production increases as well as price doubled the unit price from December 06 to today. PWE has such a chance and I'm of the opinion management will come to a similar conclusion that in order to stop production slide and clean up balance sheet extra cap ex must come from the dividend.
PWE will need alot more cash to develop the all the remaining assets. Easy assets are over, extraction of the tough assets must begin.
Obviously PWE management very well may wait until Jan. 2011 to cut the dividend, that would be wrong to wait so long.
Also, under the Safe Harbour Laws, American citizens do not fair well at all compared to their Canadian counterparts on the dividend no matter PWE's tax pools to protect income.
These guys ( PWE management) are playing a game I just don't know what the ultimate scenario is.

[steve Ward]

Jack, I do have questions we should put to Nunns and Company.
Production and Reserve Growth Guidance Metrics:

!. go 4 quarters out with a full share dilution
2. Breakout into 4 categories
a. natural gas
b. light crude and gas liquids
c.medium and heavy crude
d. unconventional gas

On a quartely basis all the above, per fully diluted share basis, inclusive of DRIP and Executive compensatuion.
Most Canadian companies put this out all the time and give guidance a year in advance even with step out and in-fill drilling. PWE can do the same, particularly with Nunns' E & P model.

[Jack Yetiv]

Steve, I think if prices stay at $125/$10.50, there will be more than a BILLION dollars in excess cash above (dividend + $1 billion capex) in 2009 (lots of very-low-price hedges coming off Jan 1, 2009), and if all of that extra is put into extra E & P, it will DOUBLE capex from $1 billion to $2 billion.

Remember that not only is Nunns new, there are some other new mgt people as well, plus they have to digest some big acquisitions (over $4 billion-worth) that have occurred in the past few months. Given new mgt and acqusitions, I think it will take them a quarter or two to figure out exactly how to best deploy the extra funds to maximize the increase in production. I mean, sorting out 200 different properties over 4.1 million acres will not be done in a week or a month.

I am willing to give them a quarter to get their feet wet, and I plan to ask some hard questions when they announce the second quarter in August.

I really DO NOT think they are playing games.

Jack

[steve Ward]

Jack, all that is good, but 1 billion in capex this year and next is already planned. I'm saying they need more money in capex to stop and fully reverse production slide which is now occuring.
Especially for the unconventional assets which are their largest.

But ask Nunns for guidance metrics on future production and reserve growth. Please do so on a diluted share basis. Let's hope some analysts are on the next CC and not ignoring it as last time.

[Jack Yetiv]

Steve, please reread my comments. What I said was that they will be able to afford TWO billion in capex in 2009 if oil/gas prices stay where they are now--while STILL maintaining the current dividend.

I plan to ask lots of questions at the next conf call. I hope you and others will do the same.

Jack

[J Mueller]

I believe Canroys must payout dividends at least equal to their net income. If so, PWE will have to raise the dividend by q3. I don't know if that requirement is quarterly or annual. I'll send an email to investor relations as well.

Hey, you guys know that the 192,000 BOE a day was based on the fact that the deal did not close until January 10. If it had closed Jan 1 they would've had around 202,000.

[steve Ward]

About 90 percent of these Canroys were based on a Blow Down Model, pump assets dry for the shareholder to justify the lower returns generated by lands that were on their last legs. Problem occured when management wanted sustainability to keep right on going. Other problem occured when share price to NAV started averaging 120 percent and reserve life fell under 10 years for most of these trusts. The numbers didn'tadd up. The Canroys then piled on debt and share dilution for for acquisitions to keep the hamster on the treadmill.

Then the Halloween Massacre occured and everything changed. And here is my point, in most cases the Canroys were not receiving enough money in netbacks per boe to break even on reserve replacement and still fund the dividend and the FD & A costs.
Penn West is no different. PWE has the largest undiscounted NAV of all the conventional trusts and one of the worst reserve replacement recycle costs in the business at a negative $17.50 per boe 3 year average. In other words PWE must spend 17.50 more per barrel to just breakeven on reserve replacement and still fund the dividend. Based on 202m per day times 365 that is rounded off to 1.3 billion a year. PWE is 300 million short this year on that key metric. It is under funded.

High oil and gas prices can change this if netbacks are high and there is enough oil and gas to conventionally prioduce. All I'm saying is at 1.4 billion a dividend cut would ease alot of problems.

Nunns talks of an E & P model 2 to 3 years down the road. That would coincide with the end of current tax treatment that favours a trust model.
Nunns may keep the current dividend until then. I believe he knows he has to spend more. To maintain current production over the next 5 years PWe must spend 1.5 billion more. There goes the dividend no matter the price of oil.

[steve Ward]

Clarification :

When I stated above that Nunns must spend 1.5 billion more over the next 5 years just to mauntain current levels I mean to say 1.5 billion more than the current 1 billion per year allocation on capex.

Current levels of capex are 5 billion over 5 years, they must spend 6.5 billion to make it work and that is just on the conventional production alone.

Tax pools be damned, all Canadian companies produce tax pools if they are drilling. Unconventional assets are going to be even more expensive to produce.

[bullwinkle]

Regarding the "post-Halloween-m... high around $36," PWE was last at that level on 6/7/07. Since then (through 6/4/08) the stock price is down 10% but the total return including dividends has been positive 3%. On the year, PWE is up 29% while XLE is up only 5%. The stock sports a 13% dividend and trades at about 11x earnings. The company is sitting on a lot of reserves situated in the friendly and secure country of Canada. What is not to like about this stock? Sure it will go down if energy prices get crushed, but if energy prices stay high and countries like China keep snapping up supplies around the globe, this stock should do very well.

One thing that could hurt the Canadian oil trusts is that Congress may pass a law that disqualifies dividends from preferential tax treatment. I have mine in my IRA anyway, but it would lessen the appeal of these stocks to US investors. In the meantime, the 13% tax-advantaged dividend is a steal.

[Georealist]

This is Bui's worst nightmare..the inept and pretentious Mr. Bui has missed the boat. All those who followed his basically gutless and non-committal "advice" have missed yet another runup for PWE.
He doesn't get the overriding issues with safe have suppliers and instead plays the "knowledgable analyst" for those looking fpor guidance in a very difficult market.
So..while he fixates on trivial "fundamental"... issues the larger picture bypasses him entirely.
Preferentil dividends are irrelevant...Obama will doaway with those in any case. What matters is the great wave..and Bui..missed.

[rawgreed]

Gorealist don't you have something better to do than to post 300+ mostly negative comments? With all that time why don't you pony up your picks? If you are so eager to find advice with guts and commitment why not start your own blog? You don't have 20 minutes to goto wordpress.com? Bui doesn't owe you a dime. By all accounts his blog is among a very select few that publish their picks and portfolio performance statistics.

Anyone who writes trivial regarding fundamental analysis has his mind set firmly in one direction. So what if the author missed a major run-up for PWE? His portfolio is up 16.6%. Hasn't anyone told you that it's better not to lose money than to make money?