They Grow Up So Fast

They’ll be larger, bet­ter cap­i­tal­ized, and prob­a­bly only work­ing in the very best pro­duc­tion ar­eas. Want to start a ju­nior en­ergy com­pany? It will cost up to $100 mil­lion


Want to start a ju­nior en­ergy com­pany? It might cost you $100 mil­lion

LIKE EVERY­ONE ELSE IN THE GLOBAL OIL PATCH, CANA­DIAN ju­nior oil and gas com­pa­nies have had a rough time of it. The oil price rout en­gi­neered by the Saudis and OPEC that be­gan in the sec­ond half of 2014 left a trail of failed ju­niors in its wake. But not of­ten dis­cussed is the ad­di­tional pres­sure of low nat­u­ral gas prices caused by the “shale gale”—as in­dus­try vet­er­ans call it—out of the U.S. With few ex­cep­tions for the best-man­aged firms, those

ju­niors cling­ing to life af­ter two years of bust are suf­fer­ing bat­tered and bruised bal­ance sheets. And when the in­evitable up­turn ar­rives, ju­niors may be con­fronted with a trans­formed in­dus­try that is not as hos­pitable as in years past.

Most Cana­di­ans think of 2014 as the start of the down­turn in the en­ergy sec­tor. But Gary Leach, CEO of the Ex­plor­ers and Pro­duc­ers As­so­ci­a­tion of Canada, says nat­u­ral gas-weighted ju­niors were al­ready suf­fer­ing since prices dropped in re­sponse to the flood of cheap gas un­leashed by U.S. shale pro­duc­ers. Af­ter peak­ing at al­most US$14 per Mbtu in 2008, prices plum­meted and to­day they re­main un­der $3. Cana­dian ex­ports to the U.S. peaked in 2007 at well over 4,500 Bcf and last year were un­der 3,000 Bcf, ac­cord­ing to the U.S. En­ergy In­for­ma­tion Ad­min­is­tra­tion. “The en­tire busi­ness model for Cana­dian nat­u­ral gas pro­duc­ers, es­pe­cially those weighted more to­ward gas, was in trou­ble,” says Leach.

Ju­niors adapted by switch­ing to more liq­uids-rich nat­u­ral gas be­cause propane, bu­tane, eth­ane, and con­den­sate were priced off oil bench­marks, which were much more ro­bust. And as the gap be­tween gas and oil prices widened, in­vestors pres­sured man­age­ment teams to chase more oil. “The ini­tial wave of tran­si­tion was through the nat­u­ral gas side of the busi­ness and it forced a lot of com­pa­nies to change their busi­ness model,” says Leach. “The world we had five years ago was marked by a big dif­fer­ence be­tween those for­tu­nate enough or clever enough to be liq­uids and oil-weighted and those that were dry gas-weighted.”

An­other change that marked the new busi­ness model for ju­niors was a shift away from rais­ing cap­i­tal on pub­lic mar­kets and, in­stead, tap­ping pri­vate eq­uity. “A point of de­par­ture be­tween the Cana­dian oil patch and other coun­tries has been the heavy re­liance by Cana­dian com­pa­nies on pub­lic cap­i­tal mar­kets,” says Leach. Even less than a decade ago the TSX and TSX Ven­ture ex­changes were full of mi­cro-caps and ju­niors. All that changed af­ter the fi­nan­cial col­lapse of 2008 dragged on for two years and sent in­vestors flee­ing into T-bills and bonds. Af­ter the car­nage stopped, in­vestors’ ap­petite for scrappy man­age­ment teams with an in­side play or a tech­no­log­i­cal ad­van­tage rapidly di­min­ished. Only 20 pub­licly traded ju­niors re­main, says Pa­trick O’Rourke, an an­a­lyst with Al­taCorp Cap­i­tal, who fol­lows ju­nior and mid-cap pro­duc­ers. For­tu­nately, pri­vate eq­uity stepped up. Man­agers rec­og­nized the op­por­tu­nity to build value, es­pe­cially af­ter oil prices took off af­ter 2011. “A lot of Cana­di­ans don’t re­al­ize it but the Cana­dian Pen­sion Plan, the On­tario Mu­nic­i­pal Em­ployee’s Pen­sion Plan, the On­tario Teacher’s Pen­sion Plan, all of these big gov­ern­ment and union pen­sion plans are big in­vestors in the Cana­dian oil patch,” says Leach.


dropped in the fall of 2014. Saudi Ara­bia opened the taps wide, flood­ing global oil mar­kets and send­ing prices into free fall. West Texas In­ter­me­di­ate briefly dipped be­low $30 at one point last win­ter—with Western Cana­dian Se­lect lan­guish­ing in the lower $20s—send­ing a chill over an al­ready strug­gling ju­nior sec­tor. Ju­nior com­pa­nies be­gan fail­ing left and right. By the sum­mer of 2016, the Land In­tegrity Foun­da­tion es­ti­mated as many as 230 ju­niors were tee­ter­ing on the brink of bank­ruptcy. Com­pa­nies shifted to sur­vival mode, some­times rip­ping up ser­vice con­tracts and ask­ing ven­dors to re­bid, or even us­ing re­verse auc­tion web­sites to drive sup­pli­ers to the low­est pos­si­ble price, says Mark Salkeld, CEO of the Pe­tro­leum Ser­vice As­so­ci­a­tion of Canada.

The up­turn isn’t far off, as oil mar­kets slowly re­bal­ance dur­ing the fall of this year and ap­pear poised to test $60 per bar­rel—or per­haps much higher, ac­cord­ing to some econ­o­mists—some­time in 2017, and gas looks to be headed north of $3 per Mbtu based on sup­ply con­cerns. What might the Cana­dian ju­nior oil and gas sec­tor look like in a re­vi­tal­ized oil patch? Much dif­fer­ent, ac­cord­ing to Leach, Salkeld and O’Rourke.

For starters, com­pa­nies will likely be much big­ger. No one agrees on a pre­cise def­i­ni­tion of the proper size of a ju­nior, but 500 to 10,000 boe/d is a com­mon yard­stick, which will likely be­come quite a bit longer in the next five to 10 years. “I think the ju­niors and in­ter­me­di­ates will re­flect a smaller group of com­pa­nies that have sur­vived and thrived through this dif­fi­cult pe­riod and come out stronger on the other side,” says Leach. “They’ll be larger, bet­ter cap­i­tal­ized, and prob­a­bly only work­ing in the very best pro­duc­tion ar­eas be­cause mar­ginal pro­duc­tion ar­eas with high costs just won’t be eco­nomic.”

One of the rea­sons for higher costs will be gov­ern­ment reg­u­la­tions. The elec­tion of the NDP in Alberta and the Lib­er­als na­tion­ally has dealt in­dus­try a dou­ble-whammy, ac­cord­ing to Leach. Canada has al­ways been a high-cost place for the oil and gas in­dus­try to do busi­ness, he ar­gues, but the past 18 months have com­pounded the prob­lem. The Alberta car­bon tax, with per­haps

a na­tional ver­sion tacked on for good mea­sure; fugi­tive meth­ane emis­sion re­duc­tion; the cost of ad­dress­ing aban­doned wells…the list goes on. Add to it de­lay—or even non-ap­proval—for new pipe­line projects and the prospects look daunt­ing. “The cost of do­ing busi­ness in Western Canada is very high, and I’ve worked all over the world,” says Leach. “Canada and provin­cial gov­ern­ments have got to pro­vide in­vest­ment and reg­u­la­tory cer­tainty.”


to the Cana­dian oil and gas ser­vices sec­tor, which could be both good and bad for ju­niors, says Salkeld. Good be­cause as pro­duc­ers shed staff and ex­per­tise, ser­vice providers are ex­pand­ing their tech­ni­cal of­fer­ings, al­low­ing cus­tomers to re­main lean and com­pet­i­tive with less over­head. “The ser­vice providers took on more and more of the tech­nol­ogy to de­liver suc­cess­ful wells,” he says. “Now, pro­duc­ers are look­ing to the ser­vice com­pa­nies for their hy­draulic frac­tur­ing or ce­ment­ing or well com­ple­tion or op­ti­miza­tion ex­per­tise. The re­la­tion­ship be­tween small pro­ducer and ser­vice com­pany is go­ing to be dif­fer­ent com­ing out the other side of this down­turn.” But Salkeld also wor­ries that ju­niors that burned bridges with ser­vice com­pa­nies to drive down costs and sur­vive may not be the high­est pri­or­ity when good times re­turn. “If the small guys ripped up con­tracts or whee­dled us down to noth­ing, but big­ger cus­tomers didn’t, our mem­bers are go­ing to stick with the cus­tomers that stuck with them,” he says.

Even if a ser­vice com­pany is will­ing to for­give a ju­nior’s sur­vival tac­tics, it may not have enough trained work­ers to pro­vide the ser­vices. Salkeld and Leach warn that oil and gas lost tens of thou­sands of trained and skilled work­ers over the past two years, many of whom have left the in­dus­try; quite a few won’t be com­ing back. “It’s go­ing to take a long time to ramp back up. We’ve passed the point of re­bound­ing quickly. It’ll be a while now, we just lost too many peo­ple,” says Salkeld, who notes that the West drilled 10,000 to 12,000 new wells an­nu­ally be­fore the down­turn, but cur­rent lev­els are only a quar­ter of the peak. Ramp­ing up, he says, will be a “long, slow process.”

One bright spot in the near-term is the role new tech­nolo­gies and tech­niques have played since 2014 in driv­ing down costs. U.S. shale pro­duc­ers have been par­tic­u­larly ag­gres­sive given their steep de­cline rates, but the flow of ex­per­tise across the bor­der is pretty much seam­less, says Leach. Pro­duc­ers are re­frack­ing wells, ex­per­i­ment­ing with fewer and more strate­gi­cally placed frack stages, low­er­ing the num­ber of days re­quired to drill, adopt­ing Big Data/an­a­lyt­ics strate­gies, and manag­ing sup­ply chains bet­ter, to name a few ap­proaches. “The tech­nolo­gies that we’re us­ing in the oil­field ser­vices for drilling, com­ple­tions, hy­draulic frac­tur­ing, mul­ti­well pads, economies of scale—that’s all grown sig­nif­i­cantly in the past four or five years,” says Salkeld. Ju­niors can ex­pect to ben­e­fit from the in­no­va­tions, but some take a less tech­nol­o­gy­in­ten­sive ap­proach, ac­cord­ing to O’Rourke: “For the com­pa­nies that are ex­plor­ing, they’re tak­ing ex­ploratory risks and in some cases want to min­i­mize tech­nol­ogy risk.”

O’Rourke adds that go­ing for­ward, in­vestors will sup­port ju­niors that have the same in­gre­di­ents they’ve al­ways looked for: a high qual­ity man­age­ment team, “good rock,” and a strong bal­ance sheet. But there is no deny­ing ju­niors will face head­winds. “You’re no longer do­ing the friends and fam­ily round and rais­ing a mil­lion or two. At the very low end I’d say you need $50 [mil­lion] to $100 mil­lion, maybe even more than that,” he said.

The days of plucky up­start Cana­dian ju­niors start­ing with a shoe­string bud­get and a smart man­age­ment team, then sell­ing out to a larger com­pany or maybe grow­ing to be a thriv­ing mid-cap, ap­pear to be over. The “lower for longer” price en­vi­ron­ment cou­pled with much higher cap­i­tal re­quire­ments and the need for ever more tech­nol­ogy fa­vor big­ger play­ers. Not that there won’t al­ways be dozens of ju­niors try­ing, say ex­perts, but the odds are get­ting longer and longer that they will be suc­cess­ful.



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