BirchCliff Energy (TSX: BIR) is a junior oil and gas exploration, development and production company. Its objective is to acquire and hold, large working interests in several highly focused producing areas in the Peace River Arch where it can hold operatorship of its assets and control the infrastructure necessary to facilitate the exploitation, development and exploration potential of those areas. Birchcliff produces roughly 70% natural gas and 30% light oil and natural gas liquids (NGLs). It has two major properties:
(1) Montney/Doig - Montney/Doig is an unconventional natural gas resource play consisting of reservoirs in tight sands, siltstones and shales. Birchcliff has 166 net sections of land in the area where 57 sections have been assigned reserves of 314 bcf (57 mboe), assuming 2 wells/section and 2.8 bcf/well. Management (consistent with other firms in the area) believes that 4 horizontal wells can potentially be drilled on each section giving Birchcliff an inventory of around 600 wells with recovery reaching 5 bcf/well.
(2) Worsley - The Worsley oil and natural gas assets in the Peace River Arch area of Alberta was acquired in September, 2007 for total cash consideration of $270 million. The purchase price was equivalent to $17.53/boe of proved plus probable reserves, which after reserve additions has now come down to around $10/boe for 24.6 mboe. The Worsley property provides stable cash flow and commodity diversification when compared to the natural gas assets in the Peace River Arch. Birchcliff owns high Working Interest (WI) lands (>80%) and has been working essentially without partners or farm outs.
The 3 year average for the Finding and Development (F&D) costs excluding future development capital were $8.01/boe and including future development capital were $15.63. This average has been decreasing where the 2008 F&D costs excluding future development capital were $5.17/boe and including future development capital were $14.06/boe and are more indicative of future F&D costs.
Valuation
The valuation of the company is as follows:
Downside
The current Book Value (BV) of Birchcliff is $4.15/share and as per the market price of $6.4/share the company is currently trading at 1.5x BV. This is higher than many E&P in Canada which are trading for < 1x BV. Furthermore, with an Enterprise Value (EV) of $1.024 B and 2008 Cash Flow (CF) of $131 million; the EV/CF ratio for the company is around 7.8 which also is much higher than most of the comparables trading at 3-4x EV/CF.
2009 Cash Flows Assuming Birchcliff produces on average 12,500boe/day in 2009; at the current AECO natural gas price of $4/mcf and oil price of $50/bbl ($32/boe – 67% gas; 33% oil) Birchcliff’s 2009 cash flow would roughly look as follows:
Revenue: 12,500 boe/day*365 days*32 $/boe: $146 million
Royalties: 146 * ~15%: $21.9 million
All Expenses (~$16/boe):$73 million
Cash flow before taxes (Operating cash netback: $11.2/boe): $51.1million
The production could increase and/or fuel prices could increase resulting in higher cash flows, but the $80 million estimated by management for capital expenditures in 2009 is much higher than the current situation dictates and there is a risk of (a) equity dilution (b) increased debt load. Furthermore, assuming higher cash flows in 2010 and 2011, it still might not be enough after capital expenditures to repay the debt with an outstanding current balance of $250 million. Interest payments on the debt load come to around $10 million annually and this is manageable even under stress scenarios.
Upside
In order to analyze the upside it is important to decipher the Montney/Doig natural gas resource play. I have already analyzed unconventional gas resource in a previous post. The gas is there, essentially the challenge is to maximize the flow rate for the lowest cost. Specifically, Birchcliff has 166 net sections of land in the Montney/Doig resource play. AJM consultants have designed resources of 314bcf to 57 net sections assuming two wells per section each producing 2.8 bcf over its lifetime. Net-net there is only engineering risk and very little exploration risk. The management plans on drilling 4 wells per section giving them a total inventory of more than 600 wells, with each costing around $5million. Management also believes (in like with other firms in the area) that each well can produce 5bcf of natural gas over its life as technology improves. Conservatively, assuming on average 1.5-2.5 bcf/well and 600 well locations (certain), Birchcliff can potentially recover 900-1500 bcf or 150-250 mboe of natural gas. This will require a lot of future capital, where each well will cost around $5million and the company will need new processing facilities as production increases leading to additional capital expenditures. Presently, Birchcliff has proved and probable reserves of 98.5 mboe (82.3 net) adding all its properties, where the Worsley light oil pool contributes 24.6 mboe.
Comparables ARC, Encana, Talisman, Crew Energy, Canadian Natural etc. all have lands adjacent to Birchcliff lands in the Montney area, with Talisman’s lands being the closest to the Pouce Coupe area. Bigger firms in the area have been pioneering to economically extract resources from this area. Managements’ estimates of potential resources and technologies in the area are in line with these companies. Duvernay Oil Corp. which has the highest quality land in the Montney region was bought by Shell Canada for $5.9 billion including debt (it was an anomaly). Duvernay quotes gas-in-place of 50 bcf per section, while Birchcliff quotes at 30 bcf per section. Shell paid $38.87/mcf for proved and probable reserves of 152 mboe and received 450,000 acres of land. This purchase price discounted the future expected recoveries in the undeveloped lands. Birchcliff at present has 98.5mboe of reserves and 380,000 acres of undeveloped land.
Finally, – The current EV is equal to $1.024 B. Based on various combinations and comparable deals, we can assume that Birchcliff is worth between $2 B to $5 B for a 2.5x – 4x upside from the present prices. As long as management manages the balance sheet conservatively, Birchcliff should not have a problem attracting a bid in due time. Seymour Schulich a prominent Canadian investor owns 22% of this company and he is more or less waiting for a bid to cash out. Please note that the thesis here is for a takeover only, you are essentially buying a 'option' when you buy the stock. Personally, the 'option' has to be much cheaper than it currently is for me to purchase the stock, but I am posting the analysis nonetheless.
Disclosure: None
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