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On the Money: Act Two for the Swan Hills play?

The Swan Hills play once looked like a disappointment. Has that changed?

Jody Chudley is the author of The Punchcard Portfolio, a value-oriented newsletter with a focus on Canadian oil and gas stocks

May 26, 2014

by Jody Chudley

The Play

North American light oil production is booming, thanks to horizontal drilling and hydraulic fracturing. One of the places that’s happening is the Swan Hills reef complex, 200 kilometres northwest of Edmonton. It’s more than 80 kilometres long and has long been recognized as a “giant” oil field. It is estimated to contain more than seven billion barrels of light sweet oil.

In 2010 and 2011 investors who were expecting Swan Hills to become the next big horizontal oil play bid up shares of Swan Hills-focused producers like Arcan Resources and Second Wave Petroleum. But that initial enthusiasm turned into something else in 2012. Shares of those companies crashed as both found themselves heavily leveraged. Even the bigger players like Crescent Point Energy went radio silent on the region. It left many wondering if Swan Hills was a bust.

Then, in March, Lightstream Resources revealed the results from its first year of activity in Swan Hills. Perhaps surprisingly, they look really good. Through the first six months, Lightstream’s wells produced 17,000 barrels – or 43 per cent – more than expected. As a result, they are more than paying back the capital invested in them in under a year. That is what makes for a successful horizontal oil play. These superior well results are due to a unique fracture and completion combination that the company has introduced. This is good news not just for Lightstream, but for everyone else with acreage in the neighbourhood.

The Picks

Lightstream Resources (TSE:LTS)
One year total return (exclusive of dividends): -37.8%

OntheMoney_story1

Since being formed as part of a plan of arrangement with TriStar Oil & Gas in October 2009, Lightstream (formerly Petrobakken) has been nothing short of an epic failure. Shares that originally traded at $35 are now changing hands at $5.50. A dividend that was once $0.96 per year is now $0.48. But I believe – perhaps foolishly – that 2014 is the year Lightstream’s share price finally bottoms and starts to climb. Corporate decline rates have come down as production has aged, all capital spending and dividends are now covered by cash flow and the company expects to reduce debt by $600 million over the next two years.

With a reduced level of debt, investors may start to focus on an asset portfolio that provides exposure to most of Canada’s emerging horizontal light oil plays. At its current rate of drilling, Lightstream has 30 years of identified drilling locations, and Swan Hills has now become one of the company’s core plays.

Arcan Resources (TSXV:ARN)
One year total return: -71.6%

OntheMoney_story2

Arcan’s 110,000 acres in the Swan Hills play are believed to have almost 400 drilling locations and 700 million barrels of oil in place. With waterflooding, Arcan has suggested that 40 per cent of that oil can be recovered. But while its land position has always been enticing, Arcan has done a terrible job of growing production in it the company has backed itself into a corner where it’s pinned down by debt and unable to grow out of it, and that big debt load makes Arcan a risky proposition for investors.

What is intriguing about the company is that nearly 40 per cent of the common shares are owned by larger producers Crescent Point Energy and the previously mentioned Lightstream. Crescent Point purchased its Arcan shares at prices in the $5 to $5.40 range, while Lightstream purchased its shares at around $0.90. That is a lot higher than the current share price, which is under $0.30.

The PostScript

It’s been a tough slog over the last couple of years for PetroBakken/Lightstream shareholders, but those who are still hanging on – or those who have come in at lower prices – may finally be on the verge of seeing some light at the end of a long tunnel. Meanwhile, although Arcan has been beaten down even more viciously, it’s not hard to imagine a situation in which it’s taken out by Crescent Point or even Lightstream. You have to think that if Crescent Point liked Arcan’s assets at $5.40, then it must really love them at under $0.30. Or, perhaps, it just made a really horrible decision buying them in the first place. Time will tell.

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