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Oil and gas companies should play it safe when spending extra cash

If your oil and gas company is lucky enough to raise some cash, then you have another problem: how to spend it

Nov 23, 2016

by Robbie Jeffrey

Spending money, for most of us, is the easiest task in the world. Most of us know how we’d spend some extra cash if it fell into our lap – and then some. But most of us don’t own junior oil- and gas-producing companies, for whom the question of how to raise and spend cash is a matter of life or death. Most of us, too, aren’t stuck in the eye of an economic storm, amid oil prices that fight to break $50, in an oversupplied market where juniors battle it out for their crumbs of market share. Most of us aren’t Bradford Goetz, and most of us don’t own Volterra Oil and Gas.

“If you’ve got economic prospects, drill them – that way you can take advantage of these low service costs.” – Brian Boulanger, ARC Financial

Volterra, as one of the most prominent junior oil and gas companies in Alberta, hasn’t been spared from the downturn. And Goetz, an industry exemplar, is finding himself in a bind like never before. “The duration of the commodity rout has taken us all by surprise,” he says. “No one expected it to last this long, and it’s taken us a while to accept the new normal. We’ve all had to rewrite our own rule books, and at the same time, learn the new rules that everyone else is writing, too.”

Goetz has certainly broken some of his otherwise ironclad rules, including taking out a massive loan while the company’s liabilities increased and selling assets at bottom-of-the-barrel discounts. It wasn’t enough to keep Volterra from the brink of bankruptcy, though, so he had to renegotiate the terms of his lending arrangements and even looked at the possibility of a merger with another company. Eventually, he sold some prized upstream assets, then Volterra, a public company, issued 250 million shares to raise funds. Now it’s got some cash burning a hole in its proverbial pockets, and needs to know the safest way to spend it to avoid another potentially fatal cash crunch farther down the road.

First, Goetz should count his lucky stars that Volterra is a public company. “Select public companies seem to be able to raise some money, but for private companies, there’s virtually no capital available for that market,” says Brian Boulanger, president and director of ARC Financial in Calgary. And, he adds, Volterra is lucky to be one of the juniors with enough assets that it can sell some while retaining its crown jewels. And that’s precisely what it should turn its attention to: the high-quality assets.

Boulanger recommends Volterra finance a strategic acquisition, since it’s a buyer’s market. The only problem is that a lot of those crown jewels won’t come easily. Boulanger says one of the biggest impediments in the market is the wide bid-ask spread: sellers think a full-blown recovery is just around the corner, so the ask remains high; buyers, however, see looming uncertainty plaguing an already besieged market, and don’t want to pay a premium in a low-return environment.

“Or you could finance a drilling program on your most economic prospects,” Boulanger adds. If a strategic acquisition is an offensive move, then this is the defensive position: “If you’re not drilling, your production continues to decline and your costs escalate, and doing nothing is a death spiral for small producers because your fixed costs catch up with you,” he says. “If you’ve got economic prospects, drill them – that way you can take advantage of these low service costs.”

The key for Volterra, as always, is to be smart with its money. The worst way to spend this extra cash would be to sink it into production in one of its high-cost assets with long payouts. Spending money, after all, might be the easiest thing in the world. Climbing out of bankruptcy is not.

Editor’s Note: Volterra is a fictional company, but we’ve imbued it with real-world problems.

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