Tuesday, July 6, 2021

Long Reserve Life Oil: Cenovus Energy Inc.

Some history of Cenovus Energy:

When the Canadian Pacific Railway was formed, the government of Sir John A. Macdonald compensated it for assuming the risk of developing the railroad with the subsurface rights for a checkerboard pattern of most of Alberta and part of Saskatchewan. These rights were later spun off to the company's predecessors. In April 2002, PanCanadian Petroleum Ltd was spun out of Canadian Pacific Limited. It subsequently merged with Alberta Energy Corporation to form EnCana. In 2009, Encana completed the corporate spin-off of Cenovus Energy, which held its oil business, representing one-third of total production and reserves, and EnCana Corporation retaining its natural gas business. In 2017, Cenovus purchased ConocoPhillips' 50 percent share of their Foster Creek Christina Lake (FCCL) oil sands projects and most of their conventional assets in Alberta and British Columbia, including the Deep Basin. Cenovus completed the acquisition of Husky Energy for C$3.9 billion in stock in January 2021. Cenovus has two projects producing oil in the oil sands – Foster Creek and Christina Lake (Alberta). Both projects use a drilling method called steam-assisted gravity drainage (SAGD).

Cenovus is listed on the NYSE (CVE, US$9.72) and the Toronto Stock Exchange (CVE.TO, CAD$12). (As you can see, a CAD$ is equal to 0.81 US$). When Cenovus acquired them, Husky shareholders received common Cenovus shares plus warrants. The warrants were issued in January 2021 and have five years until expiration (January 2026) with a strike price of CAD$6.54 (or US$5.30). With the CVE shares at $9.72, the intrinsic value of the warrant is $4.42 and they trade for $5.64. 

The combined company (Cenovus + Husky) is the third largest Canadian oil and natural gas producer and the second largest Canadian-based refiner and upgrader. As one description puts it,

"The transaction was transformational for Cenovus Energy because it filled the gaps in both companies' weaknesses. For CVE, it has excess production that it needed to sell into the market (insufficient refining capacity, and for Husky, it had excess refining capacity (insufficient production). By combining the two, the integrated business model flourishes and CVE is able to reap the benefits via synergy and better pricing realization."

As of December 2020, Cenovus reserves (proved and probable, net of royalties) were estimated to be 4.9 billion barrels. (Or, 6.3 gross of royalties.) Adding in natural gas reserves, their reserves are a total of 6.7 billion barrels (gross, 2P). At the present production rate of ~0.5 million barrels of oil equivalent per day, or 170 million barrels per year, those reserves are enough to last for 40 years.

Cenovus produces most of its oil by steam assisted gravity drainage (SAGD): "an enhanced oil recovery technology for producing heavy crude oil and bitumen. It is an advanced form of steam stimulation in which a pair of horizontal wells is drilled into the oil reservoir, one a few metres above the other. High pressure steam is continuously injected into the upper wellbore to heat the oil and reduce its viscosity, causing the heated oil to drain into the lower wellbore, where it is pumped out."

At US$67 WTI, Cenovus was projected to generate CAD$7.5 billion of operating cash flow and CAD$5.7 billion of free cash flow. The recent increase in oil price (to $75/bbl) should significantly augment the cash flow if it holds up.

The current market capitalization is CAD$23.6 billion and the net debt is CAD$13 billion for a total enterprise value of CAD $37 billion. (Or $30 billion in USD.) So, the FCF/EV yield before the latest increase in the oil price was around 15%.

Also impressive with the mature Canadian oil sands giants is the level of FCF conversion. If Cenovus spends $1.8 billion on capital expenditure and has $7.5 billion (or more) in operating cash flow, that is 75% FCF/OCF conversion which isn't bad.

Conoco got a lot of CVE stock when the 2017 acquisition took place (Conoco owns 10%), and they are selling it. When Cenovus was spun off in 2009, it traded for $25. Thanks to the long commodity bear market, it trades for a little more than a third of that price more than a decade later.

Something else you may notice is that the enterprise value of Cenovus per barrel of net 2P reserves is about US$6.

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