Aroway Energy is the New Way for Juniors – (ARW-TSXV)

by Keith Schaefer on February 13, 2013

Old style plays will be new growth model for juniors and Aroway Energy (ARW-TSXv) is ahead of the market

Old school, conventional oil plays are making a big comeback in the Canadian oil patch. They have lower costs, higher profitability, and have been ignored since the Shale Revolution took hold several years ago.

Shale plays get market love because they are predictable—but what the market now understands is that they are predictably tough for junior players.

Juniors with old style conventional pools (read: no fracking; mostly vertical wells) are able to give positive surprises to the market—that’s what moves stocks. And that’s what CEO Chris Cooper is doing this year with his Aroway Energy (ARW-TSXv).

Their news today that production increased 100% in the last three months to just over 1000 boe/d, with 90% oil.

The most important news in that release was a hit on their new Kirkpatrick Lake light oil play, at shallow depth—their fourth successful conventional play.

It clearly hit—though we don’t know how much—as they didn’t break out production by play. The fact they didn’t tell us says they want to keep the industry guessing for competitive reasons.

They have the funds, cash flow and debt capacity to drill a minimum 8-10 wells this year—almost all of it development drilling. And for Aroway, that’s more profitable than any tight oil player.

On Aroway’s top three plays so far—Peace River Arch West Hazel in Saskatchewan and in their new light oil discovery announced today–the rate of return is been between 300% and 500% on their development drilling. Compare that to the majors, who are happy to get IRRs at 20-25%.

Unlike juniors chasing the far more expensive shale plays, Aroway can replenish production fast enough to not need constant new equity. These wells cost less, take less time, and decline at a lower rate than their tight oil cousins. In other words, this business model is more sustainable, and the market is fast moving from rewarding growth to rewarding sustainability in the junior sector now.

That means Cooper has done everything right in building a junior in this market. This is the new breed of junior investors have to pay attention to—even if the investment bankers are not. Cooper’s assets are so profitable, he only raises money every three years. Because they need the market less, you don’t see as much research on these plays—the Street doesn’t get paid. So they can stay under the radar for longer until they get discovered by a big flock of retail investors.

With the funding window for most juniors shut tight, management teams will be forced to find and develop assets that recycle cash faster than their oil tight oil plays.

Shale plays put out sexy production numbers, but cash flow lags—forcing those producers into dilutive financings. Old style conventional pools—which generally have much higher IRRs than tight oil—have very sexy cash flow but on lower production numbers. They’re kind of opposite that way.

But you do need to be a certain kind of investor for this type of play. While the volatility in the stock should be less, with a steadier growth curve, they don’t grow production—or valuations—as quick as tight oil plays. There isn’t a lot of instant gratification with the market pricing in the next 100 wells on a new discovery.

However, that has been where all the capital in the junior markets has been destroyed—few of the juniors can live up to their initial hype when they discover a new tight oil play. Pinecrest Resources in the Slave Point play; Arcan Resources in the Beaverhill Lake—are former market darlings in high profile tight oil plays down 60-90% in the last year as economics didn’t meet expectations.

I’ve known Cooper personally for 10 years. I’ve watched him build and sell juniors before. I think he’s ahead of the market right now—buying low risk, low decline conventional plays. No one play can break the bank—but one well can make the company.

Like in late 2011 they hit a 900 bopd well in a Leduc reef in the Peace River Arch (450 bopd net to them)—and it produced at that rate for over a year before watering down to under 100 bopd. But payback was just over two months.
Cooper has used those funds to acquire longer lasting assets in central Alberta and Saskatchewan.

And I really like how the stock trades. His stock has strong institutional ownership, good distribution and regular volume. And he’s committed to his shareholders in both keeping dilution down, and creating volume.

SECURE YOUR INFRASTRUCTURE

Their largest play is a partnership with a private company in a land package in Alberta’s Peace River Arch totaling 110 sections (70,400 acres).

The privateco controls the infrastructure presence in the area. This is important—otherwise you’re at the mercy of local processors. It has been the downfall of more than one Canadian junior. Instead of being at the whim of the infrastructure holders, Aroway gets the velvet rope lifted every time they need to get their production online.

“Sometimes it can be a struggle if you don’t control your own infrastructure,” says Cooper. “But with our partner in control, we’re guaranteed to get our production online without the wait or extra costs.”

The partnership is still looking to acquire lands inside their joint core area. Aroway is free to pick up other assets 100%, like the new Kirkpatrick Lake and Little Bow.

Cooper has shown he can negotiate—they bought West Hazel in Saskatchewan for less than $10,000 per flowing barrel. That property is still producing 300 barrels a day today, with more development wells this year.

“We think we can drill a few wells and upgrade the facility,” says Cooper, “and get almost double the production on that property to around 600 barrels a day.”

In fact, deal flow on smaller land packages is increasing, with few buyers for fragmented acreage. That should bode well for Aroway.

SHIPPING VIA RAIL WILL INCREASE PROFITS

Cooper has hinted that they will also explore a rail option to get their Saskatchewan and central Alberta oil to market, as opposed to trucking to a pipeline terminal.

Before rail, Aroway trucked production to a larger operators and paid for diluents to meet the pipeline’s specs. Add in a pipeline tariff, and whatever discount on the oil price you get from the operator, and the costs add up. It really points out the advantage they have with the Peace River Arch JV.

In December, on their West Hazel property in Saskatchewan, they were receiving $53-54 a barrel for the sale of their oil. After paying for the diluent blend and tariffs, they were clearing a low $48 per barrel.

By taking the tracks around the trucking option, the company avoids the diluents and tariff costs, and receives $55 per barrel at a minimum. That’s $6-$9 extra in netbacks, depending on the month—11-19%. And this year it’s gets even better for them.

“We’re not saying we know exactly how the marketing works down in the refineries, but at the end of the day, this month, we’re looking to receive somewhere around $60-$63 a barrel,” says Cooper. “There’s even a possibility we’re going to see that bumped up by another $9. So our netback will be $35 to $40 for the West Hazel crude.”

At Kirkpatrick Lake, the light oil is getting better returns in the pipelines without needing to pay diluents. They still have to pay tariffs, but are getting closer to $78-$80 per barrel.

When the company starts this option in March, investors could see a 30% jump just from hopping on the train.

The trains have already had an impact on the big players up north in the oil sands. In that case, the train cars are taking bitumen down, and the empty cars are bringing condensate back up for blending. Aroway won’t need to do that, as diluent isn’t necessary with rail cars. By taking this route with their conventional oil, they’re going to see huge bumps in netbacks.

“A netback of greater than $30-$40 is a homerun for us,” says Cooper. “So we’ll probably just concentrate on drilling more wells and getting more production in, managing the field better and taking the rail car marketing arrangement.”
Cooper’s team is doing everything a junior in this economy can do right: Building up low-risk/long life production, and squeezing out higher netbacks through innovative marketing strategies (the rail option).

Aroway’s assets have very strong IRRs. Financials could show a 30% boost in netbacks coming in March when their oil hits the tracks. This is the type of junior producer that will become MUCH more prevalent in the next two years.

And as the shale game fades, the investment banks will soon turn their sights on the leading conventional producers like Aroway—with management teams that have built and sold before–and begin their promotional cycle again.

QUICK FACTS

Shares Issued 61.8 million
Fully Diluted 71.3 million
Share Price $0.60
Market Cap $37.1 million
Net Debt $2.8 million
Enterprise Value $39.9 million
Production 1,020 boe/d
Price per flowing barrel $39,117

ADVERTORIAL BY KEITH SCHAEFER

Aroway management has reviewed and sponsored this article. This is not an offer to buy or sell securities and for intormation purposes only.

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