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Merging may be the best option for junior oil and gas companies during a commodity rout

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Bradford Goetz made his name in the oil and gas sector by dividing and conquering – he bought up prized assets and merged with likeminded junior exploration and production companies. It was a great time to be in the merger business. From the early 1990s and through to the highest peaks of the oil boom, Goetz dramatically increased the value of his primary business, Siena Energy, by decorating Siena’s balance sheet with high-quality assets that once belonged to another company.

“If you’re selling the only assets a buyer will want, and the only assets that will drive long-term value in the company, you don’t really have anything left.”
– Trent Baker, 32 Degrees

Fast forward to the present price-constrained environment, and though he’s at the helm of an entirely different company with an entirely different strategy, Goetz, like other CEOs of flailing juniors, is considering a move from his old playbook. His most recent company, Volterra Oil and Gas, was formed as the latest in a string of companies that Goetz bought only to turn around to some semblance of profitability and sell them off again. But after selling some of its non-core assets in mid-2015, Goetz still needed to take out a production loan for Volterra for $7.8 million by the end of the year. Nothing unusual there – until Volterra broke the capital covenant on the loan and wrote down a major loss. It wasn’t a great way to go into negotiations with Volterra’s bank and ask for new terms. Now, as he renegotiates, Goetz needs to look at how to increase shareholder value for his company.

Shareholder value is all about how the needs of tomorrow correspond to the needs further down the road. Trent Baker, vice-president and partner at the Calgary private equity firm 32 Degrees, says balancing the short-term and long-term objectives is paramount in looking at strategic alternatives. “In most cases, people right now are managing short-term crisis situations where they need to generate short-term liquidity, but in a way that preserves long-term value,” he says. In a downturn like this one, companies don’t want to sell their assets – they’d rather be buying. But it’s hard to do that while maintaining liquidity, especially for a junior company like Volterra, the kind that banks are trying to reduce their exposure to.

Volterra does have some assets that larger companies would be excited to buy, but Baker says selling your crown jewel is the last thing you want to do. “In most cases, doing that means just kicking the can farther down the road, because if you’re selling the only assets a buyer will want, and the only assets that will drive long-term value in the company, you don’t really have anything left, and it’s just a matter of time before you go out of business,” he says.

So what’s left? Baker says the best option might be a good old merger. It makes the most sense for private equity firms, who can look at their portfolio to find common ground in ownership of assets. “Mergers give you a higher likelihood of being able to accomplish a transaction,” Baker says. “The basic premise of a merger is to add more volume. So if you can take two juniors with operating cash flow of $10 million and turn that into $20 million in operating cash flow, all of a sudden you can build a more meaningful capital budget which allows you to do more synergistic things. You get more capital efficiency when you have a larger capital budget.”

Essentially, when Goetz is looking to the future of Volterra, he’d be wise to look to his own past for an answer.

The post Merging may be the best option for junior oil and gas companies during a commodity rout appeared first on Alberta Venture.


Contango Oil and Gas sees its future onshore, in West Texas’s Delaware Basin

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The Play

Offshore exploration in the Gulf of Mexico and onshore North American resource play development are both in the business of oil and gas production. Other than that, these two activities could hardly be more different.

There aren’t too many small producers that deal in both of them but Contango Oil & Gas is one of them. The future of the company is going to be onshore in the Delaware Basin portion of the Permian. The right acreage in this play can deliver decent returns at $45 per barrel WTI. To put that in perspective, operators in the Bakken and Eagle Ford plays aren’t terribly interested in drilling wells at prices $20 higher than that. No wonder Delaware Basin acreage still goes for $20,000-plus per acre despite depressed oil prices.

In July 2016, Contango moved to secure 5,000 net undeveloped acres in the Southern Delaware Basin. The purchase price was $25 million. At $5,000 per acre, this has the look of a great deal for Contango.

The Pick

Contango Oil & Gas (NYSE:MCF)

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Contango was founded in 1999 by a sharp, charismatic CEO named Ken Peak. Like many at the time, Peak believed the U.S. was going to become desperately short of natural gas. Conventional production was in decline and new discoveries were few and far between.

He formed natural-gas-focused Contango with three core beliefs: The only competitive advantage in the commodity business is to be a low-cost producer; virtually all of the value creation that occurs in the oil and gas business is through the successful drilling of exploration wells; and the only point of the oil and gas business is to increase shareholder wealth on a per share basis.

He was smart and shareholder friendly, and was himself a major Contango shareholder. He believed the best place to find natural gas was on the Gulf of Mexico’s shelf, the relatively shallow portion of the gulf closest to the shoreline. Few companies were still actively exploring on the shelf but Peak, like many interesting businessmen, was a contrarian at heart. He also had an ace up his sleeve with access to a crack exploration team that had been responsible for several of the largest natural gas discoveries made on the shelf. Peak was able to attract this team by giving them an ownership percentage in the wells – a big upside for them with little risk.

The plan worked perfectly. Contango made several significant natural gas discoveries, natural gas prices were strong and the company’s market capitalization soared to nearly $1 billion in 2008.

Being a sharp businessman and knowing that shale gas was becoming a real risk, Peak prepared the company for sale. But before any transaction could be completed, the financial world fell apart. Lehman Brothers collapsed, financial markets froze and the opportunity to exit vanished.
The company continued on with the same business model into a lower natural gas prices. Then, in 2012, Peak was diagnosed with an inoperable brain tumour and took a medical leave of absence. In early 2013 he passed.

Faced with depressed natural gas prices, the new leadership directed the company towards onshore oil. In October 2013, Contango combined its pristine balance sheet in a merger with the overleveraged Crimson Exploration’s Eagle Ford and Woodbine shale oil assets. Both companies got what they needed, but Contango was once again thwarted by commodity markets when oil prices collapsed in 2014. Like most North American shale-oil plays, the Woodbine and Eagle Ford wells aren’t worth drilling at $45 oil.

Thus the move into the Delaware Basin. Contango is one of the few small companies with the financial strength to make such a transition.

The Postscript

Concurrent with the Delaware Basin acquisition, Contango issued five million shares at $10. With that cash, Contango has an estimated 2017 Debt to EBITDA ratio of just 1.2 times. That is amongst the best of any of Contango’s peer group. If oil and gas prices were to increase, this balance sheet would be significantly underleveraged.

The company also has lots of liquidity with $70 million drawn on a $140-million credit facility. Management has indicated it is committed to living within cash flow in 2017 so the balance sheet isn’t going to get worse.

Analysts see cash flow going from $31 million in 2016 to $60 million in 2017 and $103 million in 2018 on Delaware Basin production growth without much help from commodity prices. With an enterprise value of just over $300 million, Contango starts looking pretty inexpensive by 2018.

Jody Chudley doesn’t own shares of MCF

The post Contango Oil and Gas sees its future onshore, in West Texas’s Delaware Basin appeared first on Alberta Venture.

Daniel Costa brings the taste of Italy to Edmonton

How small retailers can succeed in today’s competitive market

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Illustration Marc Nipp

When I ask retail CEOs what differentiates their stores from the competition, they inevitably talk about customer service and the in-store experience. Yet, when I speak to consumers about their shopping experiences, I commonly hear about disinterested employees, out-of-stock products, awkward return processes, restocking fees, messy shelves and a general struggle to find the products that they want.

Clearly, there is a gap between what retailers would like to offer to every customer every day and what they are actually able to provide. That is probably not surprising. If you are Walmart or Starbucks or Zara, you have tens of thousands of employees working in thousands of stores, serving millions of customers, all around the world. Canadian retail giants from Loblaws to Indigo Books to Canadian Tire face a similar problem of scale and scope. The advantage of being big can easily become a liability. Ensuring that every employee in each of those stores is passionate about customer service and the products they sell may be an impossible task. At the same time, corporate giants are under constant pressure to grow their revenue and increase their profitability, which is not always consistent with a good customer experience.

As a result, small independent retailers have a tremendous opportunity to succeed in today’s marketplace. The path to success, however, is not what it used to be. Small companies will struggle to compete based on store locations, selection of national brands and product pricing. The big guys have many stores and tremendous power in the supply chain to negotiate and push down prices.

Instead, small retailers have an advantage in their ability to deliver personal service, curate unique proprietary products and, increasingly, custom build products. A few successful small retailers have been following this approach for years. For more than 40 years, Calgary’s Owl’s Nest Books, for example, has built its business and reputation on personalized reading recommendations. The employees at Owl’s Nest are passionate about what they do and genuinely interested in their products and their customers.

More recently, we have seen Albertan entrepreneurs – like Rocky Mountain Soap Company and Lux Beauty Boutique – leverage small product selections and exceptional service to crack the ultra-competitive cosmetics market. Others have contributed to the growth and expansion of new markets, such as Carbon Environmental Boutique in Edmonton and Reworks in Calgary. I have been especially impressed with small retailers that are taking a chance and bringing their own unique tastes to market. The Uncommons in Calgary is known for sourcing innovative products directly from designers. In Edmonton, The Prints and The Paper recently opened on 124 Street and brings a carefully selected assortment of products that wouldn’t look out of place in the trendiest shops in New York or London.

These small companies, and many others, are leading the evolution of independent retail in Alberta. They are not trying to undercut Walmart’s prices, offer Zara’s product selection or be more convenient than Starbucks. Instead, they are passionately serving a segment of customers that they understand with a level of service and a carefully selected assortment of products that larger chains cannot match.

While that evolution continues, other small businesses are leveraging technology to revolutionize traditional retail markets. Edmonton’s Poppy Barley has been celebrated for their custom-made footwear with an international reputation for innovation and quality. Less well known, but potentially more revolutionary, is Suits by Curtis Eliot, also based in Edmonton. This fast-growing company is an exciting combination of old-world tailoring and modern tech company that designs and fits suits to its individual customer’s tastes and style. The service is one-on-one, the product is custom built and the quality

is world class. They don’t have the flashy locations many of their competitors pay top dollar to maintain, nor do they tie up capital in inventory that may or may not sell. Instead, they focus on a personalized customer experience and a sophisticated supply chain that connects raw materials to the craftspeople that build the final product.

As large retailers struggle to evolve their own businesses to give customers a reason to come into the store rather than buying online, many small retailers are leading the way with truly exceptional shopping experiences. Ultimately, customers will vote with their wallets, but this approach to small retail presents a substantial challenge to big retailers.

It is not, however, a guarantee of success. Starting a small business and keeping it afloat is as tough as it has ever been. Yet, because consumers are becoming more diverse and more demanding, new opportunities are opening up to meet their needs with superior service and a unique selection of products. In many ways, there has never been a more exciting and promising time to open your own store.

The post How small retailers can succeed in today’s competitive market appeared first on Alberta Venture.

Oklahoma’s STACK formation bodes well for Newfield Exploration

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The Play

It is called the “STACK” and it has emerged as one of the better oil and gas plays in North America. By “better” I mean that drilling wells in it can actually generate a decent return at current commodity prices. That is the point, after all, isn’t it?

The STACK is part of the Anadarko Basin, which stretches across much of Oklahoma and a portion of Texas. The STACK’s in Oklahoma, and the acronym stands for “Sooner Trend, ­Anadarko Basin, Canadian and Kingfisher counties,” so you can see why the acronym is used.

This isn’t really an oil play, it’s more of a combo play. Forty per cent of production is oil, 30 per cent is natural gas liquids and the rest is natural gas. The strong liquids weighting is what creates the attractive economics.

Companies operating in the play believe there may eventually be up to 10 reservoirs that could be developed. The current boundaries of the play cover 2.4 million acres, but I wouldn’t be surprised to see that expanded significantly as the industry keeps experimenting with well designs and acreage.

The Pick

Newfield Exploration (NYSE: NFX)

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Talk about a transformation. Realizing the potential of Oklahoma’s horizontal plays led Newfield to sell off other assets and turn the entire focus of the company to the state. It is no coincidence that Newfield’s share price is actually higher than it was in 2014. How many oil producers can say that?
Newfield’s Oklahoma assets work at current commodity prices and the market has figured that out. The company believes that at $45 WTI oil and $3.00/mcf natural gas, wells drilled into the STACK generate rates of return of roughly 60 per cent.

That isn’t an incredible rate of return for drilling an oil or gas well, but remember this is what these wells generate at very low oil prices. If we get to $55 WTI the rate of return moves closer to 100 per cent and at $65 it is more like 140 per cent.

For some perspective on how other plays compare, consider what Continental Resources is doing. Continental’s CEO, Harold Hamm, is known as the “Bakken Billionaire” because of the company’s massive land position and production base in the play. These days, Continental is choosing not to put already-drilled Bakken wells into production because they don’t generate a sufficient return on investment. Instead, the only wells Continental has been drilling and putting into production are located in the STACK and a similar Oklahoma play, the SCOOP.

Newfield’s second quarter production in the Anadarko Basin was 83,000 barrels of oil equivalent per day. That is an increase of 53 per cent from the prior quarter. Not all of it is from the STACK, but that is the portion that is growing. The company recently announced the sale of its Eagle Ford and South Texas assets for $390 million. The proceeds are sure to be directed into the company’s Oklahoma assets.

Newfield’s balance sheet is in fine shape with a debt to EBITDA ratio of two times. The company has no debt maturities to deal with for six years and has ample liquidity.

The exciting thing is that this STACK play is still young. Newfield is working towards driving well and completion costs down to $5 million per location. This would make the play work at sub-$40 oil and mean that it is a money printing machine at $60-plus oil prices with current service-industry pricing.

The Postscript

When oil was $90 per barrel, the name of the game in the shale oil business was to get your hands on as much money as you could and drill as fast as possible. Capital was easy to come by with lenders lining up to hand out money and institutions happy to provide support. The stock market rewarded production growth ahead of all else, so it was hard not to join the party.

Today what matters, and what should have always mattered, is being able to live within cash flow and hopefully grow a little bit while doing so. The percentage of rigs active in the Bakken and Eagle Ford has shrunk dramatically. The Permian Basin and the STACK have been the two regions that have seen their percentages grow.

It doesn’t take a rocket scientist to figure out why. These are the plays that are worth drilling today. As an investor, unless you are certain that oil prices are going to soar, the best companies to invest in are the ones that have the ability to drill profitable wells at current oil prices, even if they do look more expensive.

Jody Chudley doesn’t own shares of Newfield

The post Oklahoma’s STACK formation bodes well for Newfield Exploration appeared first on Alberta Venture.

Habit and familiarity drive the retail-consumer relationship

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Sasha CS6

Most retailers are merchants at heart. They focus on products, rather than customers. Yet profitability and long-term success are not driven by products, they are the result of strong customer relationships. In the competitive retail marketplace, products are an essential component of the value proposition, but it is the customers who are of greatest value to the business.

The key to customer satisfaction is delivering an experience that exceeds expectations. A customer goes shopping with some expectation of what the experience will be like. When the retailer exceeds these expectations – for example, if it is easier to get to the store than expected and the product selection is outstanding – customers tend to be more satisfied. When the retailer fails to meet them – for example, if the aisles are difficult to navigate or prices are surprisingly high – customers tend to be less satisfied.

This is often referred to as the “gap” model of customer satisfaction, because what drives satisfaction is the gap between what customers expect and what they experience.

For a retailer, this requires an understanding of individual customers and their expectations. Market research, combined with a little competitive intelligence, can ascertain consumers’ baseline expectations for a shopping experience in a particular category. Customer surveys and focus groups can even uncover opportunities to enhance the experience as consumers reveal wants and needs that are currently unmet in the marketplace. However, many major breakthroughs are driven by ideas for products that customers do not yet know they want. For example, there was not a widespread demand for espresso drinks that led to the creation of Starbucks. Similarly, most consumers had no idea how important yoga clothing would be to their wardrobe before Lululemon Athletica.

That, of course, is part of the problem with constantly exceeding consumers’ expectations: it is difficult to come up with the next great innovation on a regular basis. Relying on such innovations alone to drive customer satisfaction is a tenuous approach to competition over the long term. Similarly, as ongoing market research and satisfaction surveys have become a staple of consumer marketing, it is difficult to uncover insights that the competition has not. As a result, whether through innovation or market research, it is increasingly difficult to improve customer satisfaction over time by consistently exceeding expectations. Fortunately, it is not necessary to do so.

Think about the relationship between a retailer and a customer in terms of interpersonal relationships. The first time a consumer shops at a retail store she has not previously visited is a lot like a first date. If the experience is considerably worse than what the consumer expected, the probability of a “second date” is substantially lower. In contrast, if the first experience was much better than she expected, the probability of future dates is far higher.

As that relationship grows, the consumer moves from the state of active evaluation that characterizes initial shopping trips to a more habitual purchasing pattern. Habit and the convenience that comes with familiarity drive many relationships between retailers and consumers. Of course, some relationships go beyond habitual behavior and connect the consumer to the business in a deeper and more meaningful way. For example, consumers who are passionate about coffee, electronics, yoga, outdoor activities or organic food may develop a strong relationship with their preferred provider of related products. Retailers such as Starbucks, Apple, Lululemon, MEC and Planet Organic have been successful in this regard.

Both habitual and passion-based relationships can provide the business with several important benefits that are difficult to obtain in any other way. These include efficiency (shoppers who are more familiar with a retailer are able to shop with less support), accommodation (consumers who feel connected to a retailer are willing to make more of an effort to accommodate that retailer), tolerance and forgiveness (solid customer relationships can help protect the retailer when it does not meet consumers’ expectations), perceptual bias (loyal customers evaluate the retailers they patronize and the brands they buy more favourably on price, quality, and other attributes than non-loyal consumers), trust (in a world of increasing complexity and an overwhelming array of choices, trust may be the most important currency in retailing) and advocacy (great relationships lead consumers to recommend the retailer to their friends and family).

Competition today is less about differentiation through store formats or products and more about the relationships retailers establish with their customers. Ultimately, it is more profitable to build and maintain a solid base of loyal customers than it is to constantly fight to attract customers away from the competition.

The post Habit and familiarity drive the retail-consumer relationship appeared first on Alberta Venture.

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

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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.

The post Oil and gas companies should play it safe when spending extra cash appeared first on Alberta Venture.

Janice Price is Right


Christmas shopping actually can be good for you

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Attending A Christmas Carol is a holiday tradition in Alberta. Theatre Calgary and Edmonton’s Citadel Theatre put on heartwarming productions of Charles Dickens’ classic tale. Although it takes multiple visits from the ghosts of Christmas past, present and future, Scrooge is eventually transformed into a kinder and more generous man. He opens his heart and his pocketbook to embrace and celebrate the season with family and friends. The story is a timely and entertaining reminder of the spirit of the holidays.

Today, many people are finding it difficult to reconcile the spirit of Christmas with an increasingly materialistic and commercial holiday season. Retailers stock their Christmas sections as early as the summer months and the festive music loops begin early in the fall. As annoying as many people find “Christmas creep,” retailers are feeling intense pressure to perform during the holiday season. The average Albertan is expected to spend more than $2,000 on Christmas this year, including gifts, entertaining, decoration and travel. Our biggest retailers, from Walmart and Canadian Tire to Loblaws and Sobeys, are in a heated competition for those dollars.

As dependably as Santa puts presents under the tree, we will crowd malls, join long lines and spend hours surfing online for the perfect present. At the same time, headlines and coffee shop conversations will decry the rise of materialism. Just last year, the Pope used his Christmas homily to denounce consumption and warn us not to be intoxicated by possessions. But is materialism such a bad thing?

Actually, most research in this area tends to support the Pope. When consumers focus on buying things, they often pay a price, beyond the cash register, that is reflected in a lower overall sense of well-being. In some cases, excessive consumption even appears to be crowding social relationships out of our lives. One particularly interesting recent study, published in the Journal of Consumer Research, investigated the link between loneliness and materialism. The study examined 2,500 consumers over a six-year period and found that materialism does indeed make us lonelier. Moreover, when we are feeling lonely, we become more materialistic. This leads to a vicious cycle of buying more and feeling less connected to other people and then buying more and feeling even lonelier. The effect was particularly strong among young adults and seniors. Single people were more likely to pursue happiness through purchases than those in a relationship.

However, the same study found that not all types of materialism are the same. The impact of materialism on loneliness depends on why you are buying and accumulating things. If you are comparing yourself and your possessions to other people, then the impact is decidedly negative. Such comparisons tend to make us feel alone and cause us to focus on buying more. Similarly, if you are thinking about what you have relative to what you would like or expect to have, then you are also likely be lonelier. But if you simply enjoy shopping, buying and owning things, not relative to others or your ideal self, then materialism doesn’t have a negative effect. Consumption can be a positive part of the Christmas experience, whether that is the prize turkey Scrooge buys at the end of A Christmas Carol or the new TV you buy to watch hockey over the holidays.

Of course, we can consume too much and waste money on things that bring us neither utility nor pleasure, but the take-away from this research is that materialism is not in itself a bad thing. It depends on why we value material goods. If we feel caught in a cycle of materialism and loneliness, science tells us that, like Scrooge, we can make a positive change by connecting with others. Christmas doesn’t need to focus on competitive consumption. It can be a chance to take pleasure in material things and spend time with other people. Research in this area tells us to worry less about what we want or what others have and to focus more on the pleasure of what we are given, whether that is a new toy or a new pair of socks. Then, make an effort to connect and reconnect with friends and family.

Although often overlooked, part of Scrooge’s transformation is that he gives up his miserly ways and begins spending his money to celebrate Christmas. In fact, part of the message of A Christmas Carol is that money has little value on its own and buying things is not necessarily bad. One of my favourite lines from the play is spoken by Scrooge’s nephew, who says about Scrooge, “His wealth is of no use to him. He don’t do any good with it. He don’t make himself comfortable with it.” In the end, Scrooge does do something good with it and, as a result, he also makes himself more comfortable. Maybe a little Christmas materialism can be a good thing?

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John Stanton was born to run

How to prepare for an upswing in oil prices

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“Lower for longer” isn’t just your game plan for winning the next limbo competition – it’s the mantra of the wilted oil and gas sector. Besieged by the multi-front offensive of low crude prices, creeping regulatory pressure and a public pillorying from activists the world over, with each passing earnings report the landlocked engine of wealth feels more like a V8 Chevy rusting in a junkyard.

“We’re seeing more accountability for results and a greater emphasis on accountability being driven from the top down.” – Paul Craig, Deloitte

But last we checked, Imperial Oil, Enbridge and Suncor all reported about $30 billion in revenue for 2015 and Albertans still outearn their Canadian counterparts by more than $20,000 every year. To its detractors, fossil fuel extraction has an expiration date, but today it’s still fresh – look out your window and chances are you’ll see gasoline-fueled vehicles, not Teslas.

The National Energy Board recently predicted that oil will hit $68 by 2020 and $90 by 2040 – but even the NEB regularly reneges on its predictions. And in the age of electric cars and renewables, 24 years is a long time to wait for a better oil price. Monitor Deloitte, the financial services company’s management consulting wing, just released a report on the future of Canadian oil and gas, and it stresses the ambient uncertainty. It also proposes some guideposts: optimize your place in the carbon value chain, focus on innovation and bolster your corporate social responsibility (CSR) efforts. Those are noble aims, but mere tweaks on the industry’s already-major talking points. So how should an oil and gas company prepare for the next oil boom when we’re not sure we’ll even have one?

That question has been on Bradford Goetz’s mind. The CEO of Volterra Oil and Gas has been through a rough patch of broken loan covenants, deepening debt and a frantic pursuit of valuable assets to buy while the iron’s hot. Now, Volterra’s balance sheet is finally in a respectable state and Goetz is confident in the company’s value proposition. But juniors don’t have the capital for revolutionary technological innovation like Suncor or Imperial might, nor can they embolden their CSR with fancy energy-is-life ad campaigns like their billion-dollar competitors. “Our future won’t be built on revolutionary carbon-sequestration technology or anything like that,” Goetz says. “We’ll build it by pumping oil.” So when it comes to positioning itself for the future – whatever that looks like – what’s a junior to do?

Paul Craig, senior oil and gas sector specialist with Deloitte, agrees that it’ll be a price-constrained environment for the foreseeable future. “From a pure economics perspective, it probably doesn’t make sense [for producers] to invest in building new infrastructure,” he says. Indeed, one of the only constants will be the need to get product to market, so Craig says smart companies will be “investing in some kind of midstream infrastructure.” But this is true for the entire oil and gas sector, too: “[Market access] has an impact on whether Canada remains an attractive value proposition for some of the global companies making choices about where they’re going to invest their capital,” Craig says. “Market access is one of the keys to remaining relevant.”

But there’s something to be said for having the right attitude, too. “When I look around at our clients, we’re seeing more discipline in terms of the decisions being made and the resources being allocated,” Craig says, remembering the glory days of soaring overhead costs. “We’re also seeing more accountability for results and a greater emphasis on accountability being driven from the top down.”

When there’s a price correction, then, there ought to be an attitude adjustment, too. Maybe the best way to prepare for the next oil boom is to pretend there won’t be one.

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

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Baytex Energy stock is a sleeper pick

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The Play

Baytex Energy has three core assets: Two of them are Canadian heavy oil plays located near Lloydminster and Peace River, Alberta, and the third is the Eagle Ford shale in Texas.

The Eagle Ford is capable of turning a profit at lower oil prices than the Lloydminster and Peace River properties. With a typical $15 differential between West Texas Intermediate pricing and Western Canada Select (heavy oil) pricing, $45 WTI equates to just $30 WCS for the heavy oil assets. To make money generating oil at $30 per barrel a field would need to have virtually no production costs.

Baytex’s operating cost for producing a barrel of Canadian heavy oil in Q1 of this year was $10.91. That compares to $8.17 in the Eagle Ford, and the heavy oil operations barely generated positive operating netbacks in the first quarter. That is bad considering that operating netbacks don’t include any of the cost of drilling the wells.

There is something else you need to know: The economics of heavy oil get better quickly as oil prices increase. If WTI prices were to recover to just $60 per barrel, the Canadian heavy oil wells actually generate better economics than the Eagle Ford. At $70 per barrel these wells generate world class returns on investment.

The reason for this is partially because these heavy oil wells have a much higher fixed cost component which doesn’t rise as oil prices do. The other factor is just how low the WCS differential drives heavy oil prices down. Just a $5 per barrel oil price increase is a 26 per cent increase in Baytex’s Q1 WCS sales price.

The Pick

Baytex Energy (TSX: BTE)

08-baytex-healthy-stock-story

Baytex Energy did well by shareholders for years as a reliable dividend payer with a focus on Canadian heavy oil. But being basically a pure heavy oil producer meant the company was fully exposed to WCS pricing.

With pipelines in North America overflowing with surging production, the pricing of WCS often suffered from huge negative differentials to WTI. What’s more, with environmental groups stifling progress on not just the Keystone XL but various Canadian pipelines, the future for WCS pricing looked ever worse.

That led Baytex to make the sensible decision to diversify its operations.

On February 6, 2014 Baytex announced a $2.8 billion acquisition of Eagle Ford focused Aurora Oil & Gas. The acquisition was funded by a $1.5 billion equity issuance, $800 million of debt (senior notes) and the sale of Baytex’s interest in the North Dakota Bakken.

While the idea to diversify away from Canada’s pipeline issues was likely a good one, the timing involved in adding debt to the balance sheet couldn’t have been worse. By the time the deal closed, the price of oil had already headed into decline.

Prior to the Aurora acquisition, Baytex’s balance sheet was pristine. After the acquisition, it had a significant but sensible amount of debt for a $90 per barrel environment. At sub-$50, that new debt load was not so sensible.

Despite an equity issuance in April 2015 and the elimination of its dividend, Baytex still finds itself with far too much debt for current oil prices. The good news is that the company has loads of liquidity and zero debt maturities until 2021.

While significantly overleveraged at current oil prices, this company has time to let oil prices rise.

The Postscript

With Baytex’s leverage on its balance sheet and the leverage to higher oil prices, the company’s debt structure could make it an interesting way to play a future oil price increase.

There is something else to be aware of: The operator of almost all of Baytex’s Eagle Ford acreage is Marathon Oil. As operator, Marathon gets to make all of the decisions about how much drilling to do.

This year, Marathon acquired a large position in the STACK play in Oklahoma. This is significant for Baytex because Marathon believes the STACK has better economics than the Eagle Ford. That could present a situation where Marathon chooses to greatly reduce how much it spends in the Eagle Ford to focus on the more profitable STACK.

If Marathon curtails Eagle Ford activity, Baytex has to as well. That would leave the company with only Canadian heavy oil as a place to invest new capital. At current oil prices, that is not a great position to be in.

This company needs oil prices to rise.

The post Baytex Energy stock is a sleeper pick appeared first on Alberta Venture.

Swimco is a family affair – with Lori Bacon at the helm

Should the oil industry drop acid?

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Illustration Marc Nipp

Todd Parker has a technology that improves the flow of oil from a well and is a safer, more enviro-friendly, lower-risk way of doing it than is currently used. His company, Blue Spark Energy, has developed a device that is sent down the well and emits brief, intense electrical shock waves to break up and dislodge the gunk that sometimes builds up. Blue Spark has developed a good track record for using the technology to improve the flow of oil and extend the life of wells.

The alternative to Blue Spark’s process is acidizing, a century-old practice by which hydrofluoric acid (usually) and other chemicals are poured down a well to dissolve the gunk (it can also dissolve sediments and mud to increase permeability). As Parker puts it, the production company hires a truck that carries several hundred gallons of acid along the highway, through the towns and across the fields to the well (in fact, the acid is often made on site). Then guys in hazmat suits pump the acid into the wellbore and wait.

There’s not much evidence that acidizing causes harm to the environment, but there’s not much that it doesn’t, either. Because nobody is gathering the information. Nowhere in Canada is anyone required to report when and where they acidize a well, nor how much acid they use in what concentrations. There’s no measurement of nearby groundwater before or after. Basically, there are no regulations surrounding it, despite the fact there is cause for concern similar to that shown toward hydraulic fracturing. A recent study out of UCLA found 200 chemicals used in acidizing, many of them similar to those used in fracking.

Parker says we’re picking and choosing environmental policies based not on science but on emotion. “If you want to have environmentally responsible hydrocarbon production, you have to look at a number of issues and not just the hot button issues,” he says, referring to greenhouse gas emissions, fracking and pipelines. “There’s a wide spectrum of things we could improve upon from an environmental perspective in the hydrocarbon production process. It’s just who has Twitter and a sign out protesting today that kind of steers public policy.”

Acidizing, on the other hand, has been flying under the radar. “We’re focused on greenhouse gases and not what we pump into the ground to help oil wells continue to flow,” Parker says.

California introduced the first regulations in the U.S. on acidizing in 2015. They require companies to obtain permits for every acidizing job (as well as every fracking job), and to disclose water and chemical use. Adjacent landowners and tenants are notified, and there are groundwater monitoring requirements before and after acidizing. Blue Spark has seen business growth in California and other U.S. markets where legislation is tightening, and in jurisdictions like the U.K., Denmark and Norway where transportation of hazardous materials is complicated.

But so far, nothing in Canada on the regulatory or legislative front.

What has happened in this country, Parker says, is that some producers have started to twig to the idea that, down the road, moving away from acidizing will be of value to their company, “something you can put in your quarterly report or on your web page saying you’re doing something different and green,” he says. “They should start walking down that road now, but mostly they haven’t.” And without prompting from regulations, many are unlikely to make the required leap of faith to invest in a new technology. “This is an industry where everyone is in a race to use technology, but the race is different from what everybody thinks,” Parker says. “Everybody wants to be the first to be second.”

This is the first in Alberta Venture’s new series entitled The Last Word, which focuses on the ideas of experts who are scheduled to deliver seminars in association with business schools in the province. Todd Parker will deliver the ConocoPhillips IRIS public seminar at the Haskayne School of Business at the University of Calgary on January 12, 2017 at 4:30 p.m.

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Dan Balaban’s thoughts on renewable energy

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Balaban at Enbridge’s 300 MW Blackspring Ridge wind farm north of Lethbridge. Developed by Greengate, it’s the largest wind farm in Western Canada, with 166 turbines
Photograph Bryce Meyer

Alberta Venture: Renewable energy is a growth industry and the government recently announced 400 MW of new procurement. How is this going to affect the outlook for Greengate and for renewables?

Dan Balaban: The NDP government has put renewable energy in Alberta back in business. It started last year when the NDP announced the Climate Leadership Plan. That sends a strong signal to the market that this government is serious about improving Alberta’s environmental performance, and at the same time diversifying our economy by driving investments into renewables.

Then, a couple weeks ago now, the government announced it’s going to have its first round of procurement, where there’s going to be 400 MW of contracts auctioned off and all the various companies with renewable energy projects under development will be able to bid for these contracts. These contracts provide a predictable revenue stream for renewable energy projects to be built and financed. At the same time, they provide what I believe will be a low-cost, long-term source of power for consumers in Alberta. Under this structure we should see some of the lowest-price renewables in Canada.

Alberta Venture: And how does that bode for the future of Greengate and other renewable-energy companies?
DAN BALABAN:
We’re very excited about the future of renewables in Alberta. Alberta has some of the best renewable energy sources in the world – it’s probably not well known, but our onshore wind resources are among the best in the world, and our solar resources are as good as those in Florida.

Greengate has a number of projects we’re developing, both wind and solar, and I’m confident that we’ll be able to compete in this upcoming auction. But even if we’re not the successful bidder, I’m very confident that the outcome for Alberta consumers will be great – which is going to be a long-term source of power.

AV: Alberta’s electricity market is an outlier among the provinces. How does this change how you do business here?
DB:
We’re the only power market in Canada that’s a merchant power market, meaning the power generated is sold into what’s called the Alberta Power Pool, which has a volatile power price. It can go from zero to $999/MW in any given hour. That’s caused a lot of grief for consumers, and it makes the financing of power projects difficult. To finance a project of this size, it’s important to have a long-term offtake agreement, and the way the market is structured in Alberta, those have not been available.

AV: The public conversation around renewable energy can get surprisingly heated. What do Albertans get wrong about renewables?
DB:
I always hear that renewables are expensive. That’s simply not true. Technology has improved very dramatically over the last decade and it’s continuing to improve. Wind in Alberta is arguably lower cost than natural gas-fired generation, so renewable can absolutely compete on a cost basis.

Another thing I hear is that the technology is unreliable. That’s not true, either. Wind and solar technologies have been around for decades. They’re commercially proven technologies. They’re financeable technologies. And they can provide a reliable source of power.

AV: You come from an entrepreneurial background – is this a unique opportunity for entrepreneurs interested in renewables?
DB:
I see the world going through a pretty dramatic transformation right now in the way we produce and consume energy, moving away from fossil fuel-based energy to renewable energy. Like I said, Alberta has some of the best renewable resources in the world, and we have an “open for business” attitude from our provincial government, to our municipal governments, to local land owners. We have amazing resources, a relatively well-defined regulatory process and, now, we have a set of policies to encourage growth in the sector. You combine all those things and there are lots of exciting opportunities for entrepreneurs to participate in the sector in Alberta.

On the price of power in Alberta: “It can go from zero to $999/MW in any given hour. That’s caused a lot of grief for consumers.”
– Dan Balaban, Greengate Power

AV: What’s been holding it back?
DB:
The lack of policy support. Our provincial government previous to the NDP basically chose coal over renewables, dirty power over clean power. I think that was a mistake because it didn’t allow us to realize the potential we have in this exciting new industry, and I think it unnecessarily damaged our environmental reputation internationally and has affected our ability to get our product to market and build pipelines to where we need to build them to.

If we can demonstrate that we’re environmentally responsible, we’ll be encouraging economic diversification and, hopefully, getting the social licence we need to get our product to market and build pipelines. Because in Alberta, the two industries, fossil fuels and renewable energy, have to go hand in hand. I think they’re complementary to one another and we can help each other out.

But it’s certainly not helpful to have false information put out there, because sometimes [renewable energy] is perceived as a threat. It’s not. I think it’s going to help us all achieve our mutual goals. We should be having fact-based conversations.

AV: Does this go both ways? I’ve heard from environmentalists who’d have ­Alberta switch over 100 per cent to renewables right now, who say we shouldn’t even be considering pipelines. But I’ve also heard from oil and gas boosters who see renewable energy almost as a frivolous curiosity – “Sure, it’s neat, but we don’t need it.”
DB:
I certainly wouldn’t say we can move to 100 per cent renewables today. But I certainly would say that we can see a lot more on the grid than we currently have. The future is going to be a mix … I think we’ll see the mix change over time with more renewables in it, but it’s all about diversity. It’s not 100 per cent this or 100 per cent that.

Balaban has led Greengate, which developed the province’s two largest wind farms, since its founding in 2007. He worked for Ernst & Young and PwC before founding Roughneck.ca, which provided operations software to the energy sector, in 1999

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Royal Dutch Shell is the biggest player in LNG game

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The Play
“We’re more a gas company than an oil company. If you have to place bets, which we have to, I’d rather place them there.” – Ben van Beurden, CEO, Royal Dutch Shell, to Bloomberg Businessweek

I’m concerned about where natural gas prices are going to go over the next five years, and I don’t mean them shooting higher and pushing up my heating bill. If you have been paying attention, you will have noticed that the Montney formation, in northeastern B.C. and northwestern Alberta, is one incredible shale gas play. What pure-play Montney companies like Painted Pony, Advantage Oil & Gas and Crew Energy are doing and are capable of doing in terms of production growth is staggering.

But if we don’t get our liquefied natural gas (LNG) export ducks in a row, Canadian natural gas is going to be sold at rock bottom prices for years to come.

It isn’t like there won’t be plenty of demand for LNG globally. Exxon Mobil is forecasting that global consumption of liquefied natural gas will triple to 100 billion cubic feet per day by 2040. Asian countries with big populations and modest natural gas production will be relying on LNG imports to provide half of the natural gas they consume.

And those projections are based on how the world is currently viewed. I believe there is a strong possibility that China and eventually India will surprise us in how quickly they abandon coal to improve air quality. That would mean even more demand for LNG.

But, without new pipelines and LNG facilities on the B.C. coast, Canadian natural gas may end up being stuck. From an investors point of view, that could work well for other, more global, players in the market. The biggest in that game by far is Royal Dutch Shell. After acquiring BG Group for a cool US$54 billion, Shell has double the LNG capacity of its nearest rival, Exxon Mobil. In short, Shell has bet its future on LNG.

The Pick

Royal Dutch Shell (NYSE:RDS.A)

I mentioned the wave of Canadian Montney producers that are generating incredible production growth even with low natural gas prices. Ten years ago these companies didn’t even exist. Royal Dutch Shell has been around a little longer. The company was founded in 1833 by a man named Marcus Samuel. Originally, Samuel used his company to sell antiques before expanding into the importation of shells from the orient. It wasn’t until 50 years later that his two sons moved Shell into the oil and gas business.

It has grown into a blue chip company that is widely owned and widely followed. It might surprise you, then, to learn that this massive and durable company currently sports a dividend yield of 7.5 per cent. That kind of yield is extremely unusual and basically implies that the market believes the current dividend is unsustainable. Given the collapse in oil prices, that probably doesn’t seem surprising, but what we also need to consider is that Shell has not had a dividend cut since 1945. These oil and gas majors aren’t kidding when they say that they are committed to their dividends. Shell went through sub-$10 per barrel oil prices in both the 1980s and 1990s without cutting that dividend.

When I take a look at what Shell is planning to do in the coming few years, I have to say that it appears they can keep this dividend up. From generating free cash flow of only $12 billion per year from 2013-15 while oil was $90 per barrel, Shell is expecting to increase that to $20 billion to $30 billion in 2019-21 with oil at only $60 per barrel.

The key to achieving this is that annual capital spending, which peaked at $57 billion in 2013, will be dropping under $30 billion in the years going forward. The company will massively reduce spending by cutting back on enormous long-lead-time mega-projects and by squeezing every penny out of the money it does spend. There is nothing like necessity providing the incentive to create radical improvements in cost efficiency.

The Postscript

A big fly in the ointment of Shell’s long-term plans could be LNG pricing. There will be demand growth, but the problem could be how efficient Shell and its competitors continue to become at producing oil and natural gas.

LNG prices, which are linked to oil pricing, have taken it on the chin in recent years. That means that not only does Shell need to worry about massive amounts of natural gas coming from shale flooding the market, it also needs OPEC to stop overproducing to get oil prices up.

Having to rely on OPEC to do anything is not a comforting position to be in. At least for shareholders of Shell, you know that you are invested in a company that, having been around since 1833, has lived through a few challenges.

The post Royal Dutch Shell is the biggest player in LNG game appeared first on Alberta Venture.

The power of Trump’s personal brand

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On January 20th, the U.S. will swear in the country’s 45th President: Donald Trump. That is shocking to many people. How was a political neophyte with little support from his own party able to win a general election for the most powerful office on the planet? A complete answer to that question is complicated, but there is no denying that the personal brand of Donald Trump played a central role. Not the brand he built as a real estate developer or reality TV star, but the brand he invented as his political persona.
Personal branding is an idea that has become increasingly popular in recent years. Historically, branding was about selling products. Marketers quickly realized, however, that it was also important and powerful in many other endeavors. From government services to employee recruiting to charity fundraising – brands matter!

When it comes to personal branding, you can say whatever you want, but ultimately it’s what you do that matters.

At the core of a great brand is a value proposition that is compelling to the target audience. Trump’s success in this regard holds lessons for anyone interested in personal branding. As a starting point consider how Trump clearly and concisely promised to “Make America Great Again.” By doing so, he established how selecting him would benefit the voter. Explaining the benefits of whatever you are selling is the first stage of a strong
value proposition. It is relatively easy to do, requiring only that you identify the value you plan to deliver.

The second stage is differentiation. What is different and better about the benefits you are offering as compared to the competition? This is a little more challenging, as it requires not only that you understand what you are going to do, but also what your competitors are up to. Trump, for example, was faced with a lineup of competitors who were predominately experienced politicians. In response, he turned his neophyte status to his advantage and focused on his success in business to differentiate himself. He consistently talked about his wealth, pointed out that he was paying for his own campaign, and explained how being a tough negotiator meant he could bring back jobs and prosperity. Facing Hillary Clinton in the general election, he reinforced his outsider status, but also adopted a few traditional Republican positions that further differentiated him as fiscally and socially conservative. Throughout the campaign, Trump consistently and clearly established that he was unlike other presidential candidates.

The third stage of a strong value proposition – by far the most important and difficult – is ensuring that what is different about you is relevant to your audience. It also helps if you can be relevant to a large group of people whom others have overlooked. This is hard to do in a competitive environment because everyone is trying to connect with the segments that they believe are most important. Trump excelled at this and he found an eager audience: one that felt mistreated, underappreciated and underserved. He then made sure that he differentiated himself in a way that would resonate. Although many people strongly oppose Trump as president, many others saw him as the best available choice and more than 61 million Americans voted for him. Strong brands – from Apple to Harley Davidson to Marvel comics – can be successful without appealing to everyone.

In describing the value proposition, I may have made the process sound entirely rational. It is not. In fact, it is critically important that your brand connects on an emotional level. Many great brands are defined by the ability to bond with their target audience. That’s why we talk about the cult of Apple or the Harley Davidson community or Marvel’s fandom. What Trump accomplished was not driven by an intellectual argument for a better America; it was a promise to make the country great again. That is a powerful emotional appeal.

But this all comes with a big caveat: brands weaken and eventually break when behaviour consistently fails to meet expectations. You can promise greatness – whether that is exceeding your quarterly key performance indicators, turning your app into the next Facebook or growing your local coffee shop into the next Starbucks – but then you must deliver. It is much easier for Trump to talk about making America great again than it is to fix the complex problems facing the country. It is one thing to claim you are a strong negotiator who will build a wall and get Mexico to pay for it, and another to make that happen. Going forward, the power of Trump’s brand will depend on his ability to deliver as president. He doesn’t need to be perfect, but he will need to produce results. When it comes to personal branding, you can say whatever you want, but ultimately it’s what you do that matters.

The post The power of Trump’s personal brand appeared first on Alberta Venture.

Questor’s Audrey Mascarenhas has a technology that can reduce pollution and generate emissions-free power

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Audrey Mascarenhas says she has a ready-to-go technology that can reduce the carbon and methane emissions from the thousands of oil and gas flare stacks that dot the province, generate emissions-free power from their waste heat and do it all cost-effectively. Her Calgary-based company, Questor, has long been in the business of selling and renting incinerators to burn waste gas from oil and gas operations. But the company is now taking the process one step further by using the waste heat to generate power onsite and, in the process, is delivering one of the small-scale, proven technologies that can help solve the climate-change dilemma.

Questor is most active in the U.S., where, in response to poor air quality, clean-air regulations force companies to incinerate waste gases to a 95 per cent efficiency rate. Here at home, the uptake of the company’s technology has been slower. “In Alberta right now we’re flaring and venting about 140 million static cubic feet of gas a day,” she says. “If we focused just on flaring, venting and the waste gas going through dehydrators, we could reduce Alberta’s greenhouse gas emissions by 60 megatonnes at a cost of less than $1.70 per tonne.”

Mascarenhas says there’s enough waste heat in the province to replace all the coal-fired power the province plans to phase out by 2030, and that it comes with no emissions. “We also don’t struggle when the sun doesn’t shine or the wind doesn’t blow, because waste heat is coming off so many industrial processes that are running 24/7.”

Questor’s technology is similar to a steam turbine, but runs at a much lower ­temperature. “The advantage of this cycle is it’s at low ­temp­erature and low pressure, so you don’t need a guy with a steam ticket,” Mascarenhas says. That works well at the small, isolated sites that are so common in the oil and gas industry, but it can be attached to any manufacturing or industrial site that is generates waste heat. Questor has, for instance, studied the cooling towers at Enerkem Alberta’s waste-to-biofuels facility in Edmonton. “On our preliminary work, we’re looking at three ­megawatts of power,” she says, enough to power 3,600 homes.

Mascarenhas says dealing with waste gas – much of which is methane – from the oil and gas industry is one of the biggest opportunities the world has to make an impact on climate change. “Methane is 25 times worse than CO2 as a greenhouse gas,” she says. “When I cleanly combust it, I actually reduce the tonnage of greenhouse gas emissions nine-fold, and that’s with today’s tech. That’s with no more R&D hoping for a magic bullet.”

Mascarenhas says governments have focused on mega-projects like Shell Canada’s $1.35-­billion Quest carbon capture and storage system attached to the Scotford refinery, and on moonshot technologies that have yet to be developed. She’s critical of the October announcement by the provincial government to invest another $33 million to advance methane-reducing technologies through Emissions Reduction Alberta (formerly the Climate Change and Emissions Management Corporation). “If we took that $33 million and said, ‘You know what, industry, we’ll incentivize you to take some early action, say 25 cents for every dollar spent,’ we would have been well on our way to meet the target on emission reduction,” she says. “Instead, we’re taking it to invest in technologies that haven’t been invented yet.” Better, she says, to support the simple, perhaps mundane options staring them in the face. “We’re missing the low-hanging fruit that would not only address climate change but would help with air quality in Alberta,” she says.

Mascarenhas would rather see government bring in the same kind of tough rules around emissions, methane, volatile organic compounds and hazardous air pollutants that have been introduced in the U.S. “Companies had to pay attention to what they were emitting and if they weren’t in compliance they were fined,” she says. The clear rules allow innovators and service companies to know what they have to design to and, most importantly, companies know the expectations.

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DIALOG’s Jim Anderson opens up shop in San Francisco

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Jim Anderson
Photo Ryan Girard

Alberta Venture: One of DIALOG’s projects – the new terminal at Calgary International Airport – has been getting glowing reviews (except from WestJet, which has complained about long walks between gates). Can you summarize the project in one sentence?
Jim Anderson:
The new terminal is stunning, it shows Calgary and Alberta really well, and it’s fantastic in the way that it’s been done in terms of the sustainability of the design. It also makes Calgary a regional hub. The whole point was to create regional connectivity so Calgary becomes the hub for travellers from around the world, whether it be Asia or elsewhere. With clearance to the U.S., it can really act like Chicago or Atlanta does as a destination in North America for people to come and hub through.

AV: That was more than one sentence, but OK. The big news for DIALOG is the opening of an office in San Francisco, your first in the U.S. Why do this, and why now?
JA:
There are all kinds of reasons for us to be in the U.S. We’ve established ourselves well in Canada, growing from Alberta [the firm started in Calgary in 1960] to Toronto to Vancouver. We have a lot of talent and experience under our belt. The world is coming to our backyard for every project, so why don’t we go play in theirs? And it gives us an opportunity to learn from that experience as well and bring that knowledge home.

We’ve been talking about this for about a year and looking at it seriously for the last eight months to broaden our markets and find other places we can do great work. We’ve settled on San Francisco because it’s a gateway city to the U.S., so it’s a way to be in the U.S. market, not just the San Francisco market. At the same time, it’s a wonderful city and it aligns with a lot of our values. It has a very purpose-driven culture. People there are serious about making a difference with what they do.

We’ll start out slow. We see building the San Francisco studio as building a little microcosm of DIALOG. It will be a handful of people that represent the diverse characteristics of our firm. We’ll have design talent. We’ll have technical depth. It’s important for us to start out with all of that. Being an integrated firm is one of the values of our firm so we want that diverse set of skills around the table right from the get-go.

AV: Will you populate the office with some of your 600 current employees?
JA:
It will be a balance of people from our current studios and hiring people locally. There’s an important aspect to being local: Each of our four studios has their own culture.

AV: Do you see it as an opportunity for growth?
JA:
I don’t know if growth is the right word. Our goal isn’t to get bigger, it’s to get better.
We do have a mantra that we want to be as big as we need to be to do the scale of projects we want to do and to compete with the other people who do those projects. But we also want to be as small as we possibly can be to preserve that small firm culture that we feel is important.

AV: Did the recent U.S. election cause you any pause?
JA:
The calculation didn’t change. This is a long-term commitment for us. We’ve been thinking about it irrespective of political concerns. Canada and the U.S. are sharing some of the infrastructure deficits and the need to develop some of the things that we
feel we have expertise in.

AV: You have said DIALOG has something to offer the U.S. market in terms of your firm’s experience with mass transit.
JA:
We’ve worked in Calgary with their system. In Edmonton we did a few stations going back 10 years. We’ve done some stations on the Canada Line in Vancouver and we’re doing some stations on the Eglinton cross-town line in Toronto, so we’ve been involved in the urban transportation systems of all of our cities.

We led the sustainable urban integration team for the Valley Line LRT in Edmonton. It’s a fancy way of saying, “Everything matters. Design everything so that it integrates into its neighbourhood and its surroundings, whether that’s the station or the landscape leading up to it, the sidewalk, the streetlamps, all those things that frankly take building an LRT system to building a city, building a community.”

There’s a need for transit development throughout the U.S., so that’s something we can take lots of places. We had a large delegation at a conference in San Francisco called Rail-Volution presenting some of the work we’ve been doing and showing that
off to the world.

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Vistra Energy deserves another look

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The Play

Even great investors make mistakes. Warren Buffett did just that in 2007 when he purchased the junk bonds of Texas power company TXU Energy. By 2015, when it was all said and done, Buffett’s company Berkshire Hathaway closed out this investment with a billion-dollar loss on a $2-billion investment.

“We believe our unique integrated business model will provide investors with an attractive, stable earnings profile.”
– Curt Morgan, CEO, Vistra Energy

He was far from the only big loser on TXU. In 2007, private equity heavyweights KKR & Co., Goldman Sachs Capital Partners and TPG Capital teamed up to acquire TXU for a whopping $45 billion. It was the single largest leveraged buyout (LBO) in U.S. history at the time. While Buffett lost half of his investment, these firms lost 100 per cent of their equity stake.

Where did all of these smart investors go wrong? Two things: using too much debt and getting the natural gas market very wrong. They loaded up a healthy company with a massive amount of debt and by doing so, bet on natural gas prices to stay high.

Of the $45-billion purchase price, $37 billion was financed with debt. Prior to being acquired, TXU’s annual interest expense was $830 million. After being saddled with the acquisition debt, it soared to $4.3 billion. That’s a heavy piano to drag around behind you.

If natural gas prices had stayed at the $6/mcf level that the private equity acquirers expected, this deal may have worked out. Instead, with cash flows crimped by low natural gas prices and massive interest payments, the company could not survive. In 2014, TXU Energy (renamed Energy Future Holdings at that point) filed for Chapter 11 bankruptcy.

The Pick

Vistra Energy (OTC: VSTE)

In October of 2016, the first lien bondholders of TXU/Energy Futures Holdings took control of the assets of the company and put them into publicly traded Vistra Energy.

Vistra has two operating units: Luminant and TXU Energy. TXU provides electricity to 1.7 million customers, 1.5 million of whom are residential and the rest industrial or commercial. It’s the largest retail electricity provider in Texas, with 25 per cent of the residential market. Luminant generates power. The businesses are run separately but are integrated. TXU buys electricity from Luminant and sells it to its customers at a small markup. TXU generated 53 per cent of the company’s EBITDA in 2016 and Luminant 47 per cent.

This is a utility, a stable business with predictable cash flows. Before TXU filed for bankruptcy, the company was carrying $34 billion of debt. Net debt for Vistra is now only $3 billion, an incredible improvement in the company’s balance sheet.

Against its peers, Vistra’s balance sheet has gone from worst to best. A case could even be made that the business is, for a utility, underleveraged.

And valuation-wise, the company appears inexpensive. Current enterprise value to EBITDA is 6.7 times. Competitors with three times as much debt trade at 8 to 9 times. At 8 times EBITDA, Vistra would trade for $20 per share. At nine times, that figure would be $22.52. You would think that the company that has one-third the debt would have a premium multiple, not a discounted one.

The Postscript

A discounted valuation is good. Having one-third the debt of similar companies is better. The cherry on top is that there are catalysts that should drive Vistra’s share price higher over the next 12 months. The first is that this $10-billion company trades on the over-the-counter market. When it moves to a larger exchange, a whole bunch of additional institutions are going to be able to buy shares.

Second, having just come out of bankruptcy, Vistra has yet to file any financial statements. That means it isn’t coming up on the stock screens of investors.

Third, analysts haven’t started covering the company. Once they do, more investors will get this attractive opportunity put in front of them.
Fourth, with $900 million of free cash flow expected in 2017 and no need to reduce debt, there is a good chance that a dividend will
be announced.

This isn’t a sexy business and you aren’t going to triple your money, but a 30 to 40 per cent upside is certainly possible while owning a company on solid financial footing.

The post Vistra Energy deserves another look appeared first on Alberta Venture.

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