Jason Sawatzky: There is no other oilfield services market in the world right now that has growth in front of it like Canada does, thanks to the development of West Coast LNG. Planning for Canadian LNG projects is now in motion. There are three projects that have received export approvals. Three more have applied for gas export licenses, and two more have not yet applied. These projects are going to require enormous amounts of spending on export terminals, pipelines, drilling, fracking, field development and also accommodations. Activity should begin in early 2014 and ramp up over the next five years.
TER: Who is backing the three approved projects?
JS: The three LNG projects that are advancing the fastest (in our opinion) are the Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE)/PetroChina Co. Ltd. (PTR:NYSE; 857:HKSE) project; the Apache Corp. (APA:NYSE)/Chevron Corp. (CVX:NYSE) project and the Petronas (PETRONAS) Progress project. The combined capital cost to buildout all three of these projects is in the range of $30–35 billion ($30–35B). That is why we expect to see significant amounts of capital spent in Western Canada, which will positively impact Canadian service companies.
TER: Are these companies leveraging this mammoth investment with debt or is the government participating in any way?
JS: The companies are putting their own cash into developing reserves and building out the LNG-related facilities in Western Canada.
TER: The companies must be expecting a really big return.
JS: Yes, absolutely. The way LNG development plays out in Canada should be very similar to what happened in Australia with LNG. There are significant natural gas reserves in Canada, and the foreign markets, particularly in Asia, are looking to tap into it.
TER: Please define what you mean by "oilfield services."
JS: Oilfield services include everything from drilling to fracking to servicing the well after the well has been fracked. There are also ancillary services like providing various rental products and production testing services, etc. A number of different technical skills are required to drill the well, bring it into production and maintain it over time.
TER: What firms are best positioned to provide these services?
JS: With respect to LNG development, we would highlight Essential Energy Services (ESN:TSX) and Canyon Services Group Inc. (FRC:TSX). First, Essential provides coiled tubing services used for completions, workovers and well cleanout operations. In general, the advantage of using coiled tubing over, say, regular jointed tubing in a service rig or a snubbing unit is the increased speed at which the coiled tubing string can be run in and out of the well. Also, coiled tubing operations can be performed on a live well, meaning that operators do not have to kill the well, as they have to do with service rigs, which can lead to formation damage.
With respect to LNG development in Western Canada, we think that deep coil is going to play an integral part in servicing the deep, long-reach wells in the Duvernay, the Montney and the Horn River plays. Looking forward, Essential is currently rolling out ultra-deep, generation 3 and 4 coiled tubing rigs. These rigs will be ideal for servicing the long-reach, LNG-type wells.
Canyon is a Canadian pure-play fracker and has a brand-new 225,000-horsepower fracking fleet. We believe the Canadian fracking market today is slightly oversupplied, but by 2014, our expectation is for the Canadian market to be undersupplied due to increased LNG activity. Of note, Canyon has been increasing its LNG-focused, large-cap, exploration and production client base, working for companies like Petronas and Exxon Mobil Corp. (XOM:NYSE). It is also on the bid list for other senior producers.
Interestingly, prior to Q1/13, Canyon was not working for any seniors, so this is all incremental work for the company going forward. It is well positioned to take advantage of the ramp-up in activity in the Duvernay and the Montney to support West Coast LNG development. The company's balance sheet shows $23 million ($23M) in net cash and a $100M undrawn facility as of the end of Q2/13. We believe Canyon has lots of dry powder to respond to potential LNG opportunities.
On the valuation side, Canyon is reasonably valued for a high-growth, emerging fracker. It trades at about 9.2x 2014 price:earnings on our numbers versus our midcap group average of about 10.1x. There is definite upside with Canyon.
TER: What other promising companies are involved in oilfield services?
JS: Canadian Energy Services and Technology Corp. (CEU:TSX) sells specialized drilling fluids for use in drilling longer-length horizontal wells in Canada and in the U.S. Its chemical fluid mix substantially improves the penetration rate of drill bits, and raises the overall productivity of oil and gas wells. The operators ultimately benefit from a reduction in drilling and completion costs. Canadian Energy Services has experienced strong customer adoption of its drilling fluid products, including its main product Seal-AX (reduces wellbore seepage). The company also offers synthetic oil-based muds, ABS 40 and EnerDRILL, which enhance the rate of drill penetration.
Canadian Energy Services is not as leveraged to LNG development as some of the other service companies, but it has very strong fundamentals and growth prospects for providing drilling fluids and production chemicals in Western Canada and the U.S. In terms of drilling fluids, the company is already the largest provider in Canada, with about a 30% market share; in the U.S., it has 8% market share. Of note, the company recently acquired Venture Mud LP in the Permian Basin, a small private drilling fluids company, giving it exposure to the most active basin in the U.S. (note - drilling in the Permian continues to shift from vertical to horizontal drilling). Going forward, we believe Canadian Energy Services will continue to make small acquisitions in the U.S., and will likely grow organically as well. We think the company can grow its U.S. market share to about 10–12% over the next three to five years.
On the production chemicals side, Canadian Energy Services recently acquired a U.S. company called JACAM Chemical for $240M. JACAM provides production chemicals throughout the U.S. and into Canada. Interestingly, its main production chemicals facility in Kansas is operating at a throughput of 20–25%. We believe there is tremendous upside in that business as it ramps up throughput and expands into plays in the U.S. Northeast, the Eagle Ford and elsewhere in Canada. Of note, when the JACAM facility operates at 100% throughput it can generate about $500M in revenue and about $125M in earnings before interest, taxes, depreciation and amortization (EBITDA), so lots of potential future upside. We really like this company.
TER: What kind of dividends are we talking about with these three service firms?
JS: Canyon pays a 3.4% yield right now. Canadian Energy Services pays a 4% yield. Essential Energy pays a 4.2% yield.
TER: Do you have target prices?
JS: On Canyon Services, we have a $15.50 target price and Outperform rating. For Canadian Energy Services, we have a $22 target price and an Outperform rating. On Essential Energy, we have an Outperform and a $3.50 target price, and we just recently increased that from $3.25 due to the company's expanding coiled tubing business.
TER: Do you view these companies as acquisition candidates or are they standalones?
JS: Of the three, we believe Canyon and Essential are potential acquisition candidates for a larger, U.S. service company that needs exposure to the Canadian fracking and coiled tubing markets. Canyon, in particular, is an ideal acquisition target because it is 100% focused on the Canadian fracking market and it is not too large. As Essential Energy is the largest deep coiled tubing provider in Canada and has a growing service rig fleet, it should also attract a larger Canadian or U.S. service company looking to expand into those businesses. It is worth noting that Western Energy Services Corp. (WRG:TSX) recently paid a solid premium to acquire a service rig company called IROC Energy Services Corp. in Western Canada.
TER: What are the mechanics of coiled tubing that make it special?
JS: It is steel tubing than can enter a well while it is flowing and under pressure and is mainly used for completions work. The benefit of coil is the operator does not have to kill the well and risk damaging the formation. The fourth-generation coil rigs can plunge to about 6,400 meters with 2 5/8-inch coil. Coiled tubing technology has been around for a while, but the new development is that the ultra-deep coils are being built to service the really deep LNG-related wells, for example those in the Montney and Duvernay.
TER: What is the proposed lay of the land and infrastructure for the three big LNG projects?
JS: All three are designed to facilitate export of gas from the Western Canadian shales in the Montney, Duvernay and Horn River plays that straddle Alberta and British Columbia. The majors plan to build the LNG terminals in Kitimat and various other places on the West Coast. They will need to build a network of pipelines to feed gas from the fields to the terminals.
TER: Are the companies going to share the new infrastructure?
JS: A lot of the infrastructure will be project specific, but each project is shared by two or more large companies, including Apache-Chevron, Shell-PetroChina and Exxon-Imperial. In the Canadian oilfield space, we believe LNG development is the 800-pound gorilla in the room. It's all going to start happening in early 2014, and that will be a real growth driver for the whole sector.
Some other companies on the frontlines of the LNG buildout are deep drillers, including Precision Drilling Corp. (PD:TSX), Trinidad Drilling Ltd. (TDG:TSX) and Akita Drilling (AKT:TSX). Those firms have the ultra-deep, high-spec rigs that are ideal for drilling LNG wells in the Montney, the Duvernay and in the Horn River. Trinidad and Akita have already been awarded contracts for ultra-deep, $40M rigs.
We also see the Canadian frackers as being on the front lines of LNG development. Calfrac Well Services Ltd. (CFW:TSX) is working for Petronas Progress—as is Canyon—and Calfrac currently has three to four spreads working for Petronas Progress.
A little further down the line, we are watching Horizon North Logistics (HNL:TSX) and Black Diamond Group Ltd. (BDI:TSX). They provide the pipeline camps that will be required for building the West Coast pipelines. There are also assorted compression, pipe-coating companies and the deep coil specialist that we mentioned—Essential Energy.
TER: Great, Jason, thanks for your insights and names.
JS: You are welcome, Peter.
Jason Sawatzky is Director of Institutional Equity Research at AltaCorp, where he focuses on oilfield services. Prior to joining AltaCorp, Sawatzky was an associate analyst covering oilfield services at Stifel Nicolaus from 2009 to 2011. Prior thereto, he worked at Cormark Securities covering oilfield services and E&P companies for four years. Sawatzky holds a Bachelor of Commerce degree in finance from the University of Alberta and a Bachelor of Arts degree in sociology/psychology from the University of Calgary.
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1) Peter Byrne conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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3) Jason Sawatzky: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Canadian Energy Services and Calfrac Well Services. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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