Prospecting for a turnaround in energy sector

Benj Gallander and Ben Stadelmann
Thursday, June 10, 2010

As the epic oil spill disaster in the Gulf of Mexico unfolds, one thing that is perfectly clear is that it is extraordinarily difficult to draw resources from under a kilometre and half of water. Though peak oil remains a debated theory, there is little doubt that finding easily accessible petroleum in huge quantities is a luxury from the past.

Though deepwater projects and the tar sands have the potential to post big production numbers, there are other more modest technologies that are coaxing more oil and gas from mature fields, and with far less risk of environmental catastrophe. Horizontal drilling, CO2 and water injection, multistage fracturing and shale gas extraction are some of the enhanced techniques that Fairborne Energy is using to squeeze more oil and gas out of western Canada.

Fairborne has a rather checkered past. It has a history of committing the cardinal sin of business and politics: overpromising and underdelivering. The company was formerly an investment trust, a terrible fit for the sophisticated extraction methods that Fairborne deploys. Money that should have been going towards capital expenditure instead went to distributions, and debt rose to a crippling level.

These problems were mitigated by the elimination of payouts and conversion back to a corporation, as well as the sale of assets and raising of new capital to cut the debt burden in half. But the recession and accompanying low prices for natural gas made some of Fairborne’s wells uneconomic, and production declined.

After reporting a loss of $25.6 million for 2009, the numbers for the first quarter of 2010 are looking a lot better. Net income is back in the black at $3.8 million, and, with the addition of 16 new wells, production is edging higher again. Cash flow was up sharply to $43.5 million and with less going to interest; there are now sufficient funds to promote an ambitious drilling program. The company has an excellent inventory of land, enough to keep the engineers and drillers busy for years.

The main problem is that the price of natural gas remains stubbornly low. It does seem to have bottomed out nicely, but it needs to be much higher to produce sufficient excess cash to fund a decent dividend. That probably won’t happen until the demand for electricity perks up, and that will require a more robust economic recovery than we’ve seen so far.

Nonetheless, Fairborne appears to be on the way to repairing its reputation and positioning itself well to take advantage of higher prices when they eventually occur. The stock was added to the Vice-President’s Portfolio at $3.96 per share. The sell target range is $12 to $14.