There haven’t been many companies that have taken oil’s decline worse than Penn West Petroleum Ltd. (TSX:PWT)(NYSE:PWE).

Of course, the company’s problems started long before crude tumbled more than 50%. Even going back to 2010, the company was making all sorts of acquisitions that just didn’t make sense, leaving the current management team with a mishmash of different assets to be sold. And to top it off, the previous management team was fudging the books in an attempt to goose the company’s funds-from-operations figure, a key metric analysts look at when evaluating oil producers.

The old management team was sacked and new people were brought in, led by the new CEO David Roberts and Chairman Rick George, both with decades of industry experience with Marathon Oil and Suncor Energy. You might recognize George’s name; he was the CEO of Suncor for nearly 20 years before retiring in 2011. Roberts set out to shed the company of non-core assets, to improve operating ratios, and to pay down the bloated debt load.

And for the most part, he was succeeding. More than $1 billion worth of debt has been eliminated, and the company’s new drilling program is focusing on three main areas that hold significant promise. Costs are coming down and the books are finally clean.

But is it enough? Can Penn West survive oil’s decline?

The danger

Even though Penn West has been aggressively paying off debt, there’s still nearly $2 billion of it left on the balance sheet. In a world where oil is between $80 and $90 per barrel, that would be a concern. At $50 per barrel, it’s the equivalent of having your curtains catch on fire.

Penn West has already approached lenders looking for debt relief. Bankers allowed the company to increase covenants to up to five times its debt-to-cash flow ratio before triggering a technical default. But the deal came with strict conditions, including cutting the quarterly dividend from three cents per share down to a penny, and reducing the amount of undrawn credit from $1.7 billion to $1.2 billion.

The debt deal helps, but it still doesn’t solve the main issue. If oil remains below $60 for the foreseeable future, Penn West is going to be in a heap of trouble. It just doesn’t have the ability to keep financing losses for much longer than a couple of years. Essentially, an investment in Penn West becomes a bet on oil prices increasing.

But it’s a big bet

What exactly is Penn West’s potential upside if oil recovers?

A quick look at 2014’s numbers show Penn West’s cash flow at $853 million for the year, with an average price of about $90 per barrel. Keep in mind that results kept improving as the year went on because of improved operations, but we’ll use $853 million as a base number.

Currently, Penn West’s market cap is $1.1 billion and it has $1.9 billion in outstanding debt for an enterprise value of approximately $3 billion. Based on 2014’s cash flow, the company is trading at just 3.5 times its “normalized” enterprise value-to-EBITDA ratio.

In early 2013, even as the company was struggling and investors were selling it en masse, Penn West still sold at nearly seven times its EV/EBITDA ratio. And even back then, the company was at a discount to its peers. On that metric alone, Penn West’s shares are a potential double.

Penn West is also much undervalued from a book value perspective. Even after writing off $1.7 billion in assets in the fourth quarter, the company still has a book value of more than $11 per share. That puts Penn West at just 20% of book value, which is about as cheap as stocks get on that metric.

There’s all sorts of potential for Penn West to surge upwards when oil recovers. Insiders have recently bought nearly 300,000 shares, and even CEO Roberts recently said the company has great “torque” on a recovery in oil. Yes, there’s risk here, but I think the reward is just too great to pass up.

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Fool contributor Nelson Smith owns shares of PENN WEST PETROLEUM LTD..