Despite oil rallying substantially since the start of 2018 to see the all-important North American benchmark West Texas Intermediate (WTI) up by 16%, the outlook for many of Canadian oil sands stocks remains subdued. This is because the price differential between Western Canadian Select (WCS) and WTI has widened to levels not witnessed since the start of 2018.
At the time of writing, WCS is trading at over a US$30 a barrel discount to WTI, which is sharply impacting the financial performance of many oil sands operators despite higher crude. This is because many oil sands companies that emerged at the height of the last oil boom were built around the concept of US$100 oil. One of these is Athabasca Oil Corp. (TSX:ATH).
A key problem associated with oil sands projects is the tremendous capital investment required upfront to develop the asset and bring it to commercial production. In an operating environment weighed down by sharply weaker crude, it has become increasingly difficult for oil sands operators to earn a return on their initial investment.
This has made it extremely unattractive for energy companies to invest in developing bitumen projects, and was the reason behind Athabasca’s decision to slow the pace of development for its Hangingstone steam-assisted gravity drainage project (SAGD). The project is currently producing 10,000 barrels daily with a break-even price of US$56 a barrel WTI. With WTI at over US$67 a barrel, there is therefore a considerable incentive for Athabasca to ramp up development of Hangingstone.
Another significant issue facing Canadian oil sands producers is the considerable discount of the bitumen and heavy oil produced against WTI. The benchmark heavy oil blend Western Canadian Select (WCS) is trading at a US$30 discount to WTI, meaning that they are receiving around US$47 a barrel produced rather than the US$67 per barrel of WTI. That means the financial upside for oil sands companies, despite oil’s latest rally, is limited.
Nonetheless, to offset this risk, Athabasca has bolstered its light oil assets and production.
For the second quarter 2018, the company reported an impressive 64% year over year growth in light oil output to 11,872 barrels daily. That light oil output generated an operating netback – an important indicator of its profitability – of $28.64 per barrel, which was 81% greater than the $15.79 netback reported by Athabasca’s oil sands operations. This can be attributed to Canadian light crude trading at only a US$7 a barrel discount to WTI, compare to US$30 for WCS.
These solid results position Athabasca to achieve its full-year 2018 guidance, in which total oil production is forecast to be 39,000 to 41,000 barrels daily, 28% weighted to light oil. This will give earnings a healthy boost in an operating environment where crude remains firm because forecast production volumes are up to 16% greater than 2017.
It isn’t difficult to see Athabasca’s profitability and earnings increasing.
Not only is it investing in expanding its thermal oil operations at Leismer and Hangingstone, which have the potential to produce 40,000 and 80,000 barrels daily, but Athabasca is also bolstering its light oil operations. As part of its strategic plan that aims to grow production at a compound annual growth rate (CAGR) of 15%, the driller intends to boost the proportion of its petroleum output, which is weighted to light oil. In an operating environment where the price of WTI and WCS has diverged significantly and there is no sign of the deep-discount applied to heavy oil easing anytime soon, this bodes well for greater profitability.
Athabasca aims to grow that light oil production by ramping up activity at its assets in the Montney and Duvernay plays, where across its acreage during the second quarter, it drilled five wells, completed nine and brought three to production. That is compared to the same period in 2017 when only one well was drilled, five were completed, and three came online.
Athabasca was roughly handled by the market after oil prices crashed in late 2014, but after the unanticipated rally in oil that started in late 2017, there is every sign that the company is poised to unlock considerable value, which means that its stock will continue to appreciate as oil rises.