Energy investors wouldn’t mind seeing production cuts from the world’s leading oil producers for example Saudi Arabia, because this is needed reduce the supply glut and hopefully boost prices. They simply don’t want to see exactly the same from oil producers in their portfolios.
That’s why it’s important to track the oil price required for companies to keep production steady.
Aaron Bilkoski did just that for PrairieSky Royalty Ltd.
The TD Securities analyst calculated that the Calgary-based oil and gas royalty company needs US$55 per barrel WTI to ensure that the industry to invest enough to keep flat production.
He created this number by looking at the historical relationship between capital spend on conventional exploration and development over the Western Canadian Sedementary Basin, and the cost of crude.
That the relationship between both of these variables is strong comes as little surprise, since higher oil prices means more cash is available for reinvestment.
Bilkoski also checked out the proportion of industry spending PrairieSky captures on its land.
He estimates that total industry spending arrived at $26.3 billion in 2015, with PrairieSky disclosing that $923 million of third-party capital was spent on its lands.
Breaking down the company’s Encana, Range Royalty and Canadian Natural Resources assets further, the analyst found that PrairieSky’s lands captured about 3.5 per cent of industry activity in Canada.
Since oil prices could climb above US$55, so Bilkoski checked out what the company’s free income would be in a variety of scenarios.
Based on the crude price of US$60 for the following decade, the analyst estimates that PrairieSky could generate $3.6 billion in free income, or $15.53 per share. In this scenario, he thinks that would generated an annualized return of roughly five per cent for shareholders.
In a US$70 per barrel environment, that return climbs to some very attractive eight per cent.
“We are challenged to find fault with PrairieSky’s no debt, no capex, and minimal cash cost business model that depends on third-party spending to maintain (or grow) its production,” Bilkoski told clients. “We continue to believe that the shares offer compelling valuation for investors having a long-term oil outlook above US$55 per barrel.”
