PrairieSky needs US$55 oil for flat production: TD

Energy investors wouldn’t mind seeing production cuts from the world’s leading oil producers such as Saudi Arabia, because this would help reduce the supply glut and hopefully boost prices. They simply don’t need to see the same from oil producers within their portfolios.

That’s why it’s important to track the oil price required for companies to keep production steady.

Aaron Bilkoski did exactly 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 in order for the industry to spend enough to keep flat production.

He came up with the dpi by looking at the historical relationship between capital spend on conventional exploration and development over the Western Canadian Sedementary Basin, and also the cost of crude.

That the relationship between these two variables is robust may come as little surprise, since higher oil prices means more cash can be obtained for reinvestment.

Bilkoski also looked at the proportion of industry spending PrairieSky captures on its land.

He estimates that total industry spending came in at $26.3 billion in 2015, with PrairieSky disclosing that $923 million of third-party capital was allocated to its lands.

Breaking on the company’s Encana, Range Royalty and Canadian Natural Resources assets further, the analyst discovered that PrairieSky’s lands captured about 3.5 percent of industry activity in Canada.

Since oil prices could climb above US$55, so Bilkoski looked at what the company’s free cash flow could be in a variety of scenarios.

Based on the crude cost of US$60 for the next decade, the analyst estimates that PrairieSky could generate $3.6 billion in free cash flow, or $15.53 per share. In such a scenario, he thinks that will generated an annualized return of roughly five per cent for shareholders.

In a US$70 per barrel environment, that return climbs to a very attractive eight percent.

“We are challenged to find fault with PrairieSky’s no debt, no capex, and minimal cash cost business model that relies on third-party spending to maintain (or grow) its production,” Bilkoski told clients. “We continue to think that the shares offer compelling valuation for investors having a long-term oil outlook above US$55 per barrel.”