Penn West: going horizontal in Western Canada's large oil plays

All photos courtesy of Penn West.

OIL & GAS FINANCIAL JOURNAL: Penn West Energy Trust is the largest conventional oil and natural gas producing income trust in North America. Recently however, you have talked about adopting a hybrid model with an even greater emphasis on development. Can you highlight the rationale behind this shift?

BILL ANDREW: To answer this question most effectively, it might help to provide your readers with a little background on Penn West. To start, we are the largest conventional oil and gas trust in North America and the largest producer of light and medium gravity oil in Western Canada. We have roughly seven million acres of land both developed and undeveloped, and to date, we have eight billion barrels of original oil in place spread across four oil resource plays.

As we work our way through the final months as an income trust, the most prudent approach to capture value and deliver strong returns to our shareholders is the adoption of a "hybrid model". The hybrid model would incorporate both a growth component and a dividend paying element for our shareholders. What's different now is the growth component.

Traditionally, trusts have grown by way of acquisitions, using their cost of capital advantage to acquire producing properties. Penn West Energy, however, has the reserves and the resources to grow from the drill bit and through conventional development activity from our high-potential resource plays. While we will remain opportunistic with regard to acquisitions, we believe in a balanced approach which includes leaning on the drill-bit to add reserves and production.

While we started as a conventional E&P company in 1992, we have operated as a Trust since 2005. Due to a new Canadian trust tax being implemented in January 2011, we will convert back to a conventional, exploration and production corporation. We hope to complete the transition by the end of 2011.

We estimate that our hybrid model will deliver a targeted total annual return of approximately 10%. The 10% annual return is comprised of growth through the drill-bit, as well as a yield component. As we transition from a Trust model to a conventional structure, we anticipate that our high-potential resource plays will deliver returns that will enable us to further reduce the yield component by allocating more capital to higher-return resource development projects. The target in an ideal model would see us at about half and half where we would have a yield of 3%-7% or 4%-6%, and the other side would be complimented by growth to get a total return of about 10% per year.

OGFJ: Penn West is the largest producer of light and medium oil in Western Canada and ranks second in light and medium oil reserves. Approximately 90% of the wells in 2007 were vertical. Now however, nearly 80% are horizontal. What prompted the shift in drilling and why hasn't it occurred sooner?

ANDREW: A fundamental change in technology prompted our shift. For example, while the horizontal multi-frac technology has been widely adopted throughout the US, we've only recently implemented it here in Western Canada. As a result, a radical transformation has taken shape in the Western Canadian Sedimentary Basin and in particular, at Penn West.

In 2007, 90% of our wells were vertical wells. Now however, nearly 80% of are wells are horizontal. This transformational event has led to stronger economics, improved recovery rates and overall enhanced efficiencies.

As point of fact, the economics will allow us to replace seven to eight vertical wells with one horizontal. That equates to a 25%-50% reduction in costs compared to the traditional vertical wells that we would have to drill to generate similar production results.

OGFJ: What are the economics on your current plays?

ANDREW: This is the game changer. Projects that were previously in the low double digits return, say 10% or 15% return on investment, now have the ability to drive returns of 30% to 40% to 50%. That is the biggest change.

In areas where we drilled 40 wells and have the knowledge and experience, we are seeing recycle ratios of 2.5 and return on investments of over 40%. We are still trying to reduce front-end drilling costs and adopt better techniques in some of the newer wells. Those near term returns would probably be in the 25% to 35% range; still very good.

The gas side is a little lower. We've been concentrating on two things—1) exploring our big hit gas plays looking for good accumulations and good flows in areas a little more remote; and 2) particular plays in the northern, developed or semi-developed oil and gas fields in Canada because of the cost and the current price of gas. Now we are going into fields we have held for a while that are in need of in-fill drilling and need a higher well density, and using this technology to drill cheaper wells. At CDN$4.50 or CDN$5.00 gas they're competing quite well with the oil prospects. In the more mature gas fields we have tremendous infrastructure. You usually have 30% or 40% of the cost of your project associated with infrastructure; as it's all built, we avoid those costs, thereby improving the overall associated economics.

OGFJ: What percentage of your 2010 capex budget is allocated toward oil and where specifically will it be deployed?

ANDREW: Approximately 90% of our 2010 development capital is allocated toward oil. In two primary areas and two development prospects – The Waskada Field in Manitoba; and the Dodsland Pool in Saskatchewan. These two primary areas could represent as much as 250 million barrels of incremental upside. In addition, the two development prospects; the Cardium field and a series of carbonate plays north of the Cardium in Swan Hills, are bigger from a resource potential but lack the kind of horizontal multi-frac well development of the other two. These two areas could represent additional upside potential of more than 500 million barrels assuming modest incremental recovery.

We anticipate a budget between $750 and $900 million for 2010. The extra $150 million, if it comes into play, would be channeled toward the last two projects as we look to accelerate their development. We believe these two projects in particular represent enormous upside potential. In fact, either one of these plays has the near term potential to eclipse the work of the Waskada, or the Dodsland Fields.

OGFJ: Current forecasts have Penn West drilling 100 wells in 2009, 250 wells in 2010 and 500 wells in 2011. How will you fund this aggressive drilling program?

ANDREW: Funding will be secured through a variety of channels. Starting in 2010 and into 2011, a growth component from our existing projects will provide a portion of the required capital. Improved efficiencies and lower overall costs will result in significant saving measures that will provide additional revenue. I believe that our aggressive drilling program has the potential to result in as many as 500 wells being drilled annually, within the next five years.

If you look at the potential, particularly in the larger fields like the Cardium trend, we'll have an opportunity to drill thousands of wells that will deliver strong economics and positive results for years to come.

OGFJ: Penn West has identified approximately eight billion barrels of Original Oil in Place net to your interests. What geological risk accompanies the development of these reserves?

ANDREW: The geological risk is minimal. Nothing that we've uncovered from a geological point of view frightens us. The risk is almost entirely technical, which, in the oil and gas business, is quite different from geologic risk. Technical risk involves factors such as: a horizontal multi frac technique that (a) allows us to positively align our cost structure, (b) determine the direction of the wells, (c) the life of the lateral part of the well bore and (d) the special density of the completions to gain consistent results. Our plays have several productive zones. The challenge is determining the most effective approach to generate consistent returns. Once that methodology is determined, we begin the process and proceed accordingly.

The zones we're looking at have good aerial extent. We have control from some older, vertical wells and we do not have concerns like excessive gas, excessive water, or other things that I worried about the first 35 years I was in the business.

OGFJ: Penn West Energy is in the process of making the transition from a Trust to a corporate structure? Where are you in this process?

ANDREW: We've recently taken significant steps toward a conventional E&P structure. We've added to the staff over the last year and a half. Our president and COO, Murray Nunns has recruited senior explorationists, engineers and strengthened our teams.

Our emphasis on horizontal versus vertical drilling indicates our strong commitment toward growth through the drill-bit, as well as our commitment toward completing this transition. Our large portfolio of projects, which we narrowed down to a 'basket' of 10 high-potential resources plays that contain more than eight billion barrels of original oil in place, is a positive reflection of our increased focus on projects that offer significant upside potential. On any given year, we'll focus on four or five of them.

In addition, another new aspect to Penn West is our new technical clout. While we have always had the economic clout to do something; we now have the technical clout to go after the resources we possess. We have the human capital. We have the technical experience. And we understand the processes and procedures required to successfully develop and exploit our plays.

"I believe our land position of nearly seven million acres and our push to implement our newly-adopted horizontal technology will allow us to make a smooth transition to a corporate E&P structure."— Bill Andrew

OGFJ: How will this transition benefit existing and potential new shareholders?

ANDREW: The trick is to go back to our targeted returns. We're getting back to an area where Murray and I have been very comfortable in our careers - trying to achieve consistent results and growing assets, reserves, and production. We will look at our opportunities and we will target a total return. If the best solution is putting a bit in to the ground, then that is what we will do. Our strength in light oil will continue. New shareholders will come into a company that will have a call on most of the light oil in the Western Canada Sedimentary Basin. The opportunity and potential for growth for new and existing shareholders is enormous.

OGFJ: What are the primary growth catalysts for Penn West in 2010?

ANDREW: Our identified growth catalyst is in the light oil plays. This catalyst provides us with more than eight billion barrels of original oil in place. Moreover, implementation of an aggressive horizontal drilling program is resulting in improved recoveries, reduced costs and stronger overall economics. That said, our projections for growth in 2010 are fairly modest, due to the trust-corporate transition. However, as we move into 2011, 2012, and 2013, the focus will change. We will use new technology to develop the resources currently identified. We will initiate a more aggressive drilling program and we plan to deliver stronger overall returns.

We are confident that the technology used today can take us to places of greater significance tomorrow. That being said, the exploration and exploitation opportunities going forward could result in an even greater upside potential.

OGFJ: What additional comments would you like to share with our readers?

ANDREW: We have extremely good knowledge of the rock in the basin, a tremendous technical staff, and a prudent financial team. Following two extremely large acquisitions over the past few years that doubled the size of the company, we have worked extremely hard to successfully strengthen our balance sheet. Penn West has met its guidance and its targets throughout 2009 which has been a year or turbulence in the markets, in particular commodities. We have now put the large acquisitions behind us and will exploit historical resources that have been Penn West's for years—primarily light oil and our large potential plays.

Lastly, as horizontal drilling spreads through Canada, access to land is holding numerous companies back. Many Trusts looking to convert to a corporation are encountering limitations on land. If you look at our land position and some of the big plays people talk about, we have the dominant positions in many of them. As Murray likes to say, 'the easiest oil to find is in the stuff you already own.' I believe our land position of nearly 7 million acres and our push to implement our newly-adopted horizontal technology will allow us to make a smooth transition to a corporate E&P structure.

More Oil & Gas Financial Journal Current Issue Articles
More Oil & Gas Financial Journal Archives Issue Articles
View Oil and Gas Articles on PennEnergy.com