A Bleak Update on Tourmaline Oil Corp. (TOU)

This summer CMR published a report on Tourmaline Oil Corp (TOU). We showed that the company sucked up cash harder than a black hole and becoming economically viable was nigh mathematically impossible.

Their strategy has been nothing more than bigness. They were not building a strong company and making acquisitions with internally generated cash, Instead, they gobbled up the proceeds fed to them by fanciful underwriters to buy assets so they could constantly trumpet record production numbers and drive up the share price. While Tourmaline’s C-suite speculators kept devouring funds with their capex and M&A binge, they were striving for a Hail Mary liquidity event when some bigger E&P company would hopefully buy them at a nice valuation.

The company just released its Q3 results and has only provided further support to this thesis. Tourmaline is still spending too much money with little to show for it. CMR analyst Daniel Plainview provides us with an update.

Tourmaline Oil Corp.; Q3 Update

A follow up from the quill of Daniel Plainview, Esq.

It has been a number of months since I took to this forum to share with the fine readers the patent market absurdity that is Tourmaline Oil.  While its shares have fallen since the summer (about 30%) this is by no means out of line with the declines of other Canadian oil gas companies.

Recently another quarter of financial results was announced, so perhaps it is a good time to see if this company has finally made a dollar.

tourmaline update

Nope.

(Also note that we have updated the chart to now include proceeds from asset sales; technically a positive cash flow item, as asset acquisitions would be negative. Not that it matters much.)

In the six months of new financial data we can see that Tourmaline continues to outspend what it takes in, in an effort to grow production (to lead to more of the same?)

Cash flow from operations were together another C$ 412 million, but spending (net of $0 new asset sales) was C$ 719 million.  Free cash flow was therefore -C$ 307 million for the last 6 months, bringing the grand total money pit to ~C$4.35 billion since 2009.

A positive development might be that it appear the company is now aware that they cannot promulgate cash flow and earning figures without the accompanying capital expenditures that drive the production.  In their October 14th press release they have budgeted free cash flow projections for 2016 and 2017.  In a low gas price scenario they free cash flow will be ~C$45 million followed by ~C$167 million, and in a high gas price scenario free cash flow will be ~C$103 million and ~C$414 million.

So hypothetically, at the high price scenario, investors might see positive cumulative free cash flow some time in the 2020s, but I won’t hold my breath.

Also worth noting is that the low gas price scenario assumes a median C$3.25/mcf price for Alberta natural gas.  Presently it sits at ~$2.40/GJ (or ~$2.53/mcf); so they only need their base commodity price to go up 28% too.

This is a company that grows production at any cost and has never had an economic business model.  It requires constant issuance of new shares and cannot maintain growth on a per share basis if valuations drop.  It is a house of cards waiting to fall.

It’s enough to make Tourmaline shareholders sweat.

Advertisements

Anyone Who Hates Fossil Fuels Is Anti-Human

aaa1Sources: Boden, Marland, Andres (2010); Bolt and van Zanden (2013); World Bank, World Development Indicators (WDI) Online Data, April 2014

Market Lemmings Case Study: Tourmaline Oil Corp.

The fall in oil prices is starting to expose some of the waste in the energy sector, but this central bank fueled bubble is still rife with clusters of error.

The ‘boom’ phase of the business cycle — more accurately described as the malinvestment phase — is where a lot of things just stop making sense. People will shovel money into wasteful investments based on distorted credit conditions and hyped up expectations.

Today our case study is Tourmaline Oil Corp., a favorite in the independent energy growth company category. With a 52-week high of $58.73, the consensus analyst rating is “buy” while presently trading around $39 at 18x earnings. It recently issued $168 million in new shares (at $39.50/share).

CMR analyst Daniel Plainview shows why Tourmaline is an economic black hole relying on the “greater fool.” Regardless of whatever distortions manifest in the stock market, Tourmaline is its present form is a zombie company — not an investment, but just one of many ways to gamble in the stock market casino.

A Question for Tourmaline Oil Corp.: How Do You Make Money?

By Daniel Plainview

When trying to determine the proper price of a stock the conventional rule of thumb is to predict the amount of money that stock is going to make each year over the long term, and then discount those earnings to the present at an appropriate rate for the risk you are taking.

The inverse of this, but it is in essence the exact same methodology, is to use a Price to Earnings ratio to evaluate a stock. The higher the ratio, the more expensive the stock; the lower the ratio, the more likely you are getting a good deal, so long as the future earnings hold up.

But what if the stock you are looking at is in an industry that typically doesn’t make any money?  I’m referring to industries where the company earnings are often affected, to a large degree, by depletion expenses.

Depletion is a non-cash charge and it can ensure that a company generates plenty of cash flow but renders the conventional Price to Earnings analysis moot. Industries with high DD&A (Depletion, Depreciation & Amortization) are generally involved in resource extraction.

Because earnings are essentially meaningless for a lot of resource companies (not to mention the other accounting tricks that can affect earnings) it’s always a good idea to look at a company’s cash flows.  There are three types of cash flows:

  1. Cash flows from operations
  2. Cash flows from investing
  3. Cash flow from financing

While in any given period the cash flows in any of these buckets can be either positive or negative, over the medium to longer term (2+ years) one invariably wants to see that cash flow from operations is positive, cash flows from investing is slightly negative, and cash flows from financing is also negative; with the change in cash position from period to period being immaterial.

What a positive/negative/negative cash flow segmentation is indicative of is 1) the company is making money, 2) that it is reinvesting in the business to grow the business, and 3) it is able to return capital to the shareholder, or at least doesn’t steadily require new financing to fund its investments.

It is with this in mind that we now consider the Canadian oil and gas industry.

Recently the commodity prices that drive the cash flow from operations that Exploration and Production (E&P) companies generate took a tumble.  Both oil and gas prices fell by ~50% from their levels in the first half of 2014.

By itself a single year of lousy prices shouldn’t erode as much value in the markets as what occurred, but what changed is the market is now more pessimistic about prices for all future periods too.

Companies have responded by scaling back their investing, and cutting capital expenditures for the drilling of new wells and building of new facilities.

Generally speaking, oil and gas companies always have to be spending some money on new production in order to maintain overall production levels.  Well performance declines over time, and by how much depends a lot on the geology of the particular “play”.

A really good well might only decline at ~20% per year, but it still declines.  Newer unconventional extraction methods (drilling horizontal multi-stage frac wells into shales) can come down a lot faster: ~50% per year.

So ultimately the goal of any oil and gas company, in any environment, is to have enough cash flow from operations that it can pay for all the cash flow from investing (capital expenditures needed to keep production up), and still have enough left over to pay the shareholder.

Enter Tourmaline Oil: the oil company that has 85% of their production coming from natural gas.  Etymology aside, there are more serious issues with this company’s business model.

In their last earnings announcement in March, they happily proclaimed their 76% growth in cash flow. Sounds good… but wait! There is a footnote: “Cash flow is defined as cash provided by operations before changes in non-cash operating working capital.” So what about capital expenditures?

Here is a chart of Tourmaline’s cash flows, going back to 2009:

tourmaline

The cash flow from operations is in green, and the company’s capital expenditures (only a sub-set of cash flow from investing) are in red.  The black line represents the cumulative amount of cash flow from operations minus capital expenditures (or Free Cash Flow) up to each period.

What this shows is that Tourmaline has spent almost $4.7 billion more on drilling holes in the ground, than it has made from the hydrocarbons those holes have produced, since 2009.  Furthermore, over 25 quarters of results, they have never made more money than they spent: Free Cash Flow has never been positive.

In the company’s defense, they have grown production at an industry-leading rate.  But it really looks like they’re spending a dollar to make fifty cents, and making up for it on volume.

It has gotten to the point where if the company stopped spending money, but continued to earn cash flow from operations (and let us assume the same prices and only a 20% production annual decline), they could not make that money back.  In actuality Tourmaline’s wells probably decline a lot harder than 20%, but the story is bad enough as it is.

These harsh realities force us to ask the question: where did the company get $4.7 billion?  The answer is that they got it from new investors who bought shares in secondary offerings, and some money from raising debt.  It looks as though this external funding process will have to continue ad infinitum; another secondary offering being announced just recently for $168 million.

And investors should keep this in mind: the only reason Tourmaline is able to grow production on a per share basis is because the shares have a decent valuation, but the only reason the shares manage to eke out a decent valuation is because they are able to grow production on a per share basis.  If the shares were to fall enough in price, the amount of dilution created by external financing would make it impossible for the company to grow.

And the last point to make about the company: the management team in prior iterations at Berkeley and at Duvernay were able to successfully build up and then sell the company to a bigger fish.  Duvernay in particular made a lot of people a lot of money as it was sold at the height of the commodity boom in 2008 and Shell paid an unmatched valuation in the transaction (~27x EBITDA).

In fact, the only way Tourmaline’s business model makes any sense is with an M&A exit strategy: ramp up production at any price, and find a sucker to buy it just before the house of cards collapses.

But if investors are assuming Tourmaline will be similarly sold I would only point out that Tourmaline is now worth about $9.2 billion and is the 8th largest E&P company by market capitalization in Canada.  It’s getting to be too big for others to swallow, and suckers like Shell might be hard to find this time around.

Then again, they did just find another 4.25 million suckers…

(Click here for supporting calculations.)

Chinese Slowdown Puts a Drag on Energy Markets

Oil is the world’s most important commodity. Its market provides a good indication of where the economy is going.

The price of oil fell for five days before jumping today because of strong consumer confidence numbers in the US. The push down had been largely due to news from China.

Chinese manufacturing activity fell in May after months of slower growth. Its PMI hit a seven-month low of 49.6. A value below 50 indicates a contraction.

Oil consumption in OECD countries has fallen the last few years. In the rest of the world, it is has grown. The biggest of these consumers is China.

China is the world’s major exporter of manufactured goods. The decline in manufacturing activity implies the world’s slowing demand. This in turn will result in a reduced demand for energy.

China is a major factor in the marginal demand for oil. The oil price is not set by speculators, but supply and demand. Producers pump as much as they can. Chinese demand — in no small part driven by radical monetary expansion — is largely responsible for the boom in oil prices, from $20 a barrel in 2001 to current levels.

Chinese slowdown will cause oil prices to fall. When the economy is growing, oil prices rise because there is greater demand for energy. Prices fall when demand falls. This is elementary economics. The price of oil will decline.

— Read more at Marketwatch

European Union Wants to Tax Heavy Crude from Oil Sands

The European Union is falling apart. It is desperate for money. The bureaucrats in Brussels will tax anything they can.

Now the EU wants to modify its fuel quality directives, so that refiners who use oil that is “too dirty” (according to bureaucrats) must pay a tax.

Joe Oliver, the Natural Resource Minister of Canada, thinks this amounts to specifically targeted tax on Canadian oil-sands product. He says Canada will sue the EU at the World Trade Organization if they implement the changes, because the oil-sands crude isn’t any “dirtier” than many other crude imports which are not subject to the tax.

Firstly, let me note the hypocrisy when an official from Harper’s government whines about tariffs, while Harper’s government loves tariffs. “Oh yeah, taxing our stuff is bad; taxing your stuff is okay.” Typical government knavery.

On a more general level, yes the EU fuel quality directives and its associated penalties are bad for the economy. They are bad for Europe and bad for Canada. They reduce production of the taxed good and divert resources to government approved fuels. The government is in principle incapable of knowing to what extent a given quality of oil should be used.

Oil sands production is “dirty”, sure. The industry has a lot of flaws. Really, the CO2 emissions aren’t even a big deal, although that’s what everyone focuses on. But the environmental situation is still very screwed up, because Alberta is essentially a mini-petro-state. Property rights and laws of tort can rarely protect the environment because virtually all the pollution takes place on government land.

Even so, that is true of most oil. There is very little “clean” oil where you just turn on the tap and get light, sweet, succulent crude with minimal impact on the earth. Most of it is heavy and sour and difficult to get. Due to inept government regulation and interference with property rights, its production is environmentally problematic. So the European tax seems to be not just destructive, but arbitrary.

If the WTO agrees with Canada that the fuel directives constitutes an unjustified tax, they can’t force them to change it. It just means the Canadian government can put their own tariffs up to retaliate. That is bad for everyone. It would be better to just accept one dumb tax over which one has no controlnthan implement another dumb tax to go along with it. If the Canadian oil producer finds it harder to sell its oil, that’s already bad enough. Why should the Canadian consumer also be punished? It makes no sense, and only a politician or a shyster would advocate this.

Read more at Market Wire

TSX Loses All Gains for 2013

The Canadian stock market was hit pretty hard as oil fell and gold got hammered. At the close, gold was down nearly $75 USD. The TSX lost all of its 2013 gains over the last few days.

I have predicted that North America will face recession this year, so a falling TSX is consistent with that. An economic correction is especially hard on capital goods industries and raw materials.

I also believe it is a reasonable expectation for gold to fall to $1200-$1300/oz as the economic error cycle matures. Then, when a panic hits, and Fed and other central banks will respond with further inflation, and the gold price will rise in response to that.

A commodity broker says: “the argument for gold as a safe haven or protection against inflation just isn’t there . . . It doesn’t look too good for gold.” This assumes there another crisis will not occur, and central banks will not inflate in response. At some point central banks will have to stop inflating to prevent currency collapse and preserve their nations’ banks, yes. Yet, I do not think that time is nigh because we have not yet seen massive consumer price inflation result from the monetary expansion since the ’08 financial crisis.

Read more at Financial Post.

Ron Paul in Calgary

Last Friday, I attended the Ron Paul speech at the “Making Alberta Safe for Capitalism” summit.  This was at the Westin Ballroom in downtown Calgary. I was among approximately 300 attendees, which included financial professionals, publishers, IT nerds, engineers, students, neocons, and more.

I would like to note how this attracted virtually NO media attention. I do not think there is any “conspiracy” here — rather, it is simply due to Ralph Klein’s memorial service being held at the same time. We all know how the media loves to fill its time with the glorification dead politicians whenever the opportunity presents itself. This week, they’ve got Thatcher.

Besides, Ron Paul’s ideas make Canadians uncomfortable. Most people don’t want to talk about such things.

Ron Paul’s speech was basically what you would expect if you’ve been following him for the last few years. I’ve been watching Ron Paul’s political career since 1998, so I was very familiar with all the themes: personal responsibility, free markets, small government, anti-war, and anti-central banking. Still, it was great to pay respects to someone who is more than just an honorable statesman (a contradiction in terms when applied to anyone else), but a man whose efforts have done more for the liberty movement than anyone else in the modern era.

Having retired from politics, this was Ron Paul without any filter that might have previously been imposed by the realities of being in political office. Yet since his message has always been fundamentally radical, there was no difference with post-politics Ron Paul. The message is just as unfavorable to economic, social, and imperial intervention as ever.

At various points throughout the speech, I would look around to gauge the response to certain statements. How delightful to see various attending neocons squirm uneasily when Paul declared there should be no income tax. Some folks scowled at the suggestion to replace government welfare entirely with private charity. Otherwise, the ideas of less spending, less tax, less regulation, and more civil liberties were received favorably. Paul age and manner makes is a kind, wise grandfatherly figure — part of his great success is due to his ability to convey radical arguments in favor of liberty while making them seem completely non-controversial.

The biggest opportunity that was missed in Dr Paul’s speech was HEALTHCARE. If there is a sacred cow in Canadian politics, it’s definitely government healthcare. Without a doubt, government healthcare is a disaster, and Canadians need to learn why it will always be awful regardless of the huge piles of money thrown at it. Unfortunately, healthcare was not covered at all in Dr Paul’s remarks. Too bad. Huge missed opportunity, I think.

He is a medical doctor and an economist who can speak with authority on the failings of public healthcare. He is also old enough to speak about American healthcare system before the government became heavily involved. Before Medicaid, Medicare, the HMO Act of ’73, and so on, there was relatively little government intervention with the provision of healthcare. Basic medical services were cheap and plentiful, and a greater portion of the population had health insurance compared with now. The audience would have greatly benefited from hearing his insights on this subject. He has effectively explained the necessity of free markets in medical care — it is a message Canadians desperately need to hear from somewhere. Virtually no one will touch the issue of public healthcare in this country. We will all be worse off as long as this condition persists.

I would have also liked to hear more war-related remarks. Essentially, anything that applies to the US wasting lives and money on Afghanistan applies to Canada as well. Paul spoke about Iraq more than Afghanistan — which is fine in and of itself, but Canada was not seriously involved in Iraq. Our participation in Afghanistan is another story. Sadly, Afghanistan is an issue that people barely seem to care much about. If they do, it’s because they are dumb enough to think we have Canadian forces there “fighting for our freedom.” Yuck. The lack of interest is even more critical now, because Obama has declared he is “bringing the troops home” in 2014. This is typical government strategy: declare “victory!” and suddenly no one cares anymore. Just like Iraq, where there was never any “victory”, and as I write this the country continues tearing itself apart.

Ron Paul’s speech included a few “fanservice” parts for the Calgarian audience:

He said, “Ralph Klein sounds like a guy I might have liked.” Fair enough, given the memorial was that day, and Klein actually did cut spending at one point.  So that’s cool, whether or not Klein was a principled friend of liberty.

He also gave his support to the Keystone XL — with the important qualification that one can get the permission of property owners, the government should not stand in the way of pipeline construction. This is an rather critical proviso, because in reality pipeline construction does involve government takings/expropriations. Remember: in Canada, the Crown owns all the land as a matter of law.

Anyone who attended this event specifically for Ron Paul could be described as “cutting-edge.” Canadians are not generally ready for the radical Paulian message. For many Americans, there is the emotional connection to ideas of independence, revolution and decentralization, even these are not embraced in practice. The Paulian message can get its hooks in that. For Canadians, the state is endlessly glorified in subtle and not-so-subtle ways. There is no element within our culture that reinforces skepticism about state power. The closest thing to this is Albertans’ memories of the NEP, but that is a regional sentiment and it is being gradually overwhelmed with the pleas for more government.

I hope that the mere fact that Ron Paul has visited Canada to give pro-capitalism speeches indicates that there is a growing audience for the message of liberty in this country. Just as the 20th century demonstrated communism was a lie, the 21st century will show us that democracy is a lie. Democracy’s death throes will be earth-shattering. Liberty’s natural elite must spread and shine the light through dark times, so that a better age may yet emerge.

%d bloggers like this: