Peyto Energy Trust

Source: Exec Digital Canada

Date :31/10/2007 03:59:58

A North American leader

How Peyto Energy Trust established itself as a leading natural gas company in North America by focusing on an area where its knowledge is unrivalled

Written by James Buchanen and produced by Jason Wright

While many oil and gas companies talk about maintaining a core area focus, Peyto Energy Trust is a rare example of a company that truly does it. Over its nine-year life, this successful gas exploration and development company has systematically built itself through geographically focused drilling projects. It has stuck to what it does best in a localized area it knows best. As a result, it has become a leader amongst North American natural gas companies; a leader in cost structure and a leader in reserve life of its wells.

Vertical integration

The result, says Scott Robinson, VP of Operations for Calgary-based Peyto, is that the company has been able to offer a sustainable and steady investment opportunity for investors looking for exposure to the natural gas market.The company is a vertically integrated – wells, pipelines, and processing plants – natural gas exploration, development and processing company, which is publicly traded on the Toronto Stock Exchange.

The company is established as a Royalty Trust, which is characterized by the regular disbursement of part of its income in the form of before tax distributions. In the case of Peyto, the distributions amount to approximately 50 to 60 percent of its cash flow. The remaining cash flow is continually reinvested in order to sustain the company and its operations.

These operations are focused in the Alberta Deep Basin, which is a natural gas rich sedimentary deposit in the west central portion of Alberta along the edge of the eastern slope of the Canadian Rockies.

Peyto has focused its efforts on a design, drill and build strategy exclusively for the Deep Basin. The Deep Basin is considered Alberta’s premier exploration area for high quality gas reserves.

As such, the company reports that over the last eight years when compared to competitors such as Conoco, CNRL, Talisman, and Devon, Peyto ranks second in terms of the number of wells it has brought on production, with 548.

“The natural gas that we are producing is contained within very thick and expansive sandstone reservoirs, characterized in their flow capacity as low permeability, which results in a long, long reserve life,” he says. “Our production life is expected to last well beyond 20 years, so an investor in our company has a long horizon in the promising natural gas market that they can count on.”

In total, the company has two main areas of operation both in close proximity (60 miles) and, each with its own natural gas processing plants and extensive pipeline systems. The areas are located 140 miles west of Edmonton, Alberta in the eastern shadow of the Canadian Rockies- with total gas processing capacity of 195 million cubic feet per day.

As to the company’s choice to restrict itself to a very small area of the province, Robinson notes: “We are core property focused in the purest sense.” The benefit of this, he adds, is that the company’s assets – wells, pipelines, and processing plants – are tightly knit, which makes the company’s vertically integrated structure that much more efficient. Further, the company has developed and maintains a significant level of expertise throughout all of its departments.

Low operating costs

Robinson goes on to say that this feature of the company is unique as most of its competitors have spread their operations over a wide geographic area. For example, (according to the following companies’ websites) CNRL has operations throughout Alberta and British Columbia and Talisman’s Canadian operations are spread throughout British Columbia, Alberta, Ontario, and Quebec. This is also true when comparing Peyto to other Canadian energy trusts such as Baytex Energy Trust and ARC Energy Trust.Due to what Robinson describes as the company’s grassroots structure – its decision to drill and build its own assets as compared to the norm amongst Royalty Trusts of acquiring other companies or existing wells – Peyto has very low operating costs when compared to competitors.

According to the same 2007 company report, a contributing reason its operating costs are so low is because it produces from reservoirs that do not have the added cost of water or sour gas disposal. Its wells have relatively high productivity and it builds its own infrastructure to gather, process, and deliver its gas.

The company’s exploration personnel are very talented at applying their geophysical and geological skills to achieve a winning formula. Ken Veres, VP of Exploration says: “We focus our efforts on two or three main gas bearing zones that are vertically stacked. We employ state-of-the-art geophysical software and techniques as well as some of our own home grown concepts and methods to generate our drilling projects.

The extensive multi-zone nature of the area makes drilling a dry hole a rare occurrence.”

The company has also been very involved in developing methods to improve on the efficiency of the drilling of its wells, which in turn helps lower the company’s capital costs.

“Our drilling department has evolved the drilling process by optimizing drill bit selection, drilling fluid chemistry and the use of positive displacement mud motors,” says Robinson. “The result is that we have been able to reduce drill times by one-third to one-half, which is a tremendous accomplishment and critically important over these past few years of escalating service costs.

According to Bryan Lang, Manager of Drilling, “We continually measure the performance of our drilling results. Through application of rock mechanic science and rock-fluid interaction principles, we have been able to refine the process and achieve industry leading results. Performance at the well site is key to the successful application of these technologies. Our site supervisors provide the leadership and skills required to maintain a high level of understanding and ownership in the process right down to the rig floor.”

On the well completion side, Manager Joe Foose also relates to continuous improvement, “Each well brings us a chance to refine and improve upon our methods for perforating, stimulating, and equipping our downhole wellbores. We feel through the repetition of hundreds of wells that we have arrived at optimal processes.”

Low cost structures

The company is able to maintain a relatively low cost structure because its reservoirs contain no sour gas. Instead, the company’s reservoirs are primarily composed of sweet, liquids rich natural gas. Sweet gas lacks the poisonous chemical called hydrogen sulfide which is both hazardous to handle and expensive to process.

“Natural gas is an inherently cheaper product to operate with, and sweet natural gas is the least expensive of the natural gas types,” says Robinson.

Sean Kinoshita, Production Manager adds: “We have a great group of head office technical staff and field operations staff who are focused each day at getting the most out of our wells at the lowest possible cost.”

In all, the company has succeeded at keeping its costs low even as inflationary pressures have forced some increases. For example, according to the 2007 report, when compared to other energy trusts such as ARC, Baytex, and Bonavista Energy Trust, Peyto leads the way by far with the lowest per unit costs amongst all of its peers.

Not only has Peyto hit upon a low cost business model, but one that is sustainable, which is a critical element to any energy trust.

Sustainability in this context refers to the ability of the business to distribute regular cash disbursements to its unit holders while at the same time reinvesting to grow and perpetuate the company and its operations.

Peyto takes an aggressive attitude toward reinvesting in itself to spark growth in the size and value of its natural gas reserves. This makes for a sustainable model that has led the company to make annual reinvestments of approximately $300 million averged over the fiscal years 2004 through 2006, says Robinson.

According to the company’s 2007 report, the company’s “Keys to Sustainability,” includes its unique design, drill, build approach; long track record of high return on capital; long reserve life, high revenue and low operating cost; and consistent growth in future resource opportunities.

As to the future growth of the company, Robinson says the company is not one to acquire other companies or other existing producing wells or assets.

Rather, he says: “We have a strong conviction to continue with the model that has gotten us to where we are today.” This includes continuing the company’s focus on sweet, liquids rich natural gas. “The market, though volatile at times, is very promising in North America,” he says. “We believe our chosen area of the basin offers ample opportunity for continuing the type of development we have been pursuing over the past nine years.”