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Bond market abandons junior oil sands startups

Tags: Bonds, Oil

Southern Pacific Resource Corp.'s (STP.TO) default is being seen in the bond market as a death knell for many of Canada's startup oil-sands exploration companies in the wake of the collapse in crude prices.

The Calgary-based developer was granted protection under Canada's Companies' Creditors Arrangement Act to pursue options that include restructuring debt and selling assets, Southern Pacific said Wednesday in a statement. The company missed a $5 million ($4 million US) interest payment on its convertible debt last month. Fund managers say it's only the first early-stage developer to seek court protection as oil prices hovering below $50 a barrel threaten projects.

"The current situation is certainly dire for many of those companies," Martin Pelletier, managing director and portfolio manager at TriVest Wealth Counsel Ltd., said Thursday by phone from Calgary. "CCAA is usually the very last resort."

CCAA is similar to Chapter 11 of the U.S. Bankruptcy Code. Southern Pacific said it obtained protection from the Court of Queen's Bench of Alberta in Calgary.

Oil-sands companies face some of the highest production costs in the world and even proponents of energy investing are turning away from them after crude prices slid more than 50 percent since June. Saudi Arabia and its OPEC allies refused to curb output of the commodity, triggering the rout that sent crude to $45.99 US a barrel at 9:50 a.m. in New York, almost a 5 1/2-year low.

'BEATEN UP'

The legendary oil trader Andrew J. Hall told investors in his Astenbeck Capital Management hedge fund in a Jan. 2 letter obtained by Bloomberg News that it will be Canadian energy companies -- not U.S. shale -- that will be driven out by Mideast producers flooding the market with supply.

"We don't have any exposure to the sands right now -- the whole sector's been beaten up whether you're a high-cost producer or a low-cost producer," Keith Bachman, who oversees $6 billion US as head of U.S. high yield at Aberdeen Asset Management Inc., said by phone from Philadelphia. He has more North American energy-company bonds than benchmarks suggest, while avoiding oil-sands firms. "No one should be surprised that they're struggling to make money at these levels."

Extracting the thick, gooey bitumen reserves that lie beneath the Alberta oil sands costs $60 to $100 US a barrel, compared with $40 to $80 US for a barrel of shale oil, Bank of Canada Deputy Governor Timothy Lane told an audience in Madison, Wisconsin Jan. 13.

'WASN'T WORKING'

Aston Hill Financial Inc. was an early investor in Southern Pacific but grew wary in 2013 when the company fell short of production targets, according to Steve Vannatta, a fund manager at the firm. Southern Pacific's McKay project last year was producing about 29 percent of the oil the company had aimed to achieve by the first quarter of 2015, based on a December 2013 target, according to Desjardins Capital Markets.

"The project wasn't working -- it was evident even then," said Toronto-based Vannatta, who oversees more than $7 billion of assets at Aston Hill. "The project never even reached a quarter of design capacity."

Southern Pacific borrowed $600 million since 2011, mostly to develop fields in the Athabasca oil-sands fairway, taking advantage of the lowest borrowing costs on record as central- bank stimulus spurred a reach for yield among credit investors.

"You had yield-chasers ignoring the underlying risks, and now we're starting to see the consequences of that," TriVest Wealth's Pelletier said.

IN TALKS

Southern Pacific's $260 million of 8.75 percent notes due January 2018 were quoted at a price of 25 cents on the dollar Thursday, suggesting investors expected to recover a quarter of their principal.

The company is in talks with representatives of its first- lien term loan and holders of more than 75 percent of the senior secured second-lien notes and 50 percent of the convertible debentures, according to the statement Wednesday.

Byron Lutes, Southern Pacific's chief executive officer, didn't respond to a phone message seeking comment.

Connacher Oil & Gas Ltd., which operates in the Albertan oil sands, said Jan. 15 it was seeking a buyer to address problems with its liquidity and capital structure. The company isn't comparable to Southern Pacific because it produces significantly more crude from its oil-sands assets, Chris Bloomer, Connacher's chief executive officer, said Thursday in an e-mail. He declined to provide an update on the company's search for a buyer.

Connacher's bonds have lost more than half of their value in the past three months. The company's $550 million US of 8.5 percent notes due August 2019 were quoted at a price of 31 cents Thursday, down from 66 cents on Oct. 30.

SURVIVING DOWNTURN

Bonds of energy explorers in Bank of America Merrill Lynch's Canada High Yield Index lost 9.8 percent from Oct. 21, the most of 14 industry categories and almost three times the average 3.5 percent decline.

Expansion by investment-grade oil-sands firms will still be profitable because of the long lives of the projects, while junk-rated companies wouldn't be able to generate positive earnings with North American crude at $80 per barrel, according to an Oct. 28 report from Standard & Poor's.

Southern Pacific's rating was downgraded Friday by DBRS Ltd. to D, the lowest possible grade, bringing it in line with Standard & Poor's assessment. Connacher is rated two steps higher at CC by S&P.

"It's all about surviving this downturn in oil prices," said Bachman at Aberdeen. "We sold some of our high-cost producers, and what we're left with are companies with low-cost, full-cycle economics and companies that have liquidity and financial flexibility such that they can survive this down cycle."

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