September 09, 2020 - 5:19pm EST by
2020 2021
Price: 3.85 EPS -2.84 0
Shares Out. (in M): 333 P/E 0 0
Market Cap (in $M): 1,252 P/FCF 15 0
Net Debt (in $M): 2,237 EBIT 448 0
TEV (in $M): 3,444 TEV/EBIT 7.68 0

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Seven Generations Energy (ticker: VII) is a Canadian Oil & Gas producer; specifically, the largest player in condensation (mainly composed of propane, butane, pentane and heavier hydrocarbon fractions) production in the North Western Alberta region in Montney and is a rival to Paramount Resources. The crown jewel for Seven Generations in Montney is their Kakwa River project, in which 1.23B was invested over the past 2 years.
From its humble beginnings, Seven Generations was originally financed by private equity investors and morphed into a listed company CEO Marty Proctor has exercised great fiscal discipline in comparison to other producers Paramount Resources, NuVista Energy, Kelt, etc.
Seven Generations has been listed for less than a decade (IPO: November of 2014). Seven Generations lacks Paramount’s mature assets— Seven Generation’s wells have a delineation rate of 45%, which is decreasing every year at a rate of 2-3%. Paramount has mature wells with a 15-20% decline rate, requiring less incremental expenditure. Management is moderating decline rates to make production sustainable.
Liquefied natural gases, such as condensate, is a crucial component for the dilution of bitumen to make dilbit, which enables pipeline transportation of bitumen. Bitumen is the heaviest crude oil used today found in natural oil sands deposits. The oil sands, also known as tar sands, contain a mixture of sand,
water and oily bitumen. In a liquid form, condensate takes up about 1/500th of the volume of conventional natural gas for the same energy output, making pumping and transportation more economical.
A crucial factor in investing in condensate companies in Alberta is supply and demand Condensate domestic demand (Canada) exceeds supply by more than 250,000 bbl per day, which is why Canada imports condensate from the U.S.
Seven Generations accounts for almost a quarter of all Canadian condensate production. As the largest condensate producer in Canada with strategic pipeline opportunities to sell natural gas at favorable prices to North America, and a promise of greater amount buybacks in the future should decline rates go down, and Nest 3 prove an important catalyst Seven Generations has an intrinsic value of at least 14-16 per share or 4-7B in market cap, with an enterprise value of approximately 11-15B (current enterprise value 3.44B), which is 3-5x current worth.

Regions Nest 1 to 3
With 7G leasing about 800 sections and a total of 500,000 net acres of land (Paramount has 2 million acres); 7G has divided land parcels into 3 nest areas
1. Nest 1 is an ultra-rich condensate region with 37% IRR and a capital efficiency of $10,700/boe/day. In Q4 2019, there was a land swap that enables an optimized development plant. IP365 is 750 boe/d.
2. Nest 2 is filled with condensate rich locations, especially the north western portion of Nest 2 it was previously considered part of the Wapiti region with 100 reserve locations converted. At 43% IRR and a capital efficiency of $8,000/boe/day, there are favorable trends in condensate recoveries. IP365 is 1000 boe/d.
3. Nest 3 is a high-Deliverability Natural Gas Weighted Region with 63% IRR and a capital efficiency of $5700/boe/day. With the infrastructure and crossing in 2019 completed with a single super pad/hub which employs a spoke and hub build out, with potential to expand boundaries to the southern gas rich region. IP365 is 1400 boe/d.
* All assumptions for IRR depend on a US 40/bbl WTI, $2.5 Hub, at $3 Condensate Differentials
Seven Generations has an excellent production mix consisting of approximately 60% NGLs & Condensate and 40% natural gas.
Here are 5 reasons why Seven Generations will emerge as a successful producer
1. Manageable debt and financing with a promise of future buybacks
Seven Generation’s management indicated conservatism in their recent earning’s call with leverage— they have reduced debt levels to a range of 1.0x-1.5x debt to cash flow, versus a previous 2.0x. This allows free cash flow to accrue and we can expect future buybacks via NCIB (normal course issuer bid), which is likely when WTI exceeds usd50/bbl.
With 1.1B available on 1.37B (5 year term) of senior secured credit facility (unsecured notes). Seven Generations doesn’t have any near-term maturities as of March, Q2, 2020, 298M was drawn on that revolver to repay some of the unsecured 2023 notes with accordion feature from the earlier conversion which reduced interest rates from 6.8 % to about 2%. Maturity has now been pushed the end of 2024 from mid-2023. 700M at 5.375% is due in 2025.
By avoiding any exposure to maturity issues, and maintaining liquidity on the bank line, Seven Generations will be able to ride through commodity cycles. Seven Generation’s revolving credit facility is covenant based, not reserves based.
2. Maintenance Capex Reduction for Sustainable Production
The desire to reduce debt levels towards the 1.0-1.5x Debt to Cash flow range will naturally diminish maintenance capital expenditureswith an 11% drop in production, this results in Capex down from 1.3-1.7B to 650-800M in 2020; management promises the capex to remain intact even if commodity prices improve. To give you historical reference capital expenditures were 2012280M, 2014920M, 2015 1.35B. This allows Seven Generations to maintain production in the 180,000 boe/day range.
To protect Seven Generation’s balance sheet and preserve drilling inventory, management reduced capital budget by 41% and deferred the start-up of 11 new wells with 65-70 development wells in 2020.
In Q1, 2020 drill and complete costs were about CAD 7.3 million per well, which is 1 million per well lower than originally budgeted for the year, and 33% below the costs for 2017. Operating costs in Q1 2020 were CAD 4.54/boe, about 20% below 2017 levels. Seven Generations completed the wind-down of its 8 drilling rig and 2 completion spread program in early Q2, and commenced an operational pause. Salary and benefits were also reduced.
CEO Marty Proctor said during a recent podcast interview the company's decline rate would diminish by about 3% every year, which will lower maintenance expenditures by CAD 60 to 80 million per year, or CAD 0.98/boe at the midpoint, assuming production remains near the 200,000 boe/day range.
Seven Generations has also maximized efficiency and output through multi-level stacked pads to improve infrastructure utilization with a boost of 50% more inventory per section, and 30% increase in NPV per section and a reduction of 85,000 truck-loads of reduced water transportation. These operating cost efficiencies have given Seven Generations Energy much higher netbacks than competitors in the Canadian oil and gas landscape.
3. Decline rate moderation (40% to 30% by 2022) and diverting capital from Nest 1 to Nest 3 with higher IRR leads to sustainability as a low cost producer
Seven Generations has greater than 80Mbbl/day capacity with more than 60Mbbl/day that is wholly owned and operated with optional access to an additional 20Mbbl/day from 3rd parties is and is able to average half-cycle IRRs greater than 50%.
Seven Generation’s business model has pivoted towards a more sustainable decline rate in an earning’s call, Seven Generation’s management indicated it entered 2020 with approximately a 40% corporate decline rate, with management expecting declines to enter the 30% range by mid-2022 under
its current program. Seven Generations will break-even on a drilling and completion basis at USD 33 per barrel, but declines in to the 30% range could bring it down to USD 29-31 per barrel.
In a low 40s WTI and at a $2.50 per MMBtu price environment with weaker condensate differentials, Nest 3 is the best returning region in Seven Generation’s portfolio. As prices move into the mid-40s and condensate differentials improve to where we are today (September 2020), all regions start to exhibit favorable well economics.
Seven Generations is currently directing capital away from Nest 1 to Nest 3, which is more gas prone. All development activity for the second half of 2020 will be shifted towards the Nest 3 region to lower initial decline rate. While Nest 1 drilling economics have improved considerably, management should be flexible towards production allocations across wells.
In 2019, Seven Generations completed a 120 million pipeline network that connects the southern part, the Nest 3 area, to the core. The lower Montney well on the 10-16-62-4 pad in Nest 3 continues to exceed expectations, with the well continuing to be the best condensate producer on the pad. Overall IP270 volumes of 1,934 boe/d are 12% above the average upper/middle Montney locations on the pad, and condensate rates over the same time frame averaged 506 bbl/d, 39% above the average upper/middle Montney location on the pad.
The encouraging results from the first Nest 3 lower Montney well prompted Seven Generations to add two additional lower Montney wells in the area in 2020 improving the capital efficiency mix due to the high deliverability. Over the next 24 months, further benefits from decline rate moderation will result in another 6% to 12% decrease in total maintenance capex.
When condensate prices are stronger, Seven Generations can always consider Nest 1. Although not as lucrative as Nest 3, Nest 1’s well economics still compare favorably to wells operated by the majority of Montney producers. These wells have an IRR of about 15% and a payback of 3 years at current prices.
As oil prices firm up, the ability to blend more production from the Nest 1 region into Seven Generation’s total production profile is likely to put condensate yields back on track similar to 2018.
Revenue from condensate reached 70% of Seven Generation’s total revenue in Q1 2020 with 69,000 barrels of condensate per day. Given the same equivalent volume, due to higher prices, condensate production brings in higher revenues than natural gas.
In terms of Seven Generation’s internal rate of return for its projects, Nest 2 Wells have an IRR of roughly 40-60% at USD 40-50 WTI and USD 1.8-2.80 NYMEX gas, representing a payback period of 12-15 months. At a discount rate of 10%, the net present value of these wells is approximately 20-35 million.