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O & G Outsider CEO(s)


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Were any of the original outsiders related to businesses dependent so much on price of any one commodity?

 

It is difficult to be an outsider in a commodity based business in my opinion, mainly because being an outsider means having a firm grip on the value of your business relative to the price market ascribes to it. When you don't and most likely can't know where the price of commodity, your business is dependent on, will go, how can you be sure of the businesses intrinsic value?

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The problem with O&G is that even Peyto is forced to sell the product at low prices if the prices crash. I understand when Darren Gee argues that it is time to buy properties and invest when commodity prices is low. This is rational. But that's just one side of the coin. At the same time he is forced to sell the product for crappy prices. There is no option to dictate the price or not to take crappy prices (like Buffett does in insurance - not write losing business).

 

Peyto will survive longer than other companies, but still if O&G prices run up, it would be a sell, since in next downturn the shares will drop (again).

 

And BTW even with the argument "that it is time to buy properties and invest when commodity prices is low" Peyto dilution is nothing to be happy about.

 

Anyway, this is not particularly criticism of Darren Gee. It's a criticism of the industry. Obligatory Buffett quote: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

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Mike rose from Tourmaline. Costs have come down quite a bit as well. Like Pey not too cheap, but huge reserves and they will have a similar cost structure as PEY going forward with the new facilities. A cheap way to buy TOU is through buying PMT shares, they own almost 3x their market cap worth of TOU shares.

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I'm not sure if anyone in the O&G space has the true outsider capital allocation mentality. I actually think in many ways Murray Edwards at CNQ is the best. They never seem to sell anything, but I'd say they're very good at buying low and operating efficiently.

 

Personally, that's my dream job, outsider style CEO of small O&G company. There is so much capital inefficiency in the industry, that someone dedicated to buying only when returns were high AND selling when they were low could make out like a bandit. There are all sorts of weird capital structures (distressed debt, royalties, farm-ins, flow-through shares, etc) that I think there are opportunities for extremely accretive corporate transactions on a small scale. I don't think I'd ever choose to drill anything that wasn't proved, but capturing upside optionality from someone else's spending via opportunistic land purchases and farm-outs (sort of the Altius model) would probably make sense.

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A cheap way to buy TOU is through buying PMT shares, they own almost 3x their market cap worth of TOU shares.

 

Not really so trivial. PMT has bunch of debt, almost no OCF and a bunch of capex. Buying PMT assumes that:

- They won't sell TOU shares low

- TOU will go up

- PMT won't spend the gain to capex and pay off debt

 

It might work, but it's not that they have TOU 3x in their market cap unencumbered.

It is kinda levered bet on TOU as well as PMT treading water with their own properties at least.

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They generated several 100m in the last few years in FCF (net cash after net capex spend). It is a liquidation play of their assets. They have a huge amount of land, and their potential resources are absolutely massive. It seems they develop their resources and then sell it to other companies who can operate them at lower costs. So the upside on their other assets will come from asset sales.

 

For example the size of their land is several million acres. And the debt matures only in about 3-4 years. And costs will come down next year due to the 30m$ gas plant that will increase netbacks. Only reason im in is because of the massive discount really.  And because of Riddell.

 

They estimate NAV of their current resources to be 600m-1b. That is probably somewhat optimistic, but even at like 1/8 of that you will be fine. Then their undeveloped land is probably worth 160m$ (this assumes a really low $ per acre value).

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Mike rose from Tourmaline. Costs have come down quite a bit as well. Like Pey not too cheap, but huge reserves and they will have a similar cost structure as PEY going forward with the new facilities. A cheap way to buy TOU is through buying PMT shares, they own almost 3x their market cap worth of TOU shares.

 

market cap = $100m

value of 6.75m TOU = $200m

value of debt  = $393m

 

 

this is what is going to happen to your TOU shares.

 

Perpetual intends to retain the TOU Shares and systematically manage its debt obligations over time, including redemption of $35 million in outstanding convertible debentures (PMT.DB.E) which mature on December 31, 2015 as well as other debt obligations. The TOU Shares may also be utilized to fund the Company's development plans at East Edson as appropriate and will provide greater financial flexibility to capture and evaluate other new high impact opportunities and pursue strategic initiatives. Relative investment merits will be considered along with other leverage and risk management considerations.

 

not a good way to own TOU. my suggestion to anyone who wants to own TOU. buy TOU.

http://i.imgur.com/QgrFv.gif

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I'm not sure if anyone in the O&G space has the true outsider capital allocation mentality. I actually think in many ways Murray Edwards at CNQ is the best. They never seem to sell anything, but I'd say they're very good at buying low and operating efficiently.

 

Personally, that's my dream job, outsider style CEO of small O&G company. There is so much capital inefficiency in the industry, that someone dedicated to buying only when returns were high AND selling when they were low could make out like a bandit. There are all sorts of weird capital structures (distressed debt, royalties, farm-ins, flow-through shares, etc) that I think there are opportunities for extremely accretive corporate transactions on a small scale. I don't think I'd ever choose to drill anything that wasn't proved, but capturing upside optionality from someone else's spending via opportunistic land purchases and farm-outs (sort of the Altius model) would probably make sense.

Murray Edwards is great. He owns a shitload of stock to boot. He may own the most out of big(er) oil CEOs

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The problem with O&G is that even Peyto is forced to sell the product at low prices if the prices crash. I understand when Darren Gee argues that it is time to buy properties and invest when commodity prices is low. This is rational. But that's just one side of the coin. At the same time he is forced to sell the product for crappy prices. There is no option to dictate the price or not to take crappy prices (like Buffett does in insurance - not write losing business).

 

Peyto will survive longer than other companies, but still if O&G prices run up, it would be a sell, since in next downturn the shares will drop (again).

 

And BTW even with the argument "that it is time to buy properties and invest when commodity prices is low" Peyto dilution is nothing to be happy about.

 

Anyway, this is not particularly criticism of Darren Gee. It's a criticism of the industry. Obligatory Buffett quote: "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

 

What you say is partially true.  They are not forced to sell at low prices as you can shut in your production if you like.  They question is why wouldn't they sell their product when they are the lowest cost operator and are still profitable at current prices. 

 

Turning to the original question, the real outsider of Peyto is the Chairman and founder, Don Gray.  He isn't the most respected person in Calgary, mostly because of his mouth.  The trouble is the what he says about the O&G industry is true.  Some people would like him to shut up.  He stepped down as CEO of PEY in 2006 and let his right hand man, Darren Gee take over. 

 

I would highly recommend reading his Chairman's message (typically 1 page) on the inside of the annual report each year.  He regularly quotes Buffett.  Here is what Don said in the 2010 report.

 

Many companies in our industry try to confuse investors when they talk about production growth. When you look closer and do the math, you quickly discover they are talking in gross numbers, before adjusting for new debt or equity issued to achieve their so-called growth. In many cases, companies touting huge growth actually shrank on a per share basis. Unfortunately, this has been going on for years in our industry. I recall presenting at a major energy conference in Calgary back in June 2002. Two other CEOs had just delivered presentations in which they claimed huge growth numbers. They were outraged when, minutes later, I showed actual results for their companies and Peyto on a per share basis; my presentation completely contradicted what they had just told the audience. I decided that would be the last time I attended the conference as there was just too much noise for investors to really hear the true stories.

 

Companies have a responsibility to communicate to their owners honestly and shareholders should not have to dig deep just to find out how their share of the production, reserves and cash flow has performed. At Peyto we have a long history of treating our shareholders as partners and communicating with them openly and honestly.

 

If you think he is joking, try finding another company in Calgary that reports production growth PER SHARE at the top of every quarterly press release (first bullet point).  So if your worried about dilution, they'll tell you up front what you own as a shareholder on the first line of the quarterly results.   

 

This is also a good article on the history of Peyto, Don Gray, and all the snake oil salesmen in Alberta. 

 

http://www.theglobeandmail.com/report-on-business/rob-magazine/don-gray-is-the-biggest-jerk-genius-in-the-oil-patch/article18280515/?page=all

 

Here is a great quote from that article. 

 

Gray's motivation is twofold. One is recognition for Peyto. A September, 2004, Peyto presentation--72 pages long--features chart after chart ranking Peyto No. 1 versus its peers, all the numbers put together by Gray himself, in contrast to the usual corporate practice of synthesizing work from friendly analysts. But the overarching motivation is a truth warrior's. Gray sees little original thought in the oil patch, just a bunch of people chasing the latest trend. "I see them almost as cowards," Gray says, adding that people become too averse to risk as they climb to the top rungs of the business. "They're quite happy with just being average, being the mediocre....It's hardly my competitors that challenge us. It's more my mouth that challenges us."

 

One outlet for his combative critiques is Peyto's website (peyto.com). "I love the fact that I have a bully pulpit," he says, "where I can educate people....I take a lot of pride in having intelligent people as my investors, as opposed to some of these other guys." His mind jumps to a company (not Progress) that happens to have reported its third quarter on the day we're talking. It boasted of an increase in production of 30%. But on a per-unit basis, it was down 34%, a figure not highlighted. This is common, Gray says. "It really bothers me when people make money that they don't really deserve."

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Steve Williams at Suncor Energy. Look at what he has done since he took over. Suncor has a cash cow asset, accretive shareholder actions, and disciplined capital allocation. It may be a large cap, but it is significantly discounted and misunderstood. Imperial Oil is well run as well. But Imperial is there to serve Exxon's interests in addition to shareholders. Weigh the plusses and minuses, but Suncor is my large bet. That said, I would like to find some nat gas exposure, in some way. I've been sucking my thumb too long on finding a good one. Lots of people like Peyto..but there is a serious premium to their shares compared to some overleveraged peers and Peyto's return on capital appears to be 12-14% over the last few years (given that is a crude estimate). I mean there are coal companies that have earned that in the past couple of years and they are in the shit bucket.

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Gear Energy.  Chairman: Don Gray (of Peyto fame).  Heavy oil specialty. Junior.  Seems to be following the same principles as Peyto.  Trades at about an EV of 30k/flowing barrel.  5500 ish barrels/d. Market cap now around 60m.  Net debt just over 70m and coming down. Still had good cash flow in q1. Nice monthly updates from CEO. Plenty of drill room.  Very good debt adjusted growth and growth per share.  They've held capex substantially in 1st half and are determining what to do in 2nd half  (didn't think it made sense to have the high volume high decline portions of new wells sell into this environment).  Potential capex of around 25m for the year.  Seem to be very rational allocators with costs of about $23/b of oil.  Good hedging with collars that may get them through this very low oil phase. Stock is about 90c now - previously up to $6.  Insider buying in 2nd half of August at around $1.

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FWIW i mentioned Tourmaline earlier, this is Peyto's Don Gray's comment on Mike rose:

What's more, the Rose factor is contagious. "There are a few companies out there that trade at big valuations because of Mike Rose," says Don Gray, the maverick oilman who counts Mr. Rose as one of the small group of other operators he truly admires. "People think someone like Shell will step up and pay an amazing amount for them."

 

http://www.theglobeandmail.com/report-on-business/industry-news/energy-and-resources/an-oil-patch-pitching-ace/article4327845/?page=all

 

And Rose is actually married to the CEO of perpetual energy, Clay Riddell daughter. It seems the three safe ones to bet on are probably Gray, Rose and Riddell in that order.

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Lots of people like Peyto..but there is a serious premium to their shares compared to some overleveraged peers and Peyto's return on capital appears to be 12-14% over the last few years (given that is a crude estimate). I mean there are coal companies that have earned that in the past couple of years and they are in the shit bucket.

 

These off hand comments may sound good but are not true. 

 

Can you please name one coal company that has consistently earned 12-14% on capital in the last couple years?

 

I'll spare you the effort as Peabody, Alpha, Arch, and Walter have all had negative returns on capital for the past couple years, most of them for 3-5 years.  Teck, part of which is coal, has earned 2% on capital for the last couple years. 

 

The average return on capital for all oil and gas companies in Canada is -1.5% for both Q4 2014 and Q1 2015 of this year according to Statscan.  Mining is a positive 3%.  In general, the Canadian oil and gas sector does not make money which makes it tough to have a return on capital

 

Suncor, which was mentioned, will be lucky to earn about 2% on capital this year. 

 

To be fair, Peyto earn 10% on capital last year, not the numbers you quoted, in a tough NG price environment.

 

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Lots of people like Peyto..but there is a serious premium to their shares compared to some overleveraged peers and Peyto's return on capital appears to be 12-14% over the last few years (given that is a crude estimate). I mean there are coal companies that have earned that in the past couple of years and they are in the shit bucket.

 

These off hand comments may sound good but are not true. 

 

Can you please name one coal company that has consistently earned 12-14% on capital in the last couple years?

 

I'll spare you the effort as Peabody, Alpha, Arch, and Walter have all had negative returns on capital for the past couple years, most of them for 3-5 years.  Teck, part of which is coal, has earned 2% on capital for the last couple years. 

 

The average return on capital for all oil and gas companies in Canada is -1.5% for both Q4 2014 and Q1 2015 of this year according to Statscan.  Mining is a positive 3%.  In general, the Canadian oil and gas sector does not make money which makes it tough to have a return on capital

 

Suncor, which was mentioned, will be lucky to earn about 2% on capital this year. 

 

To be fair, Peyto earn 10% on capital last year, not the numbers you quoted, in a tough NG price environment.

 

Alliance Resource Partners and Consol Coal Resources.

 

Suncor Energy will likely earn about 6-7% return this year.

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Lots of people like Peyto..but there is a serious premium to their shares compared to some overleveraged peers and Peyto's return on capital appears to be 12-14% over the last few years (given that is a crude estimate). I mean there are coal companies that have earned that in the past couple of years and they are in the shit bucket.

 

These off hand comments may sound good but are not true. 

 

Can you please name one coal company that has consistently earned 12-14% on capital in the last couple years?

 

I'll spare you the effort as Peabody, Alpha, Arch, and Walter have all had negative returns on capital for the past couple years, most of them for 3-5 years.  Teck, part of which is coal, has earned 2% on capital for the last couple years. 

 

The average return on capital for all oil and gas companies in Canada is -1.5% for both Q4 2014 and Q1 2015 of this year according to Statscan.  Mining is a positive 3%.  In general, the Canadian oil and gas sector does not make money which makes it tough to have a return on capital

 

Suncor, which was mentioned, will be lucky to earn about 2% on capital this year. 

 

To be fair, Peyto earn 10% on capital last year, not the numbers you quoted, in a tough NG price environment.

 

Alliance Resource Partners and Consol Coal Resources.

 

Suncor Energy will likely earn about 6-7% return this year.

 

Alliance - Can you tell me more about this company?  They are the only immensely profitable coal company I have ever seen. 

 

2014 ROCE - 32%

2013 ROCE - 24%

 

Consol - Just like everyone else. 

 

2014 ROCE - 3.2%

2013 ROCE - 1.7%

 

Suncor earned 5.7% on capital last year.  Net profit was $2.7 USD billion.  So far in 2015 they have earned $388 USD million so return on capital will be hardly above zero.  Value line has them earning 2.5% on capital this year and I think that is generous. 

 

 

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Suncor requires some adjustments. The cash flow is what to look at, as earnings can be distorted with exchange rates. I swear Consol's coal segment has higher returns, but regardless, on to Alliance.

 

With Alliance, you have pretty good insider ownership. It is a dual structure, one is the general partner and the other is the LP, both are MLPs. So if you want the full return on capital, going to have to own both.

 

It's kinda remarkable honestly that they have remained so profitable. People seem to discount them because of this, they want to invest in the other coal names because they have a more speculative appeal. Their mines are close to utilities, they are in both the Indian and Northern App. coal basins, which are benefiting from the installation of scrubbers and low cost underground mining. These basins were once thought of being extinct because of EPA regulations. EPA made dirtier coal clean essentially. There mines are very productive and operating margins are very solid. Hence, the strong returns.

 

How you value them is up to you. Currently, about 10% distribution yields, so a significant amount of excess capital is distributed to the general partner structure and LP units. The remaining capital is used for growth opportunities and sustaining capex. They have the ability to pick up additional sales contracts or mining assets with more bankruptcies.

 

The coal market probably doesn't attract the most talented executives, as you bluntly noticed with the many who are flirting with bankruptcy. But, these guys have a pretty good track record. You can order 2009-2014 annual reports and they'll arrive fairly quickly.

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Given the stress in the O&G industry the Outsider CEO's should be busy at work.  I think Darren Gee at Peyto is an Outsider along with Michael Watford at Ultra Petroleum.  Who are your picks in the O&G space?

 

In my opinion, you don't want an "Outsider" CEO that fits the mold of Thorndike's book.  Leverage is a dangerous strategy in the oil and gas space because too much debt means you blow up at the bottom of the cycle, when returns are the most attractive.

 

Ken Peak was a great oil & gas CEO but he passed away.

 

Don Gray owns very few shares in Peyto and Gear Energy.  If you think that actions speak louder than words, he doesn't seem excited about either company.

 

I used to like what Kinder Morgan was doing in it's enhanced oil recovery (EOR) business.  I like the way they communicate to investors- they are one of the few management teams that explain what they're doing and explain the business.  But if you look at the futures curve, most downstream oil & gas assets aren't that attractive.  I think midstream energy companies are more interesting at the moment- the shale boom is driving huge demand for new energy infrastructure like gathering pipelines, wet gas treatment plants, pipelines, (LNG export), etc.

 

but capturing upside optionality from someone else's spending via opportunistic land purchases and farm-outs (sort of the Altius model) would probably make sense.

Contango Oil & Gas / Ken Peak did that in its early days with farm-outs.

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I agree with you if you have a high cost position in O&G but if you have a low cost position you can still produce and reduce debt while others are blowing up.  There is also an aspect of continuous cost reductions in place like Peyto & Gear where they generate profits not by higher sales prices but by reducing costs in combination with production increases on a economic basis.  I was surprised but Peyto is the best performing stock in all of Canada since its IPO based upon increasing cash flow per share more than anyone else.  If you look what was started by Don Gray and continued at Peyto & Gear it is really exceptional.  Right now Peyto is priced at a well deserved premium to other O&G companies but Gear is not.  However, Gear is also in a different market (heavy oil) that some think is high cost but Gear is generating heavy oil at a cost of C$23/boe, pretty low in my book.

 

Packer 

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i tend to agree. gray has been selling his peyto for years. and he does not have a lot of his net worth in gear. and he is not ceo of gear. I believe he spends most of his time looking for the next big "thing". I don't see anything special about gear. yes they seem well run and will be a low cost operator. but after this clean out every survivor that produces oil will be until prices go higher again.

 

one of things I noticed was the prices for gas are far different today than when gray was running peyto. gas prices were way higher then. that's when it paid huge dividends to be a low cost operator. net backs were very large and it paid handsomely to be low cost. with prices high there were a lot of companies that were probably "cruising". not peyto.

 

but today anybody who plans to make even minimal money selling gas has to be low cost operator by definition. it's part of every business plan now. you have to or you are out of business. so the benefits of being the absolute lowest cost operator are not as great as they were when gray ran peyto from 1998-2006, when the value creation at the company was off the charts.

 

here's something interesting that illustrates what happened to gas companies in the last 10 years. peyto was producing 22k boe/d at end of 2005. At end of 2014 they are producing average 83k boe/d. over last ten years the stock has been flat. but they have paid steady dividends. so the economics of the business has changed dramatically in last 10 years. it's just a tough business now. if gas prices go up it changes everything. a lot of gas companies would benefit but it might pay off in spades to study which ng related entities are best positioned if prices do go up. peyto obviously is one to look at if you expect gas to go higher. others are betting on companies like lng.

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I agree with you if you have a high cost position in O&G but if you have a low cost position you can still produce and reduce debt while others are blowing up.  There is also an aspect of continuous cost reductions in place like Peyto & Gear where they generate profits not by higher sales prices but by reducing costs in combination with production increases on a economic basis.  I was surprised but Peyto is the best performing stock in all of Canada since its IPO based upon increasing cash flow per share more than anyone else.  If you look what was started by Don Gray and continued at Peyto & Gear it is really exceptional.  Right now Peyto is priced at a well deserved premium to other O&G companies but Gear is not.  However, Gear is also in a different market (heavy oil) that some think is high cost but Gear is generating heavy oil at a cost of C$23/boe, pretty low in my book.

 

Packer

 

I'll take a CEO who allocates capital wisely and is disciplined with capital. If you read through Suncor's 10-Ks, you'll see how dramatic the change Steve Williams has done changing Suncor from a growth only to a disciplined capital company. Peyto has done a good job to date, but Gear is heavy oil with no operational leverage or scale advantage. Suncor has scale, efficiently, and free cash flow. It is well on its way to increasing production to 700,000 boe/d by 2019. Oil Sands are long-term investments, but Suncor has has integrated refineries to capture Brent market pricing unlike all of its peers.

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I agree with you if you have a high cost position in O&G but if you have a low cost position you can still produce and reduce debt while others are blowing up.  There is also an aspect of continuous cost reductions in place like Peyto & Gear where they generate profits not by higher sales prices but by reducing costs in combination with production increases on a economic basis.  I was surprised but Peyto is the best performing stock in all of Canada since its IPO based upon increasing cash flow per share more than anyone else.  If you look what was started by Don Gray and continued at Peyto & Gear it is really exceptional.  Right now Peyto is priced at a well deserved premium to other O&G companies but Gear is not.  However, Gear is also in a different market (heavy oil) that some think is high cost but Gear is generating heavy oil at a cost of C$23/boe, pretty low in my book.

 

Packer

 

I think most of their low-cost ness is being able to find and develop assets cheaply.  If you ignore their F&D and look at their G&A, it's very low.  Peyto's G&A as a percentage of revenue is around 4%, their peers are around 4-11%.  I think it might be difficult for them to create value by driving down their G&A because it's so low.  To create value, they have to go drill new wells.  Unfortunately, those opportunities will depend on what other people do.  If their competitors oversupply the market and bid too much on land / oil services / etc., then it will be difficult for Peyto to create value.  They'll probably keep finding high-IRR opportunities going forward, but there's a small chance that they won't due to macro conditions outside their control.

 

I feel like the market cap of the stock exceeds what the liquidation value / private market value of the company would be.  Certainly their secondary offering suggests that the shares were overpriced.  I don't feel like paying a huge premium for the company.

 

2a- I think the late Ken Peak is a cut above Don Gray (and Derren Gee).  The stuff in the Peyto letters about 50+ year lives on their wells is a little... misleading.  The longer life only makes a small impact on the NPV of a well due to the time value of money.  As well, assuming a 50 year life on your wells may turn out to be overly optimistic.

 

One of the problems is that horizontal drilling + hydraulic fracturing on low-permeability reservoirs is a new phenomenon.  We have virtually no historical data on how long the well life will be and what the decline curves will be.

 

2b- The metrics that Don Gray used to present in the investor presentations don't fully capture what's important about the business. 

 

In general, I think that every single Canadian oil and gas company has overly-optimistic reserves, including Peyto.  That skews some of Peyto's metrics.  But they don't really explain the reserve estimation shenanigans that go on in Canada.

 

At the end of the day, they're good operators who have joined the party of selling overpriced shares in secondary offerings.

 

Oil Sands

If the current futures strip pricing holds, a lot of these guys will stop producing.

 

I believe he spends most of his time looking for the next big "thing".

 

He's involved with a third company that has been diluting its shareholders via private placements.  It's not publicly-traded.... yet.

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