An oilfield pumpjack, owned by PennWest Petroleum, works on an oilfield amidst fields of ripening grain near Drumheller, Alberta.Larry MacDougal/The Canadian Press
Welcome to the Twilight Zone of budgeting. If the numbers are not working or perhaps volatility is making it harder to make a financial plan, simply delay it, as the federal government has done with this year's budget. Even postpone it until the next year. Now we mere mortals or businesses do not have that luxury, but if you are the Canadian government with a trillion-dollar-plus budget, why not? Our thinking is that this is irresponsible; those in power counter that this will give them better information to prep the plan.
The thing about budgeting is that no matter when the proposal is created, there are always assumptions that must be applied. Perhaps the Minister of Finance should read Benj's best-seller, The Canadian Small Business Survival Guide, now in its 12th printing, where forecasting is presented front and centre. If the mechanics of projecting reads like Chinese to those preparing the numbers, there is also a Chinese edition. Really.
If you want real difficulties with anticipating next year's cash flow, cast a glance to the oil and gas patch. One of the companies that Benj purchased in November that has proven to be his quickest thrashing in well over a decade is Penn West Petroleum. When the corporate budget was presented in November, management crowed about how over $1-billion of asset sales had occurred, important to this highly leveraged enterprise. Over the preceding 12 months they noted how cash costs had dropped 23 per cent and drilling and completion costs had dropped 30 per cent. The dividend of 15 cents per share each quarter was deemed sustainable. The assumptions outlined in a corporate press release were, "... of $86.50 (Canadian) per barrel of Canadian light sweet, $3.69 (Canadian) [per thousand cubic feet AECO natural gas prices], and a Canadian to U.S. dollar foreign exchange rate of $1.04." That was then, this is now.
One month later, recognizing that the suppositions were faulty, rather than avoiding a troubling situation, Penn West faced it dead on and changed their budget. The dividend was slashed to 3 cents a quarter, which will save the company about $160-million. The capital budget was cut from $840-million to $625-million.
Since then, the company has stated that it is in talks with bond holders to seek relief. It is difficult to prognosticate how these negotiations will play out, but the likelihood is that at the end of the day, it will increase the company's cost of capital while negatively impacting the bottom line.
Of course, the fastest relief for the company would be higher oil prices. Over the past decade, this commodity has spent about 60 per cent of the time over $80 (U.S.). Being guys who don't polish their crystal ball in public, it seems reasonable to us that over the next 12 months oil will surpass $65 again. No certainty though.
Penn West was purchased for $4.01 (Canadian). As of midday Tuesday, it was trading at $2.66, up 24 per cent on the day. The initial sell target is $21.44. Given the current state of affairs at the company and the oil price, it could easily take a decade or more to retrace to this level where it was in 2011, if it manages to get there at all.
As an aside, given the pickle that many of our governments currently face with deficits the norm, this seems like an opportune time to raise the gas tax. Perhaps an additional nickel or dime per litre. That would aid their coffers and given the steep drop in prices at the pump, should not cause consumers much angst. Ideally if the price of oil recovers, governments could then reduce their take.
Corporations regularly have to adapt to a changing business climate. Effectively they have to evolve, or sometimes switch operations dramatically, or perish. Penn West is doing just that.