The big block letters on Penn West Petroleum Ltd.'s 2010 annual report said it all: Full Bore Ahead.
The Calgary energy company, bogged down by debt following its biggest deal, the $3.6-billion takeover of Canetic Resources Trust, had devised an aggressive growth plan to spend heavily on new drilling techniques to tap its huge land position in Western Canada in hopes of sending production and cash flow soaring.
In the end, though, Penn West could not drill itself to success. Production and cash flow lagged expectations. That led to a host of management changes and asset sales in an effort to refocus the company. But now it faces a new problem: the discovery of accounting irregularities in the hundreds of millions of dollars, making it the target of numerous investor lawsuits and clouding its future.
It's been a rough ride for shareholders. Since early 2011, shares of Penn West have plunged more than 70 per cent.
"They just kind of drilled and drilled and they didn't really have the production to show for it," said Laura Lau, a senior vice-president and portfolio manager at Toronto's Brompton Funds.
Some of Penn West's problems can be traced to the poor integration of Canetic, according to analysts and former company staff. The companies had grown through acquisitions during the income-trust era, but the disparate collection of businesses had different corporate cultures and failed to work together in a cohesive strategy. It led to inefficient drilling and unrealistic assumptions about production growth.
Penn West's production has fallen every year since 2008. That squeezed the company's cash flow and left it with a large debt burden.
"That was a tremendous hole to start digging ourselves out of," a former company insider said. Penn West posted a loss of $838-million last year, and its long-term debt stood at $2.29-billion at the end of the first quarter of this year.
The Canetic deal, under former chief executive Bill Andrew, was designed to nearly double Penn West's production to 200,000 barrels of oil equivalent a day. The most it achieved was an average of 189,426 barrels of oil equivalent per day in 2008.
Penn West's output fell despite a drilling frenzy of hundreds of new wells each year that used horizontal drilling and specialized extraction techniques using water and carbon dioxide.
It revealed Penn West's operational weaknesses. For several years before early 2013, it took Penn West an average of 120 days to drill and complete a well compared with an average 40 days among its peers, said Jeremy McCrea, analyst at AltaCorp Capital Inc. Besides taking longer to start yielding cash for the oil and gas, it pushes up drilling costs. In Penn West's case, they could be as much as twice the industry average.
"The story here over the last five years has been the poor capital efficiency. Operating costs got out of control, they had a difficult time disposing of assets to help pay off debt. The overall efficiencies of the company were just abysmal," Mr. McCrea said.
A spokesman for Penn West declined to comment for this story.
Penn West did take steps to address its problems. Under new CEO David Roberts, it set a new course to streamline the company, conserve cash and sell assets. But the emergence of the accounting scandal, revealed July 29, was a new blow to shareholders. The irregularities made Penn West's operating costs appear smaller than they actually were.
"In general, Penn West didn't have a great culture. There had been a lot of turmoil. I knew there were a lot of issues on the engineering side, but I didn't realize it actually flowed to the financial side," Ms. Lau said.
Penn West's current management and directors blamed its accounting problems on former staff. The company said it found $381-million worth of questionable accounting entries in 2013 and 2012, and is reviewing financial statements as far back as 2010. It has forced the company to seek breathing room from its lenders. Penn West on Thursday said it "obtained waivers from the holders of its senior unsecured notes … of certain defaults" tied to delaying its second-quarter results and restating previous filings. It obtained waivers from its bankers earlier this month.
Penn West's accounting problem is the second alleged scandal tied to money.
An investor, in early 2013, alleged in court documents the company manipulated the price of stock options in favour of six former board members between 1993 and 2010. The court filings accuse Penn West of backdating options, which are often used as compensation for directors and executives. Because the backdating allegation includes 2010, and the financial review stretches back to the same year, it is possible the company was manipulating options at the same time as it was using questionable accounting practices that year.
Meanwhile, Penn West continues to auction assets in an effort to pull itself out of financial trouble. But, again, history is hurting this process. Penn West at times in the past decade bought assets in order to push its numbers closer to the targets it had set. Those properties, including some acquired through the Canetic takeover, often came with heavy decommissioning liabilities.
The liabilities, which are the highest in the Canadian oil patch for a company its size, means companies now considering buying Penn West's assets must account for those risks, Mr. McCrea said. Penn West "hasn't been getting top dollar" for the assets because of the decommissioning liabilities, he said.
Over recent quarters, Penn West has brought down costs and sped up the time it takes to get wells producing oil and gas.
"If they could have continued the momentum, things would have improved," Mr. McCrea said.
"But now they've got the accounting scandal that's going to plague the company for a long time," he said. "When you're selling assets that have all these decommissioning liabilities attached to them, you're not getting good prices. But you have to sell them because you're breaching your bank covenants. This is where things unravel very quickly. Who knows where the bottom of the share price could be?"