Are Penn West's Losses Significant?

Strange as it may sound, derivatives -- the very instruments used to hedge against losses -- are capable of turning against oil exploration and production companies. Volatility in oil prices, along with fluctuations in currency foreign exchange rates, prompts upstream companies to hedge themselves against price shocks, which are certainly tedious for investors to understand. Canada's Penn West Petroleum (NYS: PWE) has been the latest to suffer net losses due to hedging activities.

But do these losses reflect much about the company's performance and its potential? I doubt that.

Number crunching
Keeping in mind that the Canadian dollar trades roughly on par with the U.S. dollar, fourth-quarter net loss stood at C$62 million, compared to a C$37 million loss a year ago, with pre-tax losses coming in at C$110 million. However, if we were to remove all items pertaining to risk management and hedging (against exchange rates as well as oil price movements), Penn West actually made a healthy pre-tax profit. Again, out of the total C$266 million in losses listed under risk management, only losses worth C$13 million are realized. The rest are only notional, which means that cash hasn't left the building yet. This gives me hope. Things aren't as bad as it seems.

Gross revenue stood at C$979 million -- a 25% jump from the year-ago quarter. Sales from light oil and natural gas liquids contributed to a huge 75%, up from 70% in the year-ago quarter. Penn West's management has been sticking to its strategy of focusing on light oil plays in the Cardium, Carbonates, Spearfish and Viking regions. And why not? Revenue from light oil and NGLs grew 34%, while their production rose just 2%. The average sales price for this grade rose a substantial 25%, and the company seems to have done a fine job exploiting higher market prices.

In sync with the times
Production-wise, light oil and NGLs grew 2% to 90,185 barrels per day while heavy oil saw a 6% increase to 17,886 bbl/d. Again, management took advantage of a 24% hike in the average sales price for heavy oil and boosted production accordingly.

For the whole year, production of light oil and NGLs increased 6% over 2010, while total production remained flat. The company's strong asset base in the Western Canadian Sedimentary Basin is gradually translating into actual growth.

Promising future
Penn West has moved to full-scale development of the Cardium play and is accelerating drilling in Spearfish. In 2011, excluding asset acquisitions, the company replaced a record 234% of its 2010 production in proved plus probable reserves.

The Spearfish play has five active rigs with the expansion scheduled to be completed in the first quarter of 2012. As a result, production is expected to increase by 13,500 bbl/d. The Carbonates play currently has seven rigs in action.

Foolish outlook
Investors shouldn't read too much into Penn West's fourth-quarter net loss. The bottom line doesn't really reflect the company's actual performance or its potential going forward. Additionally, for investors favoring steady paychecks, it's a consistent dividend payer currently yielding 5%, but quarterly payments have fluctuated in the past. In my opinion, Penn West is worth watching.

In order to stay up to speed on the top news and analysis on Penn West, you can start here by adding the company to your free watchlist.

At the time thisarticle was published Fool contributor Isac Simon does not own shares of any of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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