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Oil Sands Dream Evaporates With 40% Bondholder Loss Seen

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Aug. 25 (Bloomberg) -- Southern Pacific Resource Corp.’s failure to find a buyer may leave bondholders struggling to recoup little more than half their investment as the Canadian oil-sands energy explorer burns through cash.

The Calgary-based company’s 8.75 percent notes due 2018 dropped 10 cents today to 63 cents on the dollar. Desjardins Capital Markets analyst Justin Bouchard estimates the notes are worth 57 cents, based on the company’s assets. Raymond James Ltd. analyst Chris Cox projects Southern Pacific has six months before exhausting its remaining C$34 million ($31 million) of working capital.

“Names like Southern Pacific, we call them hope trades -- we don’t like to fund dreams,” Jie Liu, head of credit at Sentry Select Capital, said by phone from Toronto Aug. 22.

Liu said he sold the bonds within months of buying them in January 2013. “At the very beginning we were actually involved. Then when we took a second look at the company we just don’t believe the story presented to us.”

Southern Pacific’s case highlights the risks posed by bonds from oil-sands companies that borrowed in the early stages of development to foot escalating project costs. Investment in the oil sands from China has cooled amid limits on purchases by state-owned enterprises and souring bets.

Bidders Sought

Byron Lutes, Southern Pacific’s chief executive officer, said analysts’ cash-burn projections assume no improvement in production. Inflow control devices being installed over the next eight weeks will hasten the melting of bitumen through steam and cut losses at its main McKay project, Lutes said. He said he’s not discussing a debt restructuring with creditors.

“Our plan is to be cash-flow positive by the end of the year in terms of that property,” Lutes said by phone from Calgary Aug. 22. “We understand that things are going to be tight for a while. We’re not out there looking at a debt solution today. That would be a downside scenario.”

No suitable bidders emerged for Southern Pacific eight months after it hired Royal Bank of Canada to find a buyer for some or all of the company. The explorer said Aug. 21 that none of the proposals it received were acceptable.

“We’ll continue to look at asset sales and ways to enhance our liquidity position,” Lutes said. “We think these projects belong in larger companies where there’s better access to lower-cost capital.”

Rating Review

Southern Pacific faces about C$20 million of interest payments on bonds and loans in the “near term,” DBRS Ltd., a Toronto-based credit-rating company, said in an Aug. 22 report.

DBRS said it will review Southern Pacific’s rating after the company reports earnings next month. The explorer is rated eight levels below investment grade by Standard & Poor’s and DBRS at CCC.

“If STP continues producing at current levels, we expect the second lien notes to be worth only C$0.57 on the dollar,” Bouchard at Desjardins wrote in an Aug. 22 note to clients.

Among other so-called junior explorers, Sunshine Oilsands Ltd., which is seeking to drill bitumen in Alberta, has struggled to finance development in the bond market. The Chinese-backed company sold bonds this month after cutting the size of the issue to $200 million from an initial target of $325 million and shortening the maturity to three years from five. The notes were sold at a yield of 17 percent, compared with an average 8.7 percent investors demand to invest in bonds in the lowest ratings categories of CCC and lower, according to Bank of America Merrill Lynch index data.

Missed Targets

Southern Pacific borrowed C$582 million mostly to develop fields in the Athabasca oil-sands fairway. Most recently, it agreed to a $136 million five-year loan arranged by Credit Suisse Group AG, paying 10 percentage points over the three-month London interbank offered rate, according to data compiled by Bloomberg.

“They used a lot of debt to fund an oil-sands dream,” said Liu at Sentry. “They tell you we have a lot of oil in the ground and if you lend us money, we’ll try to get it out.”

McKay is producing about 29 percent of the oil the company had aimed to achieve by the first quarter of 2015, based on a December 2013 target, according to Desjardins. Production would need to rise to 7,000 barrels a day, from 2,000 currently, in order for Southern Pacific’s assets to support outstanding debt, Desjardins said.

“The bottom line is that the McKay project is not working,” Bouchard said in an e-mailed response to questions. “No one was willing to take a chance on the project and the company has limited resources to execute on its plan.”

To contact the reporter on this story: Cecile Gutscher in Toronto at

To contact the editors responsible for this story: Dave Liedtka at Carlos Caminada

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