While most major energy companies have participated in the market rally in 2009, one Canadian based oil sands company that hasn't participated is OPTI Canada Inc (TSE:OPC). Based out of Calgary, Alberta, OPTI is an oil and gas developer with major development projects in Canada. Year to date OPTI is down about 16%, whereas the Claymore Oil Sands Sector ETF (TSE:CLO.A) is up 30% and Energy Select Sector SPDR ETF (NYSE:XLE) is up about 5%.

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One reason OPTI hasn't participated in the rally, and the rise in crude prices, is because of its weak balance sheet. In this cautious credit environment OPTI has the double whammy: huge leverage and poor cash flows. At the end of the second quarter, OPTI reported $2.357 billion in long-term debt and negative cash from operations of $58 million. OPTI also paid out a massive $42.27 million in net interest, eclipsing their total revenue of $33.6 million.

Breaking the Covenant
With a debt to EBITDA covenant of 2.5:1 tied to their $350 million revolving loan now in effect for the third quarter, in addition to the unscheduled Long Lake upgrader shutdown at the end of July, there's a high probability that OPTI's long-term revolver covenant will be breached.

On July 21, OPTI repaid $87 million on the long-term revolving credit facility reducing the drawn amount to $235 million. This means OPTI has to earn at least $23.5 million EBITDA ($94 million annualized) in Q3 2009 in order to satisfy the covenant, highly unlikely given the ongoing problems at Long Lake. Also of note is that Long Lake is OPTI's only income producing asset. (See Reading The Balance Sheet to learn about evaluating a company's balance sheet.)

If breached, OPTI would have to renegotiate the terms of the loan with the lender, which would increase borrowing costs for the company, further increasing their interest burden and stress on their balance sheet. If negotiations are unsuccessful however, the company could be forced to do another equity issuance - like the one done recently for $142 million.

Not Enough Production
Aside from its balance sheet problems, another big problem is in their operations with the slow production ramp up at Long Lake. The joint project between Nexen (NYSE:NXY) and OPTI is currently averaging only about 14,500 barrels of bitumen per day.

Philip Skolnick of Genuity Capital estimated that the project needs to produce at least 35,000 barrels per day to generate break-even cash flows. At full capacity, OPTI expects to produce 72,000 barrels of bitumen per day by the end of 2010. That's a big gap to make up for OPTI.

Wait It Out
Investors should wait until Q3 2009 for more clarity about the company's financial situation before considering buying this stock. However, I think both problems OPTI faces, financial and operational, are only temporary, and if they can get over this hurdle the stock will have significant upside potential. Major catalysts in the near term for OPTI that could turn this stock around include: (1) successful renegotiation of loan term (2) production at Long Lake proceeds as expected or better than expected and (3) OPTI gets acquired by a major oil company such as Exxon Mobil (NYSE:XOM) or Royal Dutch (NYSE:RDS.A).

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Tickers in this Article: OPC.TO, C.CLO, XLE, NXY, NXY.TO, XOM, RDS.A

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