President's Message

Please click on the links below to view a few messages from our President and CEO J.Cameron Bailey.

Q & A with President J.Cameron Bailey

Q.

Fortress is a 100 percent natural gas explorer and producer. That would appear to
cause energy investors to be wary of the Company. Why should they be taking notice
of Fortress?

A.

Two main aspects make us stand out from our peers: Fortress is 100 percent weighted to natural gas and it has long reserve life. Our reserve base, which totalled 36.6 bcf at year-end 2008, a long reserve-life-index of 10 years, gives us tremendous leverage to improving commodity prices. To provide stability we sold forward 60 percent of our natural gas production at an average price of $8.30 per mcf through March 2010.


Q.

That’s large-volume hedging relative to most E&P companies. What motivated you to put the hedges in place? 

A.

Last August we looked at the consequence of not hedging in the event that prices dropped and compared that against the possibility of prices increasing. We opted to hedge. We have a long-term view. We’re in business to be sustainable and that means protecting ourselves from exposure to weak commodity prices. Another factor is our remote operations in northeast British Columbia and northwest Alberta – we have relatively high operating costs. Our break-even natural gas price is about $5 per mcf. If natural gas went to that price and we were unhedged, Fortress would have zero cash flow and could not service its bank debt. Fortunately, we are significantly hedged.


Q.

Isn’t that kind of thinking outside the box for E&P companies?

A.

It’s a contrarian view. On average the industry hedges 20 percent of its production. Our reasoning is that it’s not that costly on the upside. We still have 40 percent of our production unhedged should natural gas prices start to recover. We had about 60 percent of our gas hedged in the first half of 2008, which proved costly and penalized us in the investment market. We didn’t see the bump in share price that our peer group had when natural gas prices were zooming in the first half of 2008. 


Q.

What were some of your 2008 highlights?

A.

Our Square Creek property in northwest Alberta has been a clear focus of our development and exploration program. It’s a classic long-life, high-productivity Cretaceous sands play – one of Alberta’s premier natural gas plays. It’s a winter-access area, so all the activity takes place in about a four-month period. We drilled 5 (3.0 net) wells in the first quarter of 2008, and constructed a compression and dehydration facility and a 41-kilometre pipeline to the Clear Prairie processing plant. We now have seven wells producing from the Notikewin and Bluesky zones at Square Creek, and we’ve been able to grow our land base in the area to 40,000 net acres. In 2009 we drilled two 50 percent working-interest wells to define the extent of the Notikewin and Bluesky zones. We expect to have these on production before spring break-up. We believe there are further locations targeting the Notikewin and Bluesky zones.


Q.

How are the Square Creek wells performing?

A.

The wells are producing at less than capacity due to constraints with a third-party owned natural gas plant at Clear Prairie. We’ve voluntarily shut-in certain wells from time to time, so the Bluesky wells have only produced for about 69 percent of the time. Production began to increase in early March and we’re working with the plant owner to permanently expand capacity. At current natural gas prices, however, it’s not a bad thing to have production curtailed. We want to ensure that we have sufficient capacity once prices recover. Overall the Square Creek area has the capability to produce over 12 mmcf/d of gas with our net share being 6 mmcf/d.


Q.

Has Fortress had success on the exploration front?

A.

Just before year-end 2008, we drilled a 100 percent working interest exploration well that we had identified on seismic and which is near our Square Creek pool, but  on a separate structure. The vertical exploration well encountered 5 metres of gas-bearing Bluesky sand and encountered the same original pressure as the Bluesky wells at Square Creek.
We also drilled a 100 percent Fortress exploratory well at Pine Creek in the Edson area, which if successful would help diversify Fortress into an all-season area. We drilled the well vertically in anticipation of adding a horizontal leg later. The target formation proved to be gas-bearing but tight, and we’ve opted not to add the horizontal leg in the current price environment. Once prices recover we will revisit this project and rank it with the rest of our opportunities.


Q.

What’s happening at Ladyfern? It appeared to be an important part of your portfolio, yet you had it for sale in late 2008.

A.

We still consider the Ladyfern area an excellent asset. We entered the area by way of an acquisition of Marauder Resources in 2006 and completed the obligations of a farm-in Marauder had entered into by drilling four wells in 2007 under our commitment. In 2008, our partner at Ladyfern sold its interest to another company at a very attractive price. That motivated us to put our asset on the market in November. Unfortunately, the window for attracting that kind of price had closed and we pulled the property off the market in January. We have 50 development drilling locations on our lands.


Q.

How do you describe the quality of Fortress’ assets?

A.

Quality can be measured in different ways. What’s attractive about Fortress is the assets are very concentrated in the Ladyfern/Square Creek area where we have an average working interest of 78 percent and operate all of our production. The average annual decline rate on our production is less than 17 percent, versus an industry average of closer to 25 percent, which provides a longer reserve-life-index than is typical for small companies and makes that decline “treadmill” much less steep. Square Creek has been an excellent investment and a successful project and we’re now generating one-third of our production from that property.


Q.

Fortress grew its production in 2008. What happened to its reserves and finding costs?

A.

Because virtually all our capital is spent in the first quarter of the calendar year, it makes it difficult to do year-over-year comparisons. According to the Sproule and Associates year-end reserve evaluation, we added 534,000 boe to our proved plus probable reserves. The year-end 2008 report includes negative reserve revisions of 325,000 boe, which reflects the hedging program and production performance.
Our two-year finding and development costs, including future development capital, averaged $18.10 per boe (excluding technical revisions) proved plus probable. We expect that our reserve numbers will be higher and our finding and development costs lower once we do the spring update on our reserves.


Q.

With most of its drilling program complete in the first quarter, how will Fortress stay busy during the remainder of 2009?

A.

Our focus right now is on reducing operating costs. We have remote operations, which translate into an average operating cost of $14 per boe versus an industry average of approximately $10 per boe. We’re dependent on helicopters to mobilize crews in the field, and those crews have to stay in camps. We have taken the initiative to consolidate our field operations with those of other companies in the same area to reduce manpower in the area.


Q.

Most Canadian E&P companies expect their production to decline in 2009 because
of sharply curtailed capital programs. What is Fortress forecasting for 2009?

A.

Fortress averaged 1,393 boe per day in 2008, which was lower than we expected due to the Clear Prairie facility constraints. We expect to grow our production by approximately 100 boe per day in 2009 – not a large amount, but significant in the current environment. The production increase will come primarily from our Square Creek property. Other than the plant capacity constraints we have the ability to moderate our production rate depending on natural gas prices.


Q.

Fortress seems relatively secure given that the majority of its production is hedged.
What is the Company’s financial health?

A.

We ended the year with net debt of $21 million. Our debt will top out at $24 million after the first quarter’s
capital program and we expect to bring it down to approximately $20 million by year-end 2009. At year-end 2008 we had a debt to trailing cash flow ratio of 3 times. Our financial health is manageable. We never expected the significant economic downturn and the impact it would have on Natural Gas prices. We didn’t configure our balance sheet for the intensity of the change.


Q.

A year ago, one of the key messages was that investors should look at the real value of
Fortress, which was trading at well below its net asset value. In the current environment,
how do you see Fortress’ real value?

A.

Today, an investor can buy a share of Fortress for a fraction of its net asset value (NAV). We really are one of the most under-valued E&P companies on the market. We’re currently trading at $0.30 per share versus a net asset value at year-end 2008 of $3.16 per share. Based on Fortress’ share price and common shares outstanding as of late April 2009, the markets are valuing us at only $21,800 per daily flowing boe and $4.70 per boe of proved plus probable reserves. We consider this substantially below Fortress’ real value based on our NAV. We believe that we will see a turn in the general economy, which will drive higher natural gas prices. Fortress has one of the best exposures to a price recovery.


Q.

Are there other things that investors should take into consideration when computing Fortress’ real value?

A.

First, the estimated mark-to-market value of our hedges is $5.1 million. Beyond that, we have applied for a $3.4 million tax refund that we anticipate capturing in 2009, based on recent tax case precedents. These are additional scientific research and experimental development credits related to the biotechnology business of a predecessor company. Essentially we’re doing what all companies are doing these days – scrubbing down our assets to see what we’ve really got. We want to take advantage of every cent of revenue.


Q.

What will it take to drive a recovery in natural gas prices?

A.

What it will take is exactly what has happened – dramatically reduced drilling activity. We’ve gone from nearly 21,000 oil and natural gas wells completed in Canada in 2008 to a forecast of just over 11,000 wells to be completed in 2009, the lowest number since 2002. You have to combine that with the sharply lower productivity of new natural gas wells in western Canada. We think both factors will have a dramatic impact on natural gas productivity.
Even more important is what’s happening in the United States. After peaking at 1,600 last September, the number of rigs drilling for natural gas fell to 810 in March, its lowest level since April 2003. Less drilling should mean reduced deliverability. Consequently, we’re anticipating an improved supply-demand picture for natural gas by the third quarter of 2009.


Q.

Will higher natural gas prices bring investors back to the energy sector?

A.

We think commodity prices generally will need to be higher than what the industry experienced in the second half of 2008. That’s the only way the industry will return to profitability and the only way investors will have the confidence to return.


Q.

What is the long-term plan for Fortress? Two years ago, when the energy trusts were acquiring junior E&P companies at a rapid pace, many companies expected to be in business only three to five years before exiting through sale to an energy trust.

A.

We have a very good team in Fortress and the tremendous capability to be profitable. We see this as a relatively short period of time when the industry cannot make money. We’re setting ourselves up for a return to higher commodity prices when we can start to be profitable again. We’re not building Fortress to sell it; we’re building and managing an asset base that can sustain long-term profitability.


Q.

Fortress has always been a contrarian. Will that continue?

A.

We’re in natural gas and we expect to stay focused on that commodity. We have been buyers in times of industry downturns and sellers at the top and we will continue to do that. We were aggressive this year in terms of our capital program and we want to continue being aggressive. We have capital constraints, but we believe there will be good corporate acquisition opportunities in 2009.
We expect there will be greater motivation for companies to sell once prices begin to recover. At this time, consolidation doesn’t fix any of the fundamental problems. It doesn’t provide greater access to capital, and it doesn’t make you more competitive in developing your prospect inventory. Few companies have good currency these days, so there’s no real benefit to merging. There may be some near-term activity driven by creditors, but so far we have witnessed very little of this activity. Creditors will have to take action in some situations, but there is no market for the underlying assets. So even creditors will end up trying to manage companies in distress and wait for a better day to force a sale.


Q.

You seem optimistic about the future. What’s that based on?

A.

We are optimistic about a commodity price recovery. Fortress’ objective is not just to survive – but to prosper. When prices recover, we think the swing will be dramatic and fast. We expect to see evidence of that
in 2009.

300, 505 - 3rd Street S.W. Calgary, Alberta T2P 3E6 | Tel: (403) 398-3345 | info@fortressenergy.ca | © 2006 - 2009 Fortress Energy Inc. All rights reserved.