Executive Summary / Key Takeaways

• Strategic Asset Transformation Complete: The $320 million Pembina asset sale in April 2025 and subsequent monetization of InPlay shares have reduced net debt from $460 million to approximately $270 million while cutting asset retirement obligations by over 50%, creating a streamlined two-asset company focused exclusively on Peace River heavy oil and Willesden Green light oil.

• Capital Allocation Over Production Growth: Management has explicitly prioritized per-share value creation over absolute production growth, deferring drilling and repurchasing 3.5 million shares for $24.5 million through May 2025 while stating it "makes no sense to burn inventory at $60 a barrel" when shares trade at a material discount to intrinsic value.

• Valuation Disconnect Persists: Trading at 0.55x book value and 1.78x operating cash flow with an enterprise value of $511 million, OBE trades at a significant discount to both its PDP value and peer multiples, despite having reduced debt-to-funds-flow to 1.0x and eliminated near-term maturity risk through 2030 note refinancing.

• Exploration-Driven Upside Optionality: The Peace River asset offers substantial undeveloped potential with 135 billion barrels of oil in place, where early Clearwater formation development has already reached over 4,000 BOE/d representing approximately 60% of regional development, while new "waffle well" technology and waterflood pilots could materially enhance recovery rates.

• Key Execution Risks: Cadotte exploration wells encountered unexpectedly high viscosity oil requiring temporary shut-in, while the company's heavy oil concentration and limited hedging create exposure to WTI volatility below $60, making the balance sheet strength and share buyback discipline critical downside protection.

Setting the Scene: A Transformed Western Canadian E&P

Obsidian Energy operates as a focused exploration and production company in the Western Canadian Sedimentary Basin, having fundamentally restructured its asset base over the past year. The company generates revenue through the development of two core operated assets: the Peace River heavy oil property in Alberta and the Willesden Green light oil position in the Cardium formation. This streamlined structure emerged from a deliberate strategy to shed non-core assets and concentrate capital on the highest-return opportunities.

The transformation began in earnest with the April 2025 closing of the Pembina asset disposition for $320 million, which included $211 million in cash deployed to debt reduction and 9.1 million InPlay (IPO) shares subsequently monetized for $91.4 million in August 2025. These transactions eliminated assets producing 10,300 BOE/d in 2024 but strengthened the balance sheet and reduced operating costs by approximately $1.60 per BOE. More significantly, the deal cut undiscounted asset retirement obligations from $747 million to $357 million, a reduction of over 50% that materially de-risks the company's long-term liability profile.

This repositioning reflects management's core philosophy: the ultimate goal of any growth program is per-share value creation, not production volume for its own sake. As CEO Stephen Loukas stated, "There is no reason to force production growth in the $60 world, specifically – even more so when you can buy your shares back at material discounts to intrinsic value." This capital discipline distinguishes OBE in an E&P sector notorious for value destruction through empire-building.

Technology, Products, and Strategic Differentiation

Obsidian's competitive moat rests on two operational innovations: its "waffle well" drilling design and its pioneering waterflood development in Peace River. The waffle well technology creates perpendicular lateral legs from a primary horizontal bore, forming a grid pattern that provides substantially more avenues for hydrocarbon flow and pressure communication within the reservoir. This design has demonstrated strong initial rates, with one North HVS pad well achieving an IP16 of 424 BOE per day, suggesting materially improved capital efficiency compared to conventional single-lateral designs.

More strategically significant is the company's first dedicated Clearwater injection pilot in the Dawson field, representing the initial waterflood project in Peace River. Enhanced oil recovery through waterflooding could fundamentally alter the reserve recovery equation across OBE's 135 billion barrels of oil in place, particularly in the Clearwater formation where production has already grown from test rates to over 4,000 BOE/d, representing approximately 60% of the region's development program. If successful, this pilot could unlock a multi-decade inventory of low-decline, high-margin production that would be uniquely valuable in a capital-constrained environment.

The company's land position provides another durable advantage. With 15-year-plus tenure on Peace River oil sands acreage and ownership of key gas plants and oil batteries, OBE controls critical infrastructure in a region where gas conservation requirements create barriers to entry. Management notes that while competitor activity has increased, Obsidian's "foundational land position and decision to move early have been a definitive advantage," particularly in the Clearwater Bluesky play where nearly three townships of land had never been tested with horizontal multilaterals before OBE's recent drilling.

Financial Performance & Segment Dynamics

The financial results demonstrate the transformation's effectiveness. First quarter 2025 production of 38,400 BOE/d represented 12% growth over Q1 2024, with all production growth attributed to the Peace River program. However, the pro forma impact of the Pembina sale reduced Q2 2025 production to 28,943 BOE/d, aligning with management's guidance of approximately 29,200 BOE/d and validating their forecasting discipline.

Funds flow from operations (FFO) of $65.8 million in Q2 2025, while down from $115.2 million in Q2 2024 due to lower commodity prices and reduced volumes, exceeded expectations due to higher-than-forecasted oil prices and lower operating costs. This performance, combined with the $270.2 million net debt position (down from $460 million at Q1 end), resulted in a debt-to-FFO ratio of 1.0x on an annualized basis—well within prudent leverage parameters.

Capital allocation reveals the strategic priorities. The company repurchased 5.4 million shares in Q2 2025 alone (7% of outstanding shares) for $36.6 million, building on 3.5 million shares bought through May 6. Since initiating the program in 2023, OBE has reduced its share count by approximately 20%. Simultaneously, management cut first-half 2025 capital expenditures by $15-20 million, deferring Peace River drilling planned for Q2. This trade-off—buying back shares trading below intrinsic value rather than drilling wells at marginal economics—demonstrates the capital discipline that underpins the investment thesis.

Segment performance highlights the portfolio's quality. The Peace River heavy oil asset, despite operational challenges in the Cadotte formation where high viscosity oil forced temporary shut-ins, delivered production growth from 11,600 BOE/d in Q1 to over 14,000 BOE/d by early June. The light oil business, now concentrated in Willesden Green and the retained 44% interest in PCU #11, provides stable free cash flow that funds Peace River development. PCU #11 is described as a "jewel for the area" and an underdeveloped asset in the core Pembina field, offering future development optionality when market conditions improve.

Outlook, Management Guidance, and Execution Risk

Management's guidance for the second half of 2025 reflects a deliberate choice to prioritize returns over growth. Development capital expenditures of $110-120 million will support 28 net operated wells, a material reduction of approximately 33% from both the first half 2025 program and the second half 2024 program. Production is expected to average 27,700-28,300 BOE/d, roughly flat to first-half production excluding the Pembina disposition, building to an exit rate of approximately 29,000 BOE/d.

This flat production trajectory is not a sign of weakness but a strategic response to commodity price volatility. As Loukas stated, "it doesn't make sense to burn inventory at $60 a barrel or sub-$60 a barrel, even more so when you can buy your shares back at more attractive metrics." The company estimates sustaining capital at approximately $180 million to hold production flat at the planned exit rate, excluding discretionary waterflood capital. This baseline requirement is manageable within current cash flow generation, providing flexibility to accelerate activity should prices recover.

The guidance assumes $65 WTI, generating approximately $113 million in second-half FFO and resulting in a net debt-to-FFO ratio of approximately 1.2x. This conservative approach contrasts sharply with peers who continue drilling through the cycle, potentially positioning OBE to capture market share through acquisition if weaker competitors face financial distress.

Execution risk centers on the Cadotte mitigation strategy and waterflood pilot results. The company shut in several wells to evaluate viscosity reduction techniques, and while management remains confident in the play's ultimate viability, the delay represents a near-term production headwind. More critically, the Dawson waterflood pilot's success will determine whether OBE can materially increase recovery factors across its Peace River acreage, which would be a game-changer for reserve additions and long-term value.

Risks and Asymmetries

The investment thesis faces three material risks that could break the narrative. First, prolonged sub-$60 WTI prices would pressure FFO and potentially force management to choose between share buybacks and maintaining the balance sheet, testing their capital allocation discipline. The company's limited hedging program, while accretive in rising markets, leaves it exposed to downside price shocks.

Second, the Cadotte formation challenges could prove more severe than anticipated. If viscosity issues cannot be resolved economically, OBE would need to write off portions of its exploration investment and shift capital to less prospective areas, reducing the overall return on its Peace River program. The fact that "seven exploration wells were drilled, with five showing promising results" means two did not, highlighting the inherent risk in frontier exploration.

Third, service cost inflation could erode the company's cost advantage. Management anticipates "spirited discussions with the service cost providers if we are in a $60 world," but if costs remain sticky while commodity prices fall, margins would compress and the economics of both development drilling and waterflood expansion would deteriorate.

The primary asymmetry lies in the waterflood pilot's success. If the Dawson project demonstrates commercial viability, OBE could unlock hundreds of millions in incremental value from its 135 billion barrels of oil in place, creating a multi-decade growth trajectory that is not priced into the stock at current levels. Additionally, the company's low leverage and strong liquidity position it to acquire distressed assets if the current price environment forces weaker competitors to sell, potentially accelerating value creation through counter-cyclical M&A.

Valuation Context

At $6.03 per share, Obsidian Energy trades at a market capitalization of $403 million and an enterprise value of $511 million, representing 0.79x trailing twelve-month sales and 1.78x operating cash flow. The price-to-book ratio of 0.55x indicates the market values the company at a substantial discount to its accounting net asset value, while the enterprise value-to-revenue multiple of 1.00x sits well below the typical range for focused E&P companies.

The company's balance sheet strength supports the valuation thesis. With net debt of $270 million and trailing FFO of approximately $260 million (annualizing Q2's $65.8 million), the debt-to-FFO ratio of 1.0x provides ample coverage and flexibility. The recent refinancing of $175 million in 8.125% notes due 2030, which redeemed the $80.8 million 2027 notes, eliminates near-term maturity risk and locks in historically attractive long-term funding.

Management emphasizes that even at $60 WTI, the stock trades below its PDP value, suggesting the market assigns minimal value to the company's 2P reserves and exploration upside. This disconnect is particularly stark given the 20% reduction in share count since 2023, which has materially increased per-share exposure to the remaining asset base. The company's significant tax pools, which position it to avoid cash taxes for approximately 10 years at $70 WTI, further enhance the equity value proposition.

Conclusion

Obsidian Energy has executed a remarkable transformation from a diversified, heavily indebted E&P into a focused, financially strong company with two core assets and a management team committed to per-share value creation. The strategic decision to sell Pembina assets and repurchase shares at cyclical lows, rather than drill marginally economic wells, demonstrates a level of capital discipline that is rare in the Canadian E&P sector and forms the central pillar of the investment thesis.

The story's success hinges on two variables: commodity price recovery and operational execution on the waterflood pilot. If WTI stabilizes above $65, the company's low-cost, high-margin production base will generate substantial free cash flow, amplifying returns from the reduced share count. More importantly, if the Dawson waterflood proves commercial, OBE will have unlocked a multi-decade inventory of low-decline production that could fundamentally re-rate the stock from its current discount to book value and peer multiples.

The primary risk is that the market's skepticism—reflected in the 0.55x price-to-book multiple—proves justified if either commodity prices remain depressed or the operational challenges in Peace River prove more intractable than management anticipates. However, the company's strong balance sheet, reduced share count, and exploration optionality provide multiple levers for value creation even in a constrained price environment, making the risk-reward asymmetry compelling for patient investors willing to bet on management's capital allocation discipline and the underlying quality of the transformed asset base.