Price movements, distribution problems, drilling rig
availability and regulatory factors have all come into play this year,
providing both challenges and opportunities for junior companies, according
to Robert Cooper, senior oil and gas analyst at Haywood Securities. But
change has been good for some of the companies he follows, and in this
interview with The Energy
Report, he shares some names that are still sitting pretty
Report: It's been
about one year since we last spoke, Robert. What do you think have been the
most significant developments in the North American oil and gas industry
Cooper: It's a
dynamic business, and a number of changes have occurred. First, the
macroeconomic backdrop remains murky, resulting in persistent volatility in
equity and commodity markets. Investors remain wary of putting on riskier
trades because the visibility simply isn't there. The fear that some Monday
morning we'll wake up with a negative surprise is inhibiting risk taking and
impacting small-cap growth equities, particularly.
winners tend to be experienced managers with proven track records."
the rapid increase in U.S. oil production has negatively impacted Canadian
producer net-backs. The spread between Canadian light oil prices and the U.S.
equivalent has been much more volatile than historical rates. The lack of
pipeline capacity has exacerbated this trend and given rise to alternative
methods of transportation, such as oil-by-rail. But overall, the
"differential risk" has been added to the list of risk factors
investors assume when investing in the oil and gas sector.
the natural gas market, after a period of massive oversupply, has, in our
view, self-corrected and appears to have returned to balance.
TER: In terms of pipeline capacity and building
potentially new pipelines and better distribution, do you have any further
thoughts on where you think that might be headed at this point—or is it
RC: There is a juicy arbitrage between waterborne
markets and domestic markets. There are a lot of smart companies and
individuals looking at ways to solve that, but in the end, these things
sometimes have political masters who need to be appeased. The current
president has indicated he's not amenable to it. We'll see what happens.
TER: In your last interview, you were seeing a potential downside in oil prices
in the $60–70 range, if the economy took a turn for the worse. Things
now seem to be slowly improving in North America. Oil has been up and down,
but it's still kind of weak. Some analysts are thinking we could still see
lower prices. What's your thinking?
RC: Higher or at least stable prices are primarily a
function of the global economy continuing to muddle through with positive,
but not thrilling, economic growth. We've seen a lot of competing evidence on
this, but on the whole, the global economy is doing just that. Conversely, I
am still of the view that global shocks, such as sovereign default or a hard
landing in China, would likely deflate the oil market. We saw the impact of
economic concerns in Q2/12, when crude tumbled from over $100 per barrel (bbl) to about $76/bbl at the
end of June. That downside risk remains. That's not our base-case forecast,
but we're certainly cognizant of the potential for black swan events that can
really deflate the equity and commodity markets.
TER: Is the new trading range somewhere between
$80–90/bbl, or is this just a temporary
RC: The oil market is highly volatile, so you could
probably make a case for somewhere between $75–100/bbl. The longer it's
at $75/bbl, the more likely it is to move higher.
Alternatively, if it hovers in the $100/bbl range,
the more likely it is to move lower. The sweet spot is somewhere in between,
and that's what we've seen on the whole in the last several quarters.
TER: Natural gas is a different story. We've bottomed
out already. Where is it headed from here?
RC: The gas market is very similar today to what it was
a year ago, and yet different in a number of
respects. Last year, the market knew that production from shale gas
reservoirs, particularly in the U.S., was rapidly increasing, and had taken
the step change down to the $4 per thousand cubic feet (Mcf)
range as a result. But the winter was one of the warmest on record.
Consequently, gas collapsed along with demand.
difference between this year's storage overhang in April versus normal was
basically equal to the lost heating demand over the winter. In other words,
we can retrospectively demonstrate that the market was balanced a year ago.
Between October of last year and April of this year, it went from balanced to
well oversupplied. What changed in the summer was
what we refer to as the power burn rally, in that utilities switched from
coal to gas en masse. In the span of three or four months, that phenomenon
has returned the market to essentially the same place it was this time last year.
In fact, prices are approximately equal to last year, as are storage levels.
difference now, however, is that there are other positive factors at work.
One, the number of gas-directed drilling rigs have
fallen from the 800s into the low-400s. Second, producers have pivoted to
liquids-rich gas and/or oil. Natural gas liquids (NGL) prices have declined
precipitously year over year (YOY). The average weighted NGL barrel as a
percentage of crude oil is down 25% YOY. This change still results in
economic, liquids-rich gas projects, but it reduces the cash flow associated
with them. With lower cash flow comes lower
reinvestment and less drilling, and then you should see a further
cannibalization of the gas rig count. Finally, gas supply has stopped
increasing. After several years of higher production, it looks like exit 2011
to average 2012 production is basically flat. All of those, in aggregate, are
TER: What happens if we have another warmer-than-normal
RC: My view now is that the gas market is balanced.
Whether or not it goes higher or lower in the near
term is largely a function of winter weather. You give me normal weather, and
I can probably give you $4/Mcf gas. If you don't,
then it's history repeating.
TER: Have the prices over the last six months to a year
had any significant impact on the way that oil and gas companies are planning
their future operations, based on what's visible to them at this point?
RC: Speaking about Canada, the small- and mid-cap
Canadian producers have embraced hedging to a greater degree than I can
recall. Generally speaking, pre-2008, the prevailing view of exploration and
production (E&P) managers was that companies existed to provide investors
beta to commodity prices. In other words, they were unhedged.
Since then, we've noticed a distinct trend toward risk management, which
means greater and more consistent hedging among the producers. This has been
driven by a number of factors, including more challenging equity markets in
which raising capital is much more difficult. It's a function of highly
volatile commodity prices and, on average, larger capital budgets that
require some certainty in the cash flow. E&Ps have attempted to take some
risk out of the business plan by providing a degree of cash-flow certainty
E&Ps have become much more focused on cost control. One manifestation of
this is that, in Canada, a number of producers have made conscious decisions
to avoid drilling during peak seasons. The goal is to utilize the best rigs
and services at off-peak times. A number of them have had success, which has
made a positive impact on capital costs and returns. The downside is that
drilling in Canada remains seasonal, and spring breakup remains an impediment
for many companies. But, overall, I think the theme is toward risk
management, simply because the equity markets of late have been rather
unforgiving of mistakes.
TER: Everybody has to adapt to changes, and it's a fluid
market. You joined Haywood Securities since we last spoke. Has that had any
impact on the way you approach your investment selections and general
RC: No. Nothing has changed in how I evaluate equities,
although I've added an international dimension to my coverage universe.
TER: Maybe you can bring us up-to-date on developments
with some of the companies we talked about last year and how they look now.
RC: Let's start off with Open Range Energy Corp. (ONR:TSX). Open Range was a huge win. We said then that once the E&P was
split, the tank business had a significant growth runway and that the company
was likely to get acquired. We got both of those right.
The tank business is now called Poseidon Concepts Corp. (PSN:TSX). It's taken off, paying a dividend and trading at about $15/share.
Growth in the U.S. has accelerated. We were predicting at that time, $130
million ($130M) in 2012 earnings before interest, taxes, depreciation and
amortization (EBITDA). Management guidance for 2012 is now $210M in EBITDA.
The E&P spinout was acquired by top-tier producer Peyto
Exploration & Development Corp. (PEY:TSX).
Energy Inc. (CTA:TSX) was another one. It has performed as I expected. We
said then that there was $4/share upside, and it got there in January. It has
since pulled back some, but the business is further advanced now at a lower
stock price than it was then. Crocotta has proven
its Edson liquids-rich gas asset and has added an emerging Cardium oil play as well. With gas strip prices as they
are now, we're likely to see further development in the Montney
play in northeast British Columbia. All the while, Crocotta
management has maintained a sterling balance sheet, so we like this story a
lot. Right now, it's about $3.20. In October of last year, it was around
Resources Inc. (YO:TSX.V) is the final one. I said last year that I liked
Yoho because it had the most resource exposure of any junior company I knew
of combined in the Duvernay and the Montney. That is still the case, and it remains one of my
favorite stories. What's changed is that Yoho has drilled some Duvernay shale wells. The development of any shale basin
tends toward lower productivity and higher well costs at the outset, and as
the plays mature, production increases and costs decrease. Yoho is following
that in the Duvernay. What's most interesting is
that Exxon Mobil
Corp. (XOM:NYSE) recently paid $2.6 billion for Yoho's partner in
the Duvernay, Celtic Exploration Ltd. (CLT:TSX). This shows you that the Duvernay
is the real deal, and that large companies want exposure here. The thesis
remains the same on Yoho as it was 13 months ago.
TER: Do you expect it to be taken out, at some point?
RC: If you look at where Yoho is and its Duvernay acreage, it is surrounded by the majors—Chevron Corp. (CVX:NYSE), Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), Exxon, Talisman Energy Inc. (TLM:TSX), Encana Corp. (ECA:TSX; ECA:NYSE) and Husky Energy Inc. (HSE:TSX). And then there's Yoho. So chances are Yoho will
not be around in 12–18 months. That would be my guess. It's been our
Top Pick this year on the basis that resource exposure is an investable theme
among the juniors. And we still feel that way today.
TER: Do you have any new names that you'd like to talk
about at this point that look interesting?
RC: I do. One is called Tamarack Valley Energy Ltd. (TVE:TSX.V). Tamarack has emerged as a very well
run junior light oil producer. The company is active in Alberta's Cardium light oil trend as well as Alberta's Viking light
oil trend. It produces about 2,550 barrels of oil equivalent per day (boe/d) currently. The company is led by the former CEO of
Apache Canada (APA:NYSE). We like the company for a
number of reasons. First, Tamarack has a number of oil projects that have
payouts in about a year. This is an attractive attribute because it means
that the company is able to self-fund under reasonable commodity price
assumptions. Second, Tamarack has demonstrated that it has been able to
reduce costs and increase productivity in both the Viking and Cardium formations. Obviously, decreased costs and
increased productivity drop right down to the bottom line in improved
economics. Third, we really like management. They work hard. They take a
risk-managed approach to their business, and they tend to meet or exceed
expectations. Finally, we like the risk-reward profile of attractive
valuation coupled with a number of near-term drilling catalysts.
TER: That's certainly one to keep an eye on. How about
any others that look interesting?
RC: The second company is called Novus Energy Inc. (NVS:TSX.V). Novus is also a Viking producer but in
west-central Saskatchewan. We like the Viking generally, for a number of
reasons, especially for a junior producer. The Viking in west-central
Saskatchewan is well defined geologically. It's low
risk, low capital cost and repeatable. The key to success is having scale,
because the initial well productivity is lower than some of the deeper, tight
oil plays in Alberta. Novus has the dominant land package in the area and is
growing production. It is guiding to 4,400 boe/d at year-end. We have written that we think
Novus' asset base could ultimately support a dividend. Based on the comparables, this should result in some value creation.
Alternatively, it's our view that the west-central Dodsland
area is going to be the domain of larger producers, and that consolidation is
likely. In either scenario, we see Novus benefiting.
TER: Could Tamarack and Novus get taken out?
RC: I think Tamarack is earlier in its life cycle than
Novus is. Larger companies need scale and scope and a number of them have
indicated that west-central Saskatchewan is going to be a focus for them. If
you want scale and scope in west-central Saskatchewan, you pretty much have
to go through Novus.
TER: So it's pretty well-situated there as far as its
RC: Yes, it is.
TER: Generally speaking, what do you think the focus
should be for our readers and people interested in playing the energy markets
in North America at this time?
RC: I think volatility creates winners and losers. The
winners tend to be experienced managers with proven track records. In times
of stress, proven managers tend to retain their multiples relative to their
peers and are able to raise capital, if required. This enables them to grow,
either organically or through mergers and acquisitions. And in the worst of
times, they survive. When the rising tide isn't lifting all boats, investors
should gravitate toward the best-in-class.
TER: That's a good closing thought. Thank you, Robert.
RC: I said this last time, and I'll say it again this
year: I hope I'm right.
TER: As does everybody. We appreciate your time today.
Robert Cooper, CFA, is Senior Oil & Gas Analyst at Haywood
Securities in Calgary. He has a diverse background including commodity
trading and merchant banking. Cooper has spent the past six years in equity
research focused on high-growth energy equities both in Canada and across the
world and is regularly called upon for insight on the oil and gas industry by
various local and national media. He is a CFA charter holder and is a past
president of the Calgary CFA Society.
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1) Zig Lambo of The
Energy Report conducted this interview. He personally and/or his family
own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: Royal Dutch Shell Plc.
3) Robert Cooper: I personally and/or my family own shares of the following
companies mentioned in this interview: Crocotta
Energy Inc. I personally and/or my family am paid by
the following companies mentioned in this interview: None. I was not paid by
Streetwise Reports for participating in this interview.
4) Haywood Securities Inc. or one of its subsidiaries has managed or
co-managed or participated as selling group in a public offering of
securities for Poseidon Concepts Corp., Crocotta
Energy Ltd., Yoho Resources Inc. and Tamarack Valley Energy Ltd. in the past
5) As of the end of the month immediately preceding this publication either
Haywood Securities, Inc., one of its subsidiaries, its officers or directors
beneficially owned 1% or more of Yoho Resources Inc.