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From the coal beds of Indonesia to oil and gas fields throughout
Europe, Sam Wahab of the London-based investment
firm Seymour Pierce is a master at spotting investment opportunities in the
topsy-turvy world of fluctuating energy prices. In this interview with The Energy Report, he deftly defines the structural problems affecting gas and coal
markets, while identifying some plays that demonstrate the savvy to come out
on top.
The Energy
Report: Sam, with natural gas production
stalling in North America, where can investors find good deals in the junior
exploration space?
Sam Wahab: Gas exploration in the U.S.,
especially of the unconventional type, has resulted in diminishing Henry Hub
spot prices. Nevertheless, gas exploration on a global scale remains strong.
The key reason is that gas prices in Europe and Asia are underpinned by
robust consumer demand and the need for energy security.
A clear
example is in Central and Eastern Europe, where Gazprom (OGZD:LSE;
GAZ:FSE; GAZP:MCX; GAZP:RTS; OGZPY:OTC) has a
strong monopoly on gas supply despite a plethora of untapped resources. Many
of the governments in these countries (Poland, Romania, Ukraine, etc.) are
now incentivizing junior domestic players through undemanding fiscal terms to
prove up these resources to secure energy self-sufficiency. In return, these
junior companies enjoy gas prices far in excess of the Henry Hub, which is
about $3 per thousand cubic feet (Mcf).
The
Romanian gas market is slated to deregulate its gas prices next year. That
should bring it inside the European average of $8–13/Mcf. We have a Buy recommendation on Hawkley Oil & Gas Ltd. (HOG:ASX), an Australia-listed company
that owns and operates Ukrainian assets. It was getting $11.80/Mcf, which is a fourfold multiple to the Henry Hub. Our
target price for Hawkley is $0.72/share. Other
beneficiaries of this type of price movement in Europe include Zeta Petroleum Plc
(ZTA:ASX), Aurelian Oil & Gas Plc (AUL:LSE) and San Leon Energy Plc (SLE:LSE; SLGYY:OTCBB), which is
merging into Aurelian.
Another
interesting proposition for investors, in my view, is the growing interest in
the supply of regassified liquid natural gas (LNG)
to gas-starved West African markets. To clarify, LNG is natural gas that has
been converted to liquid form for ease of storage or transport.
Regasification is the process of returning the LNG to natural gas prior to
distribution.
London-listed
Gasol Plc
(GAS:LSE) is looking to service this growing
demand by securing sales agreements with LNG suppliers and national
governments for fixed periods. LNG cargoes will be delivered to a floating
LNG regasification facility, which will then either pipe gas to nearby
industry or power generation facilities.
TER: Are the
explorers that you cover focused on finding and developing gas-producing
properties that they can hold onto as income producers, or are they typically
more interested in selling their properties to a major corporation once the
resources are proved out?
SW: That's a
very good question and the answer will strongly depend on the individual
management team, their strategy and the diversification of the company's
asset portfolio. It is extremely difficult for a junior gas explorer to prove
up and commercialize an asset alone, given the significant financial and
technical resource base necessary to do so. We often see juniors acquire an
asset, shoot seismic and potentially drill one or two exploration wells, at
which point they have sufficiently derisked the
acreage to attract a partner to assist in bringing the asset through field
development.
We've seen
this strategy work recently with Tethys
Petroleum Ltd. (TPL:TSX; TPL:LSE). Seymour
Pierce has a Buy recommendation on Tethys and a target price of $0.72/share.
Its most significant asset is the Bokhtar area in
Tajikistan, with an estimated 27.5 billion barrels oil equivalent (Bboe). The company recently announced a farm out of this
asset, bringing in Total S.A. and CNODC as equity partners.
We also
have a Buy recommendation on CBM Asia
Development Corp. (TCF:TSX.V), with a
target of $0.54/share. CBM is acquiring high-quality cold bed methane (CBM)
acreage in Indonesia. It plans to derisk the
properties to about 80% certainty by drilling low-cost wells to reach
early-stage production and generate cash flow. At that stage, the company
will seek to sell the property to a major oil company to capture the
valuation upside from the derisking process and
unleash shareholder value.
TER: Indonesia
is a microcosm of East Asian energy development. It is balancing its domestic
needs against export demands and it enters into production-sharing contracts
between the government and the CBM explorers that bear the burden of derisking the gas fields. Where is the margin in this
type of public-private venture?
SW: The
country's natural gas market is characterized by a declining supply of
conventional gas and a rapidly growing domestic market with a large export
segment. A clear margin exists where the domestic gas price is between
$5–11/Mcf, whereas the export prices go as
high as $15/Mcf.
It turns
out that 50% of Indonesia's gas is exported to North Asian markets in the
form of LNG—down from 62% during the past decade. So a declining
conventional gas production combined with driving domestic gas consumption is
crimping Indonesia's ability to meet its own LNG export obligations and its
ability to capitalize on the high gas prices in North Asia. Meanwhile,
domestic consumption has risen over 100% during the last 10 years. That's
largely a function of Indonesia's strong economic growth, which is headed
toward a gross domestic product of $1 trillion this year.
Looming
shortage of supply is causing the Indonesian government to support
public-private CBM development projects with incentivized production-sharing
contracts (PSCs). The terms allow contractors to take 40–45% on an
after-tax basis—higher than the industry average. The capital
requirements for CBM exploration, which is classed as unconventional, are
low—between $2.5–3 million ($2.5–3M) to acquire a
production-sharing agreement and up to $4–6M to complete the
exploration phase. The risk and costs are low with the potential for high
returns. The situation has set off a bit of a land grab in Indonesia.
TER: What
other companies are focused on CBM exploration?
SW: In
addition to CBM Asia, other companies active in CBM exploration in Indonesia
include BP Plc
(BP:NYSE; BP:LSE), Dart Energy Ltd. (DTE:ASX), Exxon Mobil Corp. (XOM:NYSE), Santos (STO:ASX) and
Total. Whilst in our view CBM Asia and Dart Energy have the most compelling
investment case at the moment, we would expect more entrants into this
particular market given the low cost of drilling and access to existing
infrastructure.
The
Australian CBM industry is mature. Between 2003 and 2011, Australia's CBM
industry consolidated through 33 mergers of small, independent operators with
a value of over 30 billion Aussie dollars. I believe a similar consolidation
could occur in Indonesia as acquirers of Australian CBM assets such as Total
and Santos, which are active in Indonesia, look to pick up small companies
like CBM Asia.
TER: Let's
talk about CBM drilling for a moment. How does it differ from conventional
gas drilling?
SW: Coal bed
methane is a byproduct of the coal formation process. It's chemically
identical to other sources of natural gas, but it's cleaner than hydrogen sulphide. In the reservoirs, the methane is absorbed into
the coal surface—held tightly in place by a layer of water. Drilling a
production well releases the water pressure in the coal stream, allowing the
gas to float to the surface following the water. The wells are shallow, less
than 1,000 meters down to the gas-rich stream. Remarkably, such a well can be
drilled and completed in less than 48 hours.
TER: When a
major is looking at CBM juniors, what metrics do they require?
SW: The
effects of the U.S. shale boom on the Henry Hub have led many majors to
deploy their technical resource base in extracting unconventional resources
in high spot-price environments. They are constantly on the lookout for
sufficiently derisked assets, made through a
combination of seismic and drilling activity. They want to take a significant
equity portion, and they want the asset to be located in geopolitically
stable regions with a strong demand or sufficient infrastructure in place so
that they can easily export the hydrocarbons. If most of these boxes are
checked, there is a good chance that a major will show interest in a junior
oil and gas company.
Recently,
BP divested many of its non-operating gas interests in the North Sea, while
increasing its presence in West Africa. It has just farmed in to Chariot Oil & Gas Ltd. (CHAR:LSX) block. Exxon exited many of
its Polish shale concessions in favor of the reported interests in onshore
United Kingdom shale by Egdon
Resources Plc (EDR:AIM). The U.K.
government has lifted a suspension on fracking in
the U.K. Now Exxon is interested in some of the onshore U.K. assets. Egdon Resources could be a key benefactor.
TER:
Nonetheless, share prices for many gas explorers are not very robust. Why?
SW: Historically,
gas prices have been linked to oil prices. Starting with the U.S. shale boom,
we have seen a divergence—oil prices have remained strong, while gas
prices have generally fallen. However, contract prices for drilling
infrastructure such as rig equipment and personnel continue to be linked to
oil prices. The upshot is that gas exploration has become increasingly less
viable.
There have
also been a number of micro-economic events that affected individual
companies and regions. The difficulty in employing extraction methods in
Central Europe using similar techniques as those in North America arises from
the significant differences in the geological makeup. This has led to
disappointing exploration performance.
TER: Are there
limits to the supply of natural gas that can be profitably brought to market?
SW: The
movement of the gas market is largely randomized on a macro level. Shifts in
supply and demand are being dictated by economic growth in emerging economies
and continued productivity from existing and untapped resources. It's fairly
unpredictable.
But in the
near term, gas prices will be dictated by the aggressive use of gas in China
and India from their growing economies, which will push prices on a global
scale. As will the discovery and utilization of gas resources in Latin
America—an up-and-coming region with a huge, untapped potential for
natural gas. There is a move away from nuclear power in Japan and some
European countries in response to the nuclear incident in Fukushima. And
Europe is continuing to process policies requiring greenhouse gas emissions
reductions. That could hinder direct gas exploration there.
In Russia,
however, people are slowly chipping away at Gazprom's monopoly. In response,
it is looking to regasify the Far Eastern region,
which could also push prices. Generally, the ongoing search for shale and
other unconventional gas will dictate the global gas price regime. In the
U.S., though, the low Henry Hub price could result in a lot less drilling for
gas and more of a focus toward oil production, which could drive gas prices
back up.
TER: Thanks
very much, Sam.
SW: Many
thanks, Peter.
Sam Wahab began his
career at PricewaterhouseCoopers (PwC), where he qualified as a prize-winning
chartered accountant. On PwC's energy team, he specialized in assurance and
transaction advisory. His clients including Royal Dutch Shell and JKX Oil
& Gas. Following a spell in the oil and gas research team at Arbuthnot
Securities, Wahab joined Seymour Pierce in 2011. He
heads up oil and gas equity research at the firm. His coverage includes
companies with global operations on multiple stock exchanges.
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DISCLOSURE:
1) Peter Byrne 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: Tethys Petroleum Ltd. and CBM Asia Development Corp.
Interviews are edited for clarity.
3) Sam Wahab: I personally and/or my family own
shares of the following companies mentioned in this interview: None. 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
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