Operating in difficult conditions—whether political, logistical or
technical—comes with the oil and gas territory, but the collapse in oil and
gas prices has added further complexity and risk to the space. Though many
companies have lost half or more of their share price in the debacle,
Stephane Foucaud of FirstEnergy Capital tells The Energy Report
how to find value in small-cap exploration and production names, and provides
several examples of companies poised to rebound on the upturn.
The Energy Report: Stephane, do you think the oil price has
hit bottom and is now recovering?
Stephane Foucaud: When the Brent oil price was close to $50/barrel
($50/bbl), I think it was the bottom. It has recovered quite a bit. There is
a risk that it might dip again, but I don't think we will reach the low $50s
for quite some time. The reason I think there is a risk that the oil price
could dip is that there has been an overreaction to the North American rig
fleet reports, and particularly to what appears to be a large number of rigs
being taken out of the market. Those rigs are, however, associated with
lower-producing areas. Therefore, I think it's more sentiment than reality in
terms of impact on the supply. The recovery has been too steep.
TER: What prices are you forecasting for 2015 and 2016?
SF: For 2015, we are anticipating $59/bbl Brent. For Q1/15, we have
$54/bbl; Q2/15 at $58/bbl; we expect to end up at $63/bbl. For next year, we
have $72/bbl. The trend on the one-year view is upward, but with some
fluctuation.
TER: The Islamic State of Iraq and Syria (ISIS) is growing in
Libya, and is threatening the oil industry there. How would capture of the
oil fields by ISIS affect commodity prices?
SF: Though it is part of the equation, and Libya is a problem,
production in Libya has already dropped a lot, and is arguably already
factored into the oil price. I think the situation in Iraq and Kurdistan with
regard to ISIS is equally, if not more, important. If you have deterioration
of the situation in Kurdistan and Iraq, that will have a positive impact on
the oil price. Now, that has to be considered in the context of Venezuela
potentially blowing up, which would be very serious, or Russia disappointing.
And Russia is currently a black box.
TER: What do you mean by black box?
SF: There are currently sanctions on Russia. But I think most of
the market does not really expect much decline in supply this year from
Russia. Very few oil forecasting agencies have a detailed model as it applies
to Russia, because there is very little visibility. So analysis is often
focused on the U.S., and to the north in Canada, where there is a free flow
of information and a lot of granularity. We don't have that level of detail
on Russia.
Russia is one of the largest producers in the world. Any deviation from
the broad assumption of production not dropping this year in Russia could be
very meaningful.
TER: You have a four-tier strategy for investment, and you've
slotted some of your companies into one tier or another. How do you evaluate
where they should go?
SF: First, I look at whether a company remains fairly defensive,
even in the current oil price environment, on the strip curve for Brent. I am
cautious about companies with overall asset value being marginal on the strip
curve for Brent, or with funding issues on the strip. Second, I look at
whether a company is operating in an area where the risk profile is not too
high, so there is not something that could suddenly blow up. Taking too much
political risk in the current market needs to offer really material upside.
Third, I look at the share price and see where I find value on the house view
for Brent.
TER: How has the collapse in commodity prices affected the oil and
gas companies you cover?
SF: First, their share prices have been hit extremely hard. Most
companies have seen their share prices halved—and sometimes more than
halved—but not all of them. The ones that are very well funded have been more
defensive. Second, the fundamental values of the assets have gone down.
Third, given the reduced cash flow, companies face issues with their balance
sheets and the repayment of any debt.
So today it's about looking at companies that are able to survive in the
current environment, and are still offering value on the strip. The companies
we like in the current environment are those whose share prices have dropped
much more than the underlying value of their assets, and those that are still
funded.
Companies we like at the moment include Premier Oil
Plc (PMO:LSE) and TransGlobe Energy Corp. (TGL:TSX; TGA:NASDAQ). Premier is
a North Sea story, and the market is somewhat concerned with its debt. The
company is embarking on a relatively low-risk exploration program in the
Falklands. A success could attract a farm-in partner, which would be a
rerating event as investors do not seem to ascribe much value to this group
of assets. TransGlobe Energy is cheap, and arguably offers the benefit of
being in an area where the politics are getting a bit better.
TER: How will TransGlobe Energy's writedown of its Yemeni assets
affect the company?
SF: I think the writedown was broadly expected. The situation in
Yemen is difficult and pretty complex. We are not fundamentally surprised
that the company decided to write down its assets. The contribution to the
company value compared to shareholder expectation is absolutely minimal.
TER: How has Premier Oil responded to the collapse in oil prices?
SF: Premier has kept its net debt almost at the same level. The net
debt level has been higher than the current market cap for some time.
The fact that Premier explores in the North Sea means it is, by
definition, quite sensitive to the oil price. At one point, the share price
was half what it was before the oil price collapse. That's quite significant
given that Premier is one of the blue-chip exploration and production
companies listed in London, with good hedge in place on its production. The
shares are also very liquid.
So it has been difficult. The value of the company has gone down because
the oil price is lower and it has fairly high-cost assets. But, again, that's
what you'd expect in a world where the oil price drops.
TER: Premier has described its hedging policy as
"conservative." What does that mean in practice?
SF: It means that the oil price at which the company is hedged is
quite high, and that a fairly important component of its production is being
hedged. Particularly when you look at the lower oil price environment, the
overall cash flow of the firm is enough—or close to being enough—for the
company to operate with confidence.
For instance, if the indebtedness of a company is quite low, and if the
costs associated with its assets are also quite low, one would argue that
such a company would need less hedging than a company that needs a high oil
price to make its assets work and to repay debt. By "conservative,"
Premier means it is quite resilient to a low oil price, and can deal with
fairly high-cost assets and a high level of debt.
TER: Is there a last company you would like to mention?
SF: Our argument for Tethys
Petroleum Ltd. (TPL:TSX; TPL:LSE) is based on growing production to
China, increasing gas export price, and exploration upside in Tajikistan. But
more than anything, it's all about the completion of the deal with a Chinese
private equity firm that would be buying 50% of Tethys' Kazakh asset. The
value of this deal is more than Tethys' current market cap. At the time that
this deal closes, the company gets over US$80 million (US$80M), which
compares with a market cap at the moment of less than £30M (about US$45M).
You can see the investment logic. This is almost 50% upside on the
transaction with the Chinese private equity firm. Beyond that, there is
production growth and exploration upside in Tajikistan. The upside is quite
significant.
TER: How are you advising investors to proceed in the oil and gas
space now, given current prices?
SF: Look for names that offer liquidity. Look at the value of a
firm based on the future curve for the oil price, and look for companies that
have value at that level. If the oil price gets better then great, there will
be some upside. Our approach is quite cautious—liquidity, value on the strip,
upside beyond the strip, and the relative assurance that there won't be a
serious debt issue in the near term.
TER: Thank you very much for your time, Stephane.
Stephane Foucaud is managing director, institutional
research, of FirstEnergy Capital LLP. Before joining FirstEnergy, he was head
of oil and gas research at Fox Davies Capital and senior oil and gas analyst
at Société Générale in London, covering Royal Dutch Shell, BP, BG Group,
Statoil and Cairn Energy. Foucaud also worked for Schlumberger for seven
years in various technical, operational management and corporate strategy
roles. He holds a master's degree in engineering from the National School of
Electrical and Mechanical Engineering of Nancy, France, a master's degree in
exploration production from the French Petroleum Institute, and a master's
degree in business administration from INSEAD in France.