The Energy Report: Looking back to your last interview with The Energy Report in November, you seem to have called the bottom in gas prices correctly. What's your view of where things are headed now?
Robert Cooper: We expect a reasonably robust pricing scenario ahead. Here's why: In 2013, we will likely see flat natural gas supply growth; this will be the first year in the last several that this will be the case. The natural gas rig count is at 350, the lowest since 1995. The declining rig count has taken its toll on almost every U.S. shale basin; the only basin that's growing is the Marcellus, and it is growing partly because infrastructure constraints are being alleviated. Unless productivity undergoes another massive step higher, or drilling time is cut in half again, rig count matters as a predictor of natural gas production levels. Natural gas liquids (NGL) prices are weak, and this impacts the ability of explorers and producers (E&Ps) to reinvest at the same level as even a year ago. This further reduces the probability that capital will be redeployed to dry gas plays.
TER: Your May 9 report shows gas storage 28% lower year over year and 5% below the five-year average. What are the implications of that?
RC: It means the gas market is in deficit. If I were an end user who was short gas, I'd be worried—the conditions are in place for a gas price rally that could catch me unaware.
TER: What do you think the chances are of that happening?
RC: I wrote in March that we're looking at CA$4 per thousand cubic feet (CA$4/Mcf) gas in Canada. We got to around CA$3.89 on the spot market, and the strip in the winter was very close to CA$4. If it's a normal summer, I think there's a better than 50% chance of hitting that CA$4 level in Q4/13 or Q1/14. I also said in our last interview that if you give me normal weather, I can give you CA$4/Mcf gas, which was the case.
TER: How low do you think gas could go again, in the next year or so?
RC: I never say "never," but I wouldn't bet on a return to last year's $1.90 price low or anything close to that. Right now, we have a favorable storage situation and we have long-term beneficial factors working in the gas market bull's favor.
TER: What do you see on the horizon for oil? Do you expect oil to be range-bound up to $105 per barrel ($105/bbl)?
RC: The economy isn't strong enough to support $100+/bbl oil for very long, nor will supply costs support prices below $80/bbl for very long. Unless there's a big change in the economy toward much stronger or much weaker growth, that range is probably what you can look for in oil prices.
TER: Storage and distribution capacities are key factors in determining North American oil prices. How are you reading those indicators?
RC: In Canada, the bulk of our oil supply growth is slated to come from the oil sands. We need pipelines to transport that. But in the short term, midcontinent refineries are scheduled to complete turnarounds this summer, and that should firm up heavy oil prices relative to West Texas Intermediate (WTI). Infrastructure, or lack thereof, has certainly been a dominant theme in the Canadian oil market, certainly for the past year or so. Oil by rail has been an important bridge, as it has allowed product to move from where it's produced to where there's demand while bypassing infrastructure constraints. The development of oil by rail has been a textbook case of the invisible hand of the market at work.
TER: What's your view on the Keystone Pipeline? Will it be built?
RC: That's the million-dollar question. President Obama is under considerable pressure from environmentalists who believe oil sands development is the main bogeyman contributing to global warming. But the U.S. has had a goal of achieving energy security since Nixon, and Keystone would move the U.S. a lot closer to this goal—that would be an important legacy for any president. In addition, Keystone is important for the U.S./Canada relationship. Rejection of the pipeline could be problematic for bilateral relations and would likely push Canada to increase its energy involvement with the U.S.' strategic competitors in Asia. If I had to guess, I'd say Keystone will ultimately be approved, but likely with some quid pro quo that will be an attempt to pacify the president's environmentalist support base.
TER: How has price action for oil and gas impacted the companies you cover?
RC: The volatility has, at times, removed the incremental and marginal buyer from the equation. In particular, foreign investors have looked at Canada and said, "I'm just going to buy Brent exposure or pure WTI exposure and avoid all of this price differential and pipeline risk." And they have. So access to capital for Canadian producers has been limited, especially for the small- and mid-cap companies, thereby limiting their strategic options. Ultimately, if this volatility continues, it will result in further culling of the investable universe.
TER: So it's going to be survival of the fittest?
RC: More or less, yes.
TER: What companies have been your best performers over the past six months?
RC: Because the market has been so bleak, the best performers have been ones we're trying not to lose money on, unfortunately. In my last interview, we talked about Crocotta Energy Inc. (CTA:TSX), Tamarack Valley Energy Ltd. (TVE:TSX.V) and Novus Energy Inc. (NVS:TSX.V). Crocotta and Tamarack are in roughly the same spot as when we last talked. Both have executed well on their business plans, and both have advanced the ball in developing new plays and properties. Each has performed quite well in a miserable market. Consequently, we still recommend both. They both have very strong management teams that are heavily invested and are motivated to do the right thing for shareholders.
Novus is a little bit of a different story. The consolidation we discussed in west central Saskatchewan's Viking area was fast coming and, indeed, has accelerated as expected. Novus has decided to participate in that. In late November and early December, it announced that it was considering methods for optimizing shareholder value, including a corporate sale. That process has been ongoing, admittedly at a slower pace than anticipated. But investors will see an answer one way or another. The Board of Directors is expected to decide which direction the company will be heading, potentially as soon as the end of the month.
TER: Another company you talked about is Yoho Resources Inc. (YO:TSX.V). Can you give us an update?
RC: Yes. Yoho's stock price has basically remained flat since the last time we talked. However, all of the underlying fundamentals continue to improve. Its core position is in the Duvernay play, in the Kaybob region of Alberta. The Duvernay, in our view, is fast becoming a world-class shale play as it continues to mature. Exxon Mobil Corp. (XOM:NYSE) recently purchased Yoho's partner. Since we last talked, PetroChina Co. Ltd. (PTR:NYSE; 857:HKSE) bought a 50% interest in Encana's Duvernay acreage, the best part of which is proximal to Yoho. This was a multibillion-dollar transaction. Yoho has continued to drill good wells that have been on cost and at expected rates. It's taken a little bit of time to gestate, but ultimately the Duvernay is going to become the domain of much larger companies. Immediately proximal to Yoho is Chevron, Exxon, Encana Corp. (ECA:TSX; ECA:NYSE), Talisman Energy Inc. (TLM:TSX) and Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE). Yoho is a prime takeout candidate. It has a sustainable business plan with well over $1 billion ($1B) of future capex to drill in the Duvernay alone, so this company could be around for a long time. But in our view, it will ultimately be purchased by a larger player. We expect Yoho will be a winner for investors who have a slightly longer time horizon than tomorrow.
TER: How about some new names that you're covering that look interesting?
RC: We're very big fans of a new company called Condor Petroleum Inc. (CPI:TSX) run by a very experienced group of managers who came out of the supermajors, Chevron Corp. (CVX:NYSE) in particular. The President and CEO, Don Streu, is a serious individual who managed very large projects for Chevron in Angola, Indonesia and Nigeria. Condor has taken a very different approach to exploration in Kazakhstan by gathering an immense amount of three-dimensional (3D) seismic data to derisk drilling. This is something that hadn't been done there before and it has paid off. Condor recently announced a large discovery well and is appraising it as we speak.
Condor represents one of the best risk-reward tradeoffs we can find. Well costs are very low—appropriate for a company its size, and yet the targeted prospect size is very large. So there is a whole lot of torque for shareholders. Condor has a fully funded balance sheet. It sold a noncore gas property for $88 million ($88M), has an active exploration program and is pursuing joint ventures with much larger companies for its largest and most expensive prospects. The main caution is that in Kazakhstan, business proceeds at a slower pace than in North America because of the large government bureaucracy and lack of developed infrastructure, especially in the rural parts of the country where Condor operates. So this is a true investment rather than just a trade.
TER: Where is the stock trading now, and where do you think it's going?
RC: It's a $0.50 stock today. We have a $1.10 target on it.
TER: What's the level of political risk in Kazakhstan?
RC: Any place outside of North America is not going to have the same sort of risk profile as we do at home. What I can say about Kazakhstan is that there is a very large and onerous bureaucracy in place because it is a deliberate attempt to stymie corruption. Kazakhstan is rapidly growing and has broader ambitions than to just be a regional player, such as joining the World Trade Organization. It's certainly not for the faint of heart, but on the other hand, we think that the risk-reward tradeoff for Condor is well in your favor right now. Condor's management team is full of individuals who have operated in the country's oil and gas sector before, which is an essential consideration. Kazakhstan has immense potential for oil and gas development and Condor knows how to operate effectively in that environment. So we recommend the stock.
TER: What's your general advice at this time for investors looking for potential profits in the oil and gas sectors?
RC: I'd recommend that you do your homework and that when you buy, ensure you have a margin of error with respect to valuation. And have patience, because this is a very jittery market. Ultimately, good companies with good assets—purchased at good prices—tend to pay off over time. But if you have a very short time horizon, you might not get that opportunity to see the value creation. There is some very good value in the oil and gas sector in Canada right now, but it also takes time for catalysts to emerge to crystallize that value. That takes an investor as opposed to a pure trader.
TER: Good advice, Rob. We appreciate the opportunity to talk with you again.
RC: Thank you for having me.
Robert Cooper, CFA, is a senior energy analyst based in Calgary with a focus on Canadian oil and gas exploration and production companies with domestic and international operations. Robert has more than 10 years experience in the investment industry and has been covering the Canadian oil and gas sector since 2006. Robert is a past president of the Calgary CFA Society.
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DISCLOSURE:
1) Zig Lambo conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He 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. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Robert Cooper: I or my family own shares of the following companies mentioned in this interview: Crocotta Energy Inc. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Crocotta Energy Ltd., Yoho Resources Inc. and Condor Petroleum Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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