The Energy Report: Stephane, what is causing the current turnaround for the oil and gas industry?
Stephane Foucaud: We have reached a point where valuations are becoming so attractive that industry is stepping in. I'm particularly talking about the U.K.-listed names and the international names. It's always an arbitrage between what the industry is willing to pay versus what the market is willing to pay. Things have dropped a lot. Now the industry is stepping in through mergers and acquisitions (M&A).
Source: FirstEnergy LLC
Another factor is sector rotation. At some point the buy side can't keep betting on the same horses, and investors have to move from a sector that's outperforming to a sector that's underperforming. In Canada, we have also seen a recovery of gas prices, and domestic Canadian names are coming back.
TER: Why were acquirers offering such high premiums for Heritage Oil Corp. (HOC:TSX; HOIL:LSE) and Caracal Energy Inc. (CRCL:LSE)?
SF: The share price of those two companies has been driven by market sentiment and by the fact that the buy side has been underweight in the sector for a long time. As you underweigh the sector, the smaller-cap companies in that sector tend to be hit harder than the larger cap. That has created a very large gap between what the industry is going to pay and how the market is pricing those shares. If you want to close that gap, then the premium has to be hefty. If not, the management teams of those companies will not accept the offers, so the offer has to be attractive for both sides.
TER: What other E&Ps are potential acquisition targets for these reasons?
SF: For a company to be more likely to be taken out, it has to have certain features. It should have world-class assets, and these assets have to be undervalued by the market. If you look at those criteria, the names that come to mind are Nostrum Oil & Gas L.P. (NOG:LSE), Ophir Energy Plc (OPHR:LSE), Bankers Petroleum Ltd. (BNK:TSX) and Tullow Oil Plc (TLW:LSE). Companies with smaller producing assets and very compelling valuations could be added to that list. This includes companies like Salamander Energy Plc (SMDR:LSE).
TER: How do operations in Africa affect the attractiveness of E&Ps?
"Africa has so many opportunities and so much exploration upside."
SF: Africa is a particular place because there are so many opportunities and so much exploration upside. There are different themes that come up, like the Nigerian theme, where the super majors divest mature assets (often with production) to new entrants or smaller companies, or to what we call indigenous (Nigerian) companies, that get specific fiscal benefit from the government. Those assets tend to be onshore or near shore and carry very low exploration costs. We have seen quite a few transactions along those lines. Another theme has been gas in East Africa, which has been dominated by national companies, majors and supermajors. These projects are often offshore with very big capex—expensive wells—and these projects are often gas. This is almost the opposite theme to Nigeria onshore, which is often oil with low-cost development.
Over the last few years, we have seen the emergence of a landlocked theme—onshore exploration in less established areas, where transport infrastructure has historically been limited. This includes onshore Kenya and Chad.
We have also seen an increase of interest in exploration offshore West Africa, which is oil-dominated. Companies are looking for presalt plays, such as those in Angola, Gabon or Congo, or prospects along the transform margin. Following successes offshore eastern Canada, the industry is also reconsidering offshore Morocco. While Angola has been a clear success, results so far at the other West African exploration themes have been less obvious. We have seen, of late, multiple asset transactions in Angola, Morocco, Liberia and Namibia among others and exploration assets along the West Africa coast remain hot, even for supermajors, which are otherwise divesting assets. Offshore West Africa, costs are high.
TER: Is the increase in oil and gas prices changing any of your forecasts for the companies you cover?
SF: Not really. We have been quite consistent with our forecasts and have not changed materially for quite a bit of time. We were expecting commodity prices to come up. There has been no material change with regard to our view of the commodity and commodity world.
TER: Do you have specific forecasts for oil and gas prices this year and next?
SF: I think we're expecting something broadly flat. In the $105–110/barrel ($105–110/bbl) range.
TER: Is that for Brent?
SF: That's for Brent. Most of the international companies are exposed to Brent rather than West Texas Intermediate.
TER: Tethys Petroleum Ltd. (TPL:TSX; TPL:LSE) is operating in the peripheral states of the former Soviet Union, Kazakhstan and Georgia. How is Russia's apparent policy to exert more power in its historic sphere of influence affecting this company?
SF: I think not much. It is particularly exposed to China, because China has also been increasing its influence on those countries. Tethys' gas in Tajikistan is likely to go to China if the company makes a discovery. The gas of Tethys in Kazakhstan would be exported through a pipeline, also to China. The oil is being sold domestically.
TER: What prompted you to rate Tethys an outperform?
SF: We think it's a unique risk/reward opportunity, assuming success particularly in Tajikistan. The share price could be a multiple of what it is today. On top of that, in the near term, you have a bit of momentum around production growth and cash flow growth associated with gas in Kazakhstan that should more than support the current valuation.
TER: You included Nostrum Oil & Gas among companies that are likely takeover targets. The Financial Times has reported the company has won approval for a premium listing in London and could even be promoted to the FTSE 250 Index in September. What do you see in Nostrum's future now?
SF: The main issue for Nostrum has been the lack of liquidity and the fact that it was listed in London with a U.S. dollar in front of the share price. For many generalist U.K. investors, who have traditionally been the investors moving the share price or taking positions in companies of similar size and profile, the lack of liquidity and the fact it was priced in U.S. dollars was problematic. Moving to a main board listing, being part of the 250 index and having pound shares should make Nostrum much more attractive to U.K. generation investors.
TER: Are there any companies that you feel especially interested in or excited about that we haven't discussed?
SF: I am a really a big fan of EnQuest Plc (ENQ:LSE). There is a particular opportunity in the North Sea at the moment, where many of the companies have the same strategy and that strategy is around divesting assets, material assets. Very few companies have the balance sheets to absorb those assets. EnQuest is one of those. I think they are extremely well positioned to benefit from that change in the North Sea. When you combine that advantage with the fact that the company is extremely attractively priced, I think it's a very good story to look at in a unique moment of time.
TER: Thank you very much for your time.
SF: Tom, thank you very much.
Stephane Foucaud is managing director of institutional research at 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 of Science in Engineering from the National School of Electrical and Mechanical Engineering of Nancy, France, a Master of Science in Exploration Production from the French Petroleum Institute and a Master of Business Administration from INSEAD in France.
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DISCLOSURE:
1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Tethys Petroleum Inc. Streetwise Reports does not accept stock in exchange for its services.
3) Stephane Foucaud: I own, or my family owns, shares of the following companies mentioned in this interview: None. 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: FirstEnergy is broker for Tethys Petroleum Inc. and Bankers Petroleum Ltd. FirstEnergy London is not authorized to give advice to retail investors. 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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