[Editor's note: This article was updated Dec. 8, 2014.]
The Energy Report: Your expertise is in the exploration and production (E&P) space. Please give our readers some key investable ideas among those names.
Philip Juskowicz: We've seen a divergence between the micro-cap space and the small-cap space within the oil and gas E&P companies. The micro caps have underperformed substantially versus the small caps over the past couple of years. I attribute that to enthusiasm for shale plays, yet only small-cap companies have the financing necessary to develop those expensive plays. Micro caps missed out on that investor appetite; that's probably why they had underperformed.
"ENSERVCO Corp. has done a good job gaining market share in existing markets, making small acquisitions and growing organically into new markets."
Given the current oil price environment—uncertainty, downward pressure—the first companies to get hit were the ones with strong exposure to oil prices, even if it was just headline exposure. In fact, my research shows a 58% correlation between the small-cap universe and oil prices, whereas the micro-cap space only vaguely correlates to oil prices. Most small caps are going to be hit regardless of what hedges those companies have in place, whereas many micro-cap companies are one-off value plays, and those value plays are still intact. There is a good case for micro-cap stocks here.
TER: The predominant oil price theory making the rounds is that surging U.S. oil production from old basins and shale plays has reduced America's dependence on imported oil and will keep downward pressure on the oil price for the foreseeable future. Is that how you see it?
PJ: I do. Research we published last week showed that the rig count in areas providing the recent U.S. production surge have to drop ~30% to offset higher rig/well productivity and result in lower production that will, in turn, raise pricing.
Given the substantial cash flow industry generated this year and its penchant for overspending, we do not foresee the rig count declining to that extent. To date, we've actually seen such companies announce major increases in both rigs and capex for the Eagle Ford Shale; we have seen moderate to significant declines for the Permian and Marcellus, but not to the 30% area.
Moreover, rig count reductions take months to implement given existing contracts. As a result, we do not expect any impact from rig count reductions—and resultant increase in pricing—until 2016.
A much more significant decline in prices would be necessary to result in curtailing existing production, given that front-end capex has already been spent. For example, Cabot Oil & Gas Corp.'s (COG:NYSE) unit cash costs in the Marcellus are ~$0.75 per 1,000 cubic feet equivalent (~$0.75/Mcfe); current gas prices are $3-4/Mcfe.
TER: What are your near- and mid-term crude forecasts?
PJ: I'm significantly below the consensus on The Street. The consensus was $86/bbl for 2015 and $92/bbl for 2016. I'm at $69/bbl in 2015 and $75/bbl in 2016. Drilling curtailments should help lower production by 2016.
TER: In mid-November, JPMorgan Chase & Co. downgraded its 2015 Brent price by $33 to $82/bbl, citing pressures in the Atlantic basin and the inability of the Organization of the Petroleum Exporting Countries (OPEC) members to curtail production. It also lowered its 2016 forecast to $87.80 from $120. What are your thoughts on those moves?
PJ: The consensus figures out there are too bullish. It feels good that there's a major bank that has lowered its pricing forecasts. JPMorgan Chase is not saying it's going to be an all-out blowout, but that its 2016 price of $120/bbl may have been too high. The company has a lot of quantitative people behind those numbers.
TER: JPMorgan Chase also warned us that if there is not a new OPEC agreement in place, crude could slip as low as $65/bbl in January. Is that likely?
PJ: Over the last three years or so, OPEC has become less relevant, less cohesive and, therefore, less able to dictate world oil prices. If the market thinks that OPEC is falling apart, there could be a psychological impact, but not an actual fundamental impact. I don't think OPEC is acting on the basis of supply/demand fundamentals.
TER: Do you expect the spread between West Texas Intermediate (WTI) and Brent to continue to contract?
PJ: I definitely don't see it widening. If anything, it should narrow or remain status quo. The main factor is that the petroleum industry has become more global. You see that with Saudi Arabia dillydallying to U.S. pricing; you see that with the U.S. moving toward exporting oil; and you see that with more infrastructure being built in the U.S., which is lessening the gap between WTI, Cook and other benchmark prices.
TER: It was recently reported that Halliburton Co. (HAL:NYSE) has made a takeover bid for Baker Hughes Inc. (BHI:NYSE) How will this merger impact the energy services sector? Do you project any other major M&A news in the coming months?
PJ: The consolidation of two major oilfield service companies can only result in stronger pricing power, notwithstanding any Hart-Scott-Rodino-mandated divestitures. This would hurt explorers and producers (E&Ps).
"Natural gas has some good demand momentum behind it."
I expect further consolidation in the oilfield services sector in an effort to compete with the new Halliburton. Any decrease in activity by the E&P space would put even more pressure on the space to engage in mergers and acquisitions (M&A). A lower pricing environment, which in some cases will constrain E&P balance sheets, should result in M&A activity within the E&P sector, as well.
TER: What themes do you expect to be dominant in the E&P space in 2015?
PJ: Number one is that there are value plays in the micro-cap space. These companies have been overlooked in the shale play revolution happening over the past couple of years.
Another item for investors to consider is good old natural gas, because lower oil prices have reduced the oil-and-gas spread. On an energy-equivalent basis, not that long ago oil was five times as valuable as gas. That number is now three times. And natural gas generally costs less to drill for and produce. The margins for natural gas companies are going to widen.
Moreover, natural gas has some good demand momentum behind it given that several petrochemical plants and liquefied natural gas facilities (some of the biggest end users of natural gas) are slated to begin production over the next couple of years, while coal-fueled electric generation facilities are being phased out.
We have a Buy rating on Dejour Energy Inc. (DEJ:TSX; DEJ:NYSE.MKT). It fits both of these criteria—it is a micro cap and most of its reserves are natural gas.
Moreover, Dejour is a value name, in our opinion, making it an ideal investment in an uncertain and volatile pricing environment. Shares are down ~40% since achieving a 52-week high in August, and the company's enterprise value stands at CA$41 million (CA$41M), less than half the value of the PV10 of its reserves.
Additionally, we see Dejour's Piceance Basin assets as low risk given the basin's long-lived, low cost and stable production (witness two semirecent industry sales to master limited partnerships within this area).Finally, the company gains from geographical diversification due to its Canadian operations.
TER: What are your 2015 and 2016 price forecasts for gas?
PJ: They're $4.16 per thousand cubic feet ($4.16/Mcf) for 2015 and $4.50/Mcf for 2016.
TER: If investors are doing their due diligence on micro-cap equities and come across companies with working capital issues, should they consider that a red flag?
PJ: It is a red flag, and I would put those companies down as speculative buys. I had one company modeled as having a negative cash position within a couple of months; my speculative buy assumed the company received a capital infusion. I think that is normal for micro-cap companies. The company doesn't have accounts receivable per se, yet has general and administrative expenses. It's not uncommon to have a working capital deficit.
TER: You recently upgraded your rating on an oil services name. Please tell us about that.
PJ: ENSERVCO Corp. (ENSV:NYSE.MKT) is a relatively small company that provides frack water heating, hot oiling and acidizing services to the E&P universe. I like that the company is increasing its exposure to these defensive types of services. We're in a questionable environment for oil prices. Drillers are being squeezed and rig counts are going down, but even in a down market drillers need someone to pump hot oil down a well to dislodge paraffin buildup or to acidize a well to stimulate production. ENSERVCO has done a good job gaining market share in its existing markets, as well as with making small acquisitions and growing organically into new markets.
TER: It recently made a small purchase of 12 hot oiling trucks. How is that material to its top line, if not its bottom line?
PJ: ENSERVCO pointed to about $6M of revenue potential related to that purchase, and that's what triggered my upgrade. The stock recently went down to levels where an upgrade made sense. This is an example of a company being able to develop relationships with much smaller companies so that it can make acquisitions to grow its business.
TER: What is your rating?
PJ: It's a Buy-rated company. I have a $2.85/share price target.
TER: What names have you recently launched coverage on?
PJ: I launched coverage on Taipan Resources Inc. (TPN:TSX.V), which operates in Kenya. I have a Speculative Buy rating on the company given that it doesn't have reserves at this point; it has "prospective resources."
"Micro-cap companies have been overlooked in the shale play revolution happening over the past couple of years."
What I like about the resource is that the first well, which will go down in December, will test a structure that's identical to several geological structures that have proven to be 100+ million barrel (100 MMbbl) discoveries over the past few years. In fact, the company's exploration manager found 1.75 billion barrels in a similar geological structure.
TER: Though Kenya is one of the more established countries in Africa, it is not an established oil production jurisdiction like South Africa or even Egypt. Is the risk of Kenya worth the reward?
PJ: I haven't seen a lot of civil unrest in the exploration areas. People automatically chalk up every country in Africa as being dangerous, but not every country is Sudan. Taipan is a Speculative Buy: It's a risky name and it's going to be years until any success becomes commercial. Tullow Oil Plc (TLW:LSE) is the main player in this East Africa rift play, and Tullow has discovered enough oil to justify the construction of infrastructure, which is estimated at $4.5 billion ($4.5B). And Kenya and Uganda are working together to commercialize the resource there.
The other thing I want to point out is that Premier Oil Plc (PMO:LSE), a large company based in the United Kingdom with a market cap of about $1.9B, paid $30.5M for a 55% interest in the well that's going to be tested in December—and it's allowing Taipan to operate the well. That investment speaks volumes about Premier's belief in Taipan's prospects in Kenya.
TER: Certainly, Chinese state-owned enterprises have bought a lot of oil and gas assets in Africa. Is there a chance of that happening in this case?
PJ: Chinese firms have traditionally come in after these plays get up and running. That has happened offshore in Brazil, in the Gulf of Mexico, and in the Eagle Ford shale. If China comes in, it would probably be farther down the road.
TER: What is your price target on Taipan?
PJ: It's $1.10/share.
TER: Are there other stories you'd like to share with us?
PJ: Despite hedges covering 90% of its current oil production at almost $100/bbl, and the majority of its gas contracted at $7/Mcf, Miller Energy Resources (MILL:NYSE; MILL:NASDAQ) has seen its stock killed, down 75% since July 1. Yet its production has come up and the company has made significant management changes, which should satisfy frustrated investors.
"I expect further consolidation in the oilfield services sector, in an effort to compete with the new Halliburton."
Miller hired Carl Geisler, former managing director of investments for Harbinger Group Inc., as CEO. At the same time, it's retained former CEO Scott Boruff's deal-making expertise. Miller has done a great job of consolidating assets, acquiring assets, finding new reserves and developing resources. Production should continue to climb. In the latest quarter, Miller produced 3,300 barrels of oil equivalent a day (3,300 boe/d). We calculate its net asset value per share at more than $7.50. Its midstream and rig assets alone have been appraised at $175M, and that does not include the value of its reserves. This company has the defensiveness of having real midstream assets that are strategic in nature, meaning that they're the only production facility in the regions where Miller operates, and it doesn't have to rely on the oil price to maintain the entire net asset value.
TER: Miller recently sold its assets in Tennessee, and now is exclusively an Alaskan play. What did you make of that move?
PJ: It's another example of Miller saving some money on selling, general and administrative expense, and consolidating its focus. It started as a Tennessee company, but production there was about 1% of the company's total production. Shareholders are interested in its Alaskan assets, not Tennessee.
TER: Miller has a nonbinding agreement to buy Buccaneer Energy Ltd.'s (BCGFQ:OTCMKTS) assets in Alaska. How likely is that to happen?
PJ: There's a good chance that a decent portion of the Buccaneer assets go to Miller. It makes strategic sense. These assets should just fit right in to what Miller does, which would be buying distressed assets. And some of the other major oil companies operating there, like BP Plc (BP:NYSE; BP:LSE), are deemphasizing their Alaskan operations.
TER: Thank you for talking with us today, Philip.
Philip Juskowicz, CFA, is a managing director in the research department at Casimir Capital, a boutique investment bank specializing in the natural resource industry. Juskowicz began his career at Standard & Poor's in 1998, where he was one of the first analysts to recommend Mitchell Energy, credited with discovering the Barnett Shale. From 2001–2005, he worked with a former geologist in equity research at both First Albany Corp. and Buckingham Research. At Buckingham, Juskowicz was promoted to a senior oilfield service analyst position, leveraging his extensive knowledge of the E&P space. From 2006–2010, he was an insider to the oil and gas industry, serving as a credit analyst at WestLB, a German investment bank. In this capacity, Juskowicz was responsible for $500M of loans to energy companies and projects. He earned a master's degree in finance from the University of Baltimore.
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Miller Energy Resources is currently a client of an affiliate of Casimir Capital L.P. and has been a client during the 12-month period preceding the date of distribution of this interview. During aforementioned period, an affiliate provided non-investment banking-related services and has received non-investment banking-related compensation from the subject company.
Taipan Resources is currently a client of Casimir Capital L.P. and an affiliate, and has been a client during the 12-month period preceding the date of distribution of this interview. During aforementioned period, Casimir Capital L.P. provided investment banking related services and has received investment banking related compensation from the subject company and an affiliate provided non-investment banking related services and has received non-investment banking related compensation from the subject company.
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