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Light oil
is the sweet spot for Jennings Capital Oil and Gas Analyst Tim Murray. He's
finding plays that tap into pools via horizontal drilling. In this exclusive
interview with The Energy Report, Tim talks about finding big growth
stories in small companies that require investors to take on a bit more risk.
Companies Mentioned: Chesapeake Energy Corp. Equal
Energy Ltd. Midway Energy Ltd. Novus Energy Inc. Palliser
Oil & Gas Corporation Reliable Energy Ltd. Renegade Petroleum Ltd.
SandRidge Energy Inc. Torquay Oil Corp. WestFire Energy Ltd. Wild Stream
Exploration, Inc.
The Energy Report: Tim, how do you describe your universe
of coverage?
Tim Murray: It's primarily small cap. So, I'm looking at market cap
sub-CAD$500M, but we don't like to get much smaller than CAD$50M. In between,
we're looking for themed ideas. The one theme that sticks out in my coverage
universe is light oil. I call it my "tight light oil universe,"
where I cover a number of companies focusing on developing assets with
horizontal multi-stage fracture stimulations. The other focus is liquids-rich
natural gas, however my universe is much smaller here, I only cover two
names. I like to have a bigger company in my themes,
and also a couple of small exploratory plays with a bit higher risk, but with
bigger bang for your buck.
TER: Under-CAD$500M market cap means that small-cap mutual funds can
buy in and still get doubles and triples out of companies starting at that
size.
TM: Yep, no doubt about it. In the small-cap world, you're not looking
for 5% or 10% returns. You're looking for meaningful returns. For higher-risk
names, doubles and triples are possible. That's what investors want out of
the space, but these smaller-cap companies also carry a higher risk rating.
TER: Why light oil?
TM: When I transitioned over to Jennings Capital back in December of
'09, we didn't see any meaningful short- or medium-term reasons to be in the
natural gas space. However, light oil, in our eyes, looked to be gaining
momentum and the emergence of horizontal drilling and multi-stage fracks
looked to be opening up a number of historic oil pools that had been
developed vertically. Horizontal drilling had the potential to push pool
boundaries and increase recovery factors. That's exactly what happened the
last two years in the basin. We still see meaningful growth potential for the
light oil space at $100 oil and even lower commodity prices.
TER: You have so many buy-rated names in your universe of coverage.
Does this mean that there's a tremendous amount of value in small-cap oil and
gas plays currently?
TM: The reason there are lots of buys in my universe is because we've
got a pretty straightforward rating schedule. If my target price is over a
10% return, it must be a buy. As I mentioned earlier, in the small-cap world
you need meaningful upside to justify the added risk so investors should
really focus on my names with returns north of 20% and—for some of my
riskier names—north of 50% would be ideal. I think there's a lot of
value to be found among small caps if oil remains above $95 per barrel.
If you are of the belief that there might be some short-term pullback in the
price of oil, then you've got to be a little bit more selective. What I'd be
looking for are companies with good balance sheets in order to complete
meaningful capital programs and lots of future running room upon success. I
think the downside risk is minimal on most of my light oil names assuming we
stay above USD$95/bbl oil as light oil-focused companies should generate
meaningful cash flow and balance sheets should remain strong. The one wild
card will be operational success and the market will reward the companies
that demonstrate this.
TER: Are these companies in your universe actually growth stories, and
can they continue to be growth stories if the price of oil remains stable?
TM: Yes. Most of the names I cover in my small-cap universe are growth
companies. There's only one that I would call a modest-growth story from a
production standpoint: Equal Energy Ltd. (TSX:EQU; NYSE:EQU). If oil stays above
USD$95/bbl, the companies in my light oil universe are all generating
meaningful cash flow relative to their size. And the smaller ones, such as Novus
Energy Inc. (TSX.V:NVS), Torquay Oil
Corp. (TSX.V:TOC.A; TSX.V:TOC.B), Reliable
Energy Ltd. (TSX:REL), could double and triple production in the next two
years.
TER: What else are you telling investors?
TM: Obviously, we like the light oil space in general, and another
name I like that is the cheapest in our light oil space is Renegade
Petroleum Ltd. (TSX.V:RPL). This story has been a laggard in my light oil
coverage group as they missed guidance targets the last couple of quarters,
so the market's a little bit leery of the story. However, this is one of the
cheaper names in my light oil space and we do like the company's assets and
believe they should be able to add meaningful production into 2012. Renegade
has also drilled its first exploratory horizontal Bakken well in Renville,
North Dakota, which has seen very little Bakken activity. The well is
currently waiting on a frack crew, so we should have well results out closer
to the third quarter. They have access to 48 gross
sections (50% working interest) so meaningful running room upon success.
TER: Will Renegade's cash flow support its capital expenditure
requirements? Will it necessarily have to go back to the market?
TM: The company did an equity raise of CAD$46M early this year and
recently received an increase to its bank, so it has lots of capacity on the
balance sheet to fund the going forward capital program.
The tightest light oil company in my universe, balance sheet-wise, is Midway
Energy Ltd. (TSX:MEL). If the company can hit our production forecasts,
it should be fine. However, any operational hiccups could lead to the balance
sheet becoming extremely stretched.
I also have two "W" companies, WestFire
Energy Ltd. (TSX:WFE) and Wild Stream
Exploration Inc. (TSX.V:WSX). I like both of these companies, which are
once again both targeting light oil. WestFire has two Viking plays—one
in Redwater, and the other in Dodsland. I think there's considerable running
room on the Dodsland area in Saskatchewan and WestFire has had tremendous
success to date at Redwater.
TER: Is there any stimulus or catalyst that could move WestFire?
TM: Oh, for sure. Right now the bulk of the first quarter
activity was at Redwater. NAL, along with several other operators, have
regulatory approval to drill 32 wells per section, but I only carry 12 wells
per section in my models. I must point out that NAL's 32-well design carries
a smaller recovery factor per well than my 12 wells, however, this generally
shows the ultimate recovery factors could be larger than we currently assign.
WestFire will also become active again in the greater Dodsland area after
spring break up and this is the company's largest asset, so any exploratory
success should help move the stock higher.
TER: The reason I ask about catalysts is because WestFire's market cap
is already up to CAD$386 million and the company's shares are up almost 60%
in the last six months.
TM: Many of the light oil stories have appreciated since Q410 due to
good operational success and the rising oil price. WestFire is one of those
as we were pushing the story hard in the summer months (around August) when
it had sold off quite a bit and we thought that it was overdone. Since then,
the story has rallied very hard, and outperformed the peer group early into
2011. We still think there's significant long-term value in the WestFire
story as the company has a very large inventory of light oil wells. It just
needs to spend additional capital to prove up the resource and, ultimately,
capture the value in the ground.
I couple that with my other "W" story, Wild Stream, which has
assets in Saskatchewan and Alberta. To date, it's done the best in adding
production and reserves of my light oil space. Through acquisitions, they
have added acreage and production in all its core areas, giving them further
running room. It has three light oil plays and there is an emerging fourth,
so, it's probably the deepest of the juniors that I cover and also the
largest in size. I like the scope of all its plays and we expect its first
horizontal well on the fourth light oil play at Swan Hills in the second half
of 2011. Wild Stream did lag our light oil group in early 2011, however, we
think it's very well positioned going forward and momentum should pick up
again in the second half of the year.
TER: You mentioned Equal Energy. You wrote a
research note saying it was very cheap. It sounds like a value.
TM: Yeah, it's definitely a value play right now. It trades well below
our 1P net asset value (NAV) of $10.40 per share and 2P NAV of $12.35. Most
companies trade closer to their 2P NAV and we think Equal should trade at
least in-line with our 1P NAV of $10.40. On top of this, we feel the reserve
report is modestly booked on a 2P basis, giving investors further exposure to
the upside.
We don't model Equal actually growing in production this year, but it's not a
major concern to us because the company has moved all its capital to focus on
light oil and liquids-rich prospects. Even though production is relatively
flat, we see cash flow increasing 30% year over year, which we believe should
help fund production growth in the future.
Equal has three light oil plays, two of which are in Canada, the Alliance
Viking play in the Halkirk area and the Cardium light oil play at Lochend.
Equal also has an emerging Mississippian play on its Oklahoma assets, which SandRidge
Energy Inc. (NYSE:SD) and Chesapeake
Energy Corp. (NYSE:CHK) are chasing very hard. Equal has very little
booked in its year-end reserve report for the Viking and Cardium and nothing
for the Mississippian play, once again exposing investors to further upside.
TER: The market has been very fond of this play. It looks like it is
up 71% over the past six months and 31% over the past three months, and you
have a 40% implied upside from current levels. Could
Equal still represent lower risk than many of your plays?
TM: Yeah. We think the downside on this company is marginal as it
trades below our 1P NAV. The next task for management is demonstrating
success on its three light oil plays and further activity on the liquids-rich
Hunton asset should help with further momentum for the stock. Ultimately if
the market is not willing to extend value to its assets they may have to look
to industry and sell some assets and become either focused in Canada or the
US.
TER: Are there any other types of plays you like?
TM: There is one other I would like to highlight. Palliser
Oil & Gas Corp. (CVE:PXL) is focused on heavy oil, primarily in
Saskatchewan. The company is targeting legacy heavy oil pools that are
well-defined and looking at increasing recovery factors by applying some more
modern technology as several of the pools were drilled up to 20 years ago. It
is employing a technique called High Volume Lift (HVL), which is essentially
putting on higher-rate pumps as the water cuts increase on the wells. The
company has had some very good success to date with this application. We
carry essentially no upside for the HVL technique in our models as we would
like to see some further production data on the wells first. The stock did
very well early in 2011 and recently has sold off. At current levels, we
think the stock is very attractively priced.
TER: Best wishes, Tim. Thank you.
TM: Much appreciated.
Prior to joining Jennings
Capital Inc. in December 2009, Tim Murray held the position as an Oil & Gas Analyst
at Salman Partners Inc. and Northern Securities Inc. covering junior and
mid-cap companies. Tim spent over a year at AltaGas Income Trust performing
risk and credit analysis on the company's midstream business for natural gas
and power assets. Prior to that, he was an Investment Advisor for three years.
Tim obtained his CFA in 2003.
The
Energy Report
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