petrocapita june 4, 2012
DESCRIPTION
Discounts Hiding in Plain Sight (Natural Gas) Peters & Company, one of Canada’s most experienced oil & gas investment banks, recently published an excellent report on the rate of return on North American oil & gas plays ranging from “Barnett Shale” to “Mississippi light oil horizontal wells”. Lloydminster conventional heavy oil, vertical wells were amongst the best performers in the North American energy sector.TRANSCRIPT
Petrocapita UpdateJune 4, 2012
1
DISCOUNTS HIDING IN PLAIN SIGHT A few weeks ago I wrote about the investment prospects of two asset classes in the energy space. One is a less-focused on part of the Canadian oil sector - conventional heavy oil in the Lloydminster area - and the other is the much beaten down North American natural gas sector. Conventional Heavy Oil: Conventional heavy oil is not be be confused with its capital intensive and costly brethern unconventional heavy oil or “oil sands”. It is heavy oil - less than 20 API - but it can be drilled and flows from the ground using simple, conventional, vertical well technology. Peters & Company, one of Canada’s most experienced oil & gas investment banks, recently published an excellent
Petrocapita Update
250%
200%
150%
100%
50%
0%
NORTH AMERICAN OIL AND NATURAL GAS PLAYS: RATE OF RETURN AT CURRENT STRIP PRICES
ROR
Shallo
w Gas
Horn R
iver S
hale
Eagle
Ford
Sha
le - D
ry Gas
Arkom
a - W
oodf
ord
Shale
Hayne
sville
Sha
le - T
X
Wolf
cam
p
Hayne
sville
Sha
le - L
A
Deep
Basin
Gas -
Alberta
Barne
tt Sha
le Ave
rage
Faye
ttevil
le Sha
le
Mon
tney
Hor
izont
al - G
reater
Town
Cardium
Hor
izont
al - P
embir
a Eas
t Unc
onve
ntion
al
Mon
tney
Hor
izont
al - R
esth
aven
Notike
win Hor
izont
al
Bone S
pring
/Leo
nard
Cardium
Hor
izont
al - G
arrin
gton
Unc
onve
ntion
al
Mon
tney
Hor
izont
al - D
awso
n/Par
kland
Wilri
ch H
orizo
ntal
Marc
ellus
Sha
le
Cardium
Hor
izont
al - P
embir
a Wes
t Unc
onve
ntion
al
Cana -
Woo
dfor
d Sha
le
Niobra
ra
North
Dak
ota B
akke
n
Cardium
Hor
izont
al
Granit
e Was
h
Eagle
Ford
Eagle
Ford
Sha
le - G
as -
Conde
nsate
Mon
tney
Hor
izont
al - K
aybo
b
Viking
Hor
izont
al - D
odsla
nd U
ncon
vent
ional
Shaun
avon
Lower
Hor
izont
als
Glauco
nite H
orizo
ntal
Pekisk
o Hor
izont
al Oil
Spear
fish S
hort
Horizo
ntals
Wab
iskaw
Hor
izont
als
Bakke
n Hor
izont
als (<
1,70
0m)
Miss
issipp
ian H
orizo
ntals
Lloyd
mins
ter Ve
rticals
Bluesk
y Sea
l Mult
ilater
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Oil Plays Natural Gas Plays
2
Petrocapita Update (continued)
report on the rate of return on North American oil & gas plays ranging from “Barnett Shale” to “Mississippi light oil horizontal wells” (Read Full Report Here). Lloydminster conventional heavy oil, vertical wells were amongst the best performers in the North American energy sector with an average rate of return of 150% - the second highest in the industry. Only “Bluesky Seal Multilaterals” with a return of just over 200% were superior. When investing in conventional heavy oil in western Canada, you benefit from two discounts: 1) the discount of heavy to WTI prices and 2) the discount of WTI to global prices. As such, Lloydminster conventional heavy oil represents a relatively inexpensive oil BTU. We also believe that fundamental drivers are in place for continued low and even declining heavy oil differentials: – Declining heavy oil production from Venezuela &
Mexico – Improved pipeline capacity projected over long
term – Heavy oil refining has highest margins relative to
other crudes
In addition, the wells are inexpensive and shallow, entailing less risk. All of these factors go to generating higher rates of return. Natural Gas: For the extreme value oriented investor with a long-term horizon, NG is trading at historic lows. More research from Peters & Company shows that prices have to recover to around $4/mscf to $5/mscf from current levels at $2/mscf in order for operators to make money.
If prices do not rise then production will decline. Or more accurately, operators are going to shut in production (voluntarily or via bankruptcies) which in turn will drive prices back to break-even levels. We believe that NG assets with large reserves and modest production levels necessary to maintain leases can be re-structured to create a low cost-of-carry long position - one which demonstrates distinct cost, volatility and return advantages over:– traditional long NG futures exposures which due
to contango currently in the forward strip incur material roll losses; and
$4.50
$4.25
$4.00
$3.75
$3.50
$3.25
$3.00
$2.75
$2.50
CANADIAN NATURAL GAS PLAYS THAT MATTER: BREAK-EVEN NATURAL GAS PRICE (HALF-CYCLE)
Median: C$3.58/mcf
Strip Price: C$3.38/mcf
Glauconite Hz.
Montney at Kaybob Hz.
Cardium Hz. Wilrich Hz. Notikewin Hz. Montney at Dawson Hz.
Montney at Town Hz.
Montney at Resthaven Hz.
Deep Basin Gas Verticals
C$/mcf
$6.00
$5.50
$5.00
$4.50
$4.00
$3.50
$3.00
NORTH AMERICAN SHALE GAS PLAYS: BREAK-EVEN NATURAL GAS PRICE (HALF-CYCLE)
Median: US$4.49/mcf
Strip Price: US$4.05/mcf
Marcellus Granite Wash
Cana Woodford
Eagle Ford - Liquids Rich
Gas
Fayetteville Haynesville Louisiana
Barnett Haynesville Texas
Arkoma Woodford
Eagle Ford - Dry Gas
Horn River
US$/mcf
3
Petrocapita Update (continued)
– investments into operating NG producers which come with 1) material bankruptcy risk and 2) have built in cost structures which make shutting in their entire production bases and going passive long NG difficult.
Obviously this is more an investment for deep value investors with a long investment horizon but to find a large, liquid asset class with such a pronounced margin of safety in today’s markets is rare and must be considered (Read More). In many ways these two investments speak directly to the idea of “discounts hiding in plain sight”. Many investors are sceptical that deeply discounted, value investments can be found in today’s efficient capital markets and yet as an investor you could/can acquire:– Farmland in Saskatchewan in 2008 at an average
of $400/acre, while today prices average over $600/acre
– Lloydminster conventional heavy oil assets in 2012 at a rate of return more than 50% higher than most North American energy plays
– Small Medium Enterprises (“SME”) in western Canada at around 4-5 times earnings, generating rates of return almost 4 times private equity averages in other developed markets
– Natural gas assets at $2/mscf when industry break-even levels may be 2 to 3 times higher than this
None of these investments were/are particularly hidden or hard to analyze - hence the concept of “discounts hiding in plain sight”. It is just a straightforward matter of looking beyond the short-term and trying to understand the underlying value drivers.
#205, 120 Country Hills Landing NWCalgary, AB T3K 5P3 Canada
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