Montreal based securities firm National Bank Financial lowered their 2009 price outlook for oil and gas, down to US$50 per barrel for oil and US$5 gas. Sell side analysts are slowly but steadily reducing their price deck to more current, and what I consider more realistic levels – hence the analogy of falling like dominoes. Calgary based Tristone Capital did the same last week, turning very bearish on gas (which we discussed in an earlier post).
(By the way, sell side=those analysts who are employed by brokerage firms, who SELL their research. Buy side=institutions/fund managers/pension funds who BUY their research (via commissions))
The Energy Information Agency (EIA) in the US is considered the definitive statistical body for oil and gas globally. They regularly come out with historical stats and forward looking “guesses” (because that’s all they are folks; don’t give them TOO much credence-they end up changing their mind A LOT) on energy prices. This week they told the world they expect US GDP to reduce by 2.9%, and all fuel prices will decrease because of this. Oil immediately dropped $4 a barrel (Tuesday) and gas prices also fell.
It has taken a couple days for the analysts to digest all these new forecasts and revise their own – downward.
Natural gas withdrawals from inventory did not meet expectations again this week (159 bcf vs 165 bcf – billion cubic feet), despite this being the coldest winter in at least five years. Again, industrial demand is down significantly – but considering that, 159 bcf is actually a heavy withdrawal.
Storage is currently at 2020 bcf, 43 bcf greater than last year and 24 bcf higher than the five year average.
Vero Energy (VRO-TSX) issued their 2008 reserve report today. I respect this company a lot – their per share growth in production over the last 3 years has been excellent, and they are one of the lowest cost natural gas producers in North America. Proven reserves were up 85%, which is all low-cost gas that can be accessed by horizontal drilling.
Most of the quality gas producers in Canada are reporting big increases in reserves so far this year – I mentioned Storm Exploration (SEO-TSX) in an earlier story on this topic. Vero and Storm and the many other producers now using horizontal drilling on huge new plays are proving our thesis that an astronomical amount of low cost gas is now being found and booked as reserves – which will keep gas prices low for years. However, I see a trend where these reserves are being booked at prices – set by independent consulting firms – that are now well above the market, and in my opinion not truly reflective of the current market.
I only use Vero as an example of the whole industry. Because of high energy prices most of 2008, the independent consultants who are hired to do the year end reserve calculations are using prices that are now WAY higher than what the market is now and higher than what they will be, realistically, for at least the next couple years. Vero’s consultants used CAD$7.90 gas and CAD$67.24 gas, which at the current US$-CAD$ exchange rate puts oil at roughly US$54.
Reserves are the assets that companies borrow money against. These companies now have the potential to be borrowing against inflated asset values – from an independent source – that are not indicative of the current market. Does that sound familiar to anyone?
To be fair, if those prices end up being average over the 11 year life of the assets, then it’s OK, and nobody can tell what the prices will be like 2 years from now much less 11.
Vero to me represents the epitomy of the quandary we have as investors. Great management. Great low cost properties. And if I’m wrong and the gas price turns up, Vero would be one of the very first stocks I would buy. But I think natural gas prices are going lower and staying lower for the rest of this year and maybe much of next year.
Several research reports came out on Vero today. One had a cash flow sensitivity analysis that showed with US$40 oil and CAD$5.50 gas, VRO would generate $1.24 per share cash flow in 2009 – and that’s with production increasing over 30%. (This proves another point- no sensitivity was done with $4.50 gas, which is what the price is now, and VRO is almost all gas – analysts aren’t using current prices, even in a wide array)
Cash flow multiples are only one valuation tool, but right now almost all these junior producers are trading at 2 times cash flow – that would equal a share price of $2.50 for VRO at higher energy prices than we see now. The stock closed today at $4 even. (Natural gas stock at this time last year were trading 5-6x cash flow – multiples contract during bear markets – that’s what gives these stocks leverage when prices turn up – cash flow increases AND multiples will increase.)
This is one of my favourite companies. But it’s difficult to justify owning any of these gas producers right now with our outlook on continued low prices. (Unless you count on a US pension fund coming and paying over 100% premium on a buyout…dreams..tsk tsk tsk.)