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What’s So Bullish About Canadian NatGas?

Why are recent natural gas deals in the Western Canadian Sedimentary Basin (WCSB) getting done at very expensive metrics, when the consensus for Canadian gas prices in the near to medium term is lower—potentially a lot lower?

The obvious answer is LNG—Liquid Natural Gas exports; even though the first exports are realistically a minimum five years away.

That theory got a boost on June 11 as Petronas gave a conditional positive Final Investment Decision (FID) to its Lelu Island LNG project.

The first gas deal—the May 27 sale by Leucrotta Exploration (LXE-TSX; LCRTF-PINK) of 1,300 boe/d (87% gas) for $80 million in the Alberta Montney play.  The buyer was unnamed but almost certainly was Tourmaline (TOU-TSX; TRMLF-PINK).

They own all the land surrounding the acreage that Leucrotta sold, and it’s in the vicinity of their Lower Montney Turbidite play (Turbidite=buried river delta) which is getting a lot of attention and capital.

Canadian brokerage firm National Bank reports that transaction metrics implied by deal are $61,500 per flowing barrel of oil equivalent (natural gas is converted to oil at 6:1, meaning 1 million cubic feet a day is 166.667 barrels of oil equivalent per day, or /boed) and 17x price-to-cash-flow (P/CF) at strip pricing.

Compare that to the 12-month average gas-weighted transactions at $32,270/boed and 6.2x P/CF, or an estimated $6,200/ac vs. historical Montney transactions at $4,400/ac (if production is assumed at $25,000/boed to make them all equal);

You can see those metrics are
1.   50% higher on an acreage basis
2.   almost double recent sales on a per flowing boe basis,
3.   and triple the value on price to cash flow basis

Then on June 9, privateco Black Swan Energy Ltd. acquired another private company Carmel Bay Exploration Ltd. for $6,800 an acre, in a $200 million deal including debt.

In a depressed market looking for deals amongst potentially distressed sellers, neither of these transactions seem like a bargain.  So what’s going on here?  Why are some producers opening up their wallets (and sacred balance sheets) to pay top dollar for these assets?

Natural gas plays are being sold for much less outside the Montney—and farther away from west coast LNG terminals.  Tamarack Valley Energy Ltd. recently bought more acreage in their core Wilson Creek region in south central Alberta.  They bought 1,450 BOE/d (55% natural gas) and 6.44 million of 2P reserves for $54 million.  And there was almost $60 million of infrastructure (e.g. pipelines; oil storage tanks called batteries and processing facilities) on the play!

Even valuing infrastructure at zero, these metrics come out to a seemingly miserly $37,500 per flowing barrel and $8.40/bbl of reserves–numbers that are more representative of a gas weighted ratio.  Infrastructure definitely wasn’t part of the Leucrotta deal.

So right now Montney gas assets are selling at a premium, almost like it’s oil. (Crescent Point (CPG-NYSE/TSX) just bought the oil weighted Legacy Oil and Gas (LEG-TSX; LEGPF-PINK) for $70,000 a flowing barrel).  That begs the question, why is someone paying a premium for natural gas today!?  Gas inventories in storage in both Western Canada and the United States are still (very) high for this time of year.

Alberta is already at 70% of capacity with over four months to go in the injection season (which usually starts 2nd week of November)!  Total storage in Canada is 143 Bcf higher than 2014 (as of June 8).  Gas production is up in western Canada for the first time in five years—about 800 mmcf/d, or 0.8 bcf/d.  Exports to the US are only up 0.46 bcf/d (mostly to the drought stricken California market).

And because of forest fires, a lot of heavy oil production in western Canada was shut in May and early June, reducing natgas demand by 0.9 bcf/d for a time.  That’s a bearish 1.7 bcf/d swing for awhile.

And later this summer, new natural gas pipelines from the Marcellus into the US Midwest by August and into Ontario in 2016 will further isolate WCSB gas—forcing it to reduce pricing to sell any product at all.

Canadian brokerage firm Scotia McLeod came out on June 16 saying prices needed to drop a minimum 10% quickly to keep competitive.

It’s not a pretty picture—for several years.

The story south of the border is not much better with current storage levels of 2,344 BCF being 47% above last year and 2% above the 5 year average.  Current natural gas prices are reflecting this with AECO spot prices down almost 50% from last year at around $2.50 per GigaJoule.

This doesn’t paint a compelling picture for natural gas and certainly doesn’t explain why anyone would be paying top dollar for Canadian natural gas assets right now.

There are a couple potential reasons for this.  Technology has improved a lot in the last year.  A fracking system called “NCS multi-stage” is now being used in the Montney, where producers can frack one stage at a time and see how much gas or oil is coming out.  It also allows producers to tell if frack stages are “communicating” or stealing hydrocarbons from the last frack stage.  This means producers can tell exactly how many fracks they need to do per well; what is the optimal distance between fracks to maximize the amount of oil or gas the well can produce.

The NCS system has been around for awhile, but not in the deeper Montney.  Producers I speak with say it’s generating a 30% increase in production for the same all-in price of a well.

The other reason is – LNG exports.  In fact, western Canadian gas really is a binary trade on LNG exports (at least it is until the monster Marcellus formation in Pennsylvania peaks in its natgas production).

Think what you want about the chances of any Canadian natural gas shipping off either coast before 2020, there are several producers out there positioning themselves to be ready.  And those producers are betting with real money.

These transactions show some producers aren’t worried about diversifying their asset base or getting the best deal.  They are strategically positioning themselves for the day Canadian natural gas can compete on a world pricing basis and escape the depressed pricing of the domestic market.

As an investor, you have to factor this in to your decision.  If you think it’s a pipe dream (pun intended) that investors will see LNG exports off the BC coast in our lifetime, then you’ll avoid stocks who are paying a premium for Montney assets.

Now, even this long term theory for land value is a bit suspect.  The two leading LNG candidates—Petronas and Shell—are already the #5 and #6 gas producer in the WCSB—and they have big land positions.

A recent study by boutique energy firm Peters & Co. shows that Progress Energy (owned by Petronas) has 2109 square miles, or sections of land in Northeast BC.  Shell has 886 square miles between NE BC and Alberta’s Deep Basin area.

Exxon and Altagas are next in line.  Exxon has 840 square miles in the Alberta Montney.  Alberta utility Altagas has a deal with Painted Pony (PPY-TSX; PDPYF-PINK) for its gas supply, and PPY says they have enough to support a 2 bcf/d LNG facility for 20 years.

The LNG player who was expected to be a big buyer of supply was BG Group—but they were recently bought out by Shell.  That LNG plan is likely a no-go now.

So buying expensive Montney land thinking you can sell it to a major LNG player for as much or more in the coming 2-4 years…for investors, that’s a speculative trade.

Through all this, multiples in the sector have increased for the leading producers and even many of the mid-tiers in the Montney as condensate and natgas prices have declined. (Think 15x cash flow vs. 10x before.) That’s likely another reason some buyers—and Tourmaline is a leader—are paying what they are.

Not to say there isn’t value in the Montney–but it’s going to be tough to find if producers keep paying these types of prices.

Keith Schaefer

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