Oil & Gas Investing Strategies for the Near Term

By
1940bkg
-
0

In Part 1 – How To Trade the Oil Markets, Canadian oil and gas research analysts Josef Schachter and Martin Pelletier explained one of the key strategies to make money in the junior oil sector—trade the volatility; learn how to read the swings.

Here, they share some of their best money-making strategies moving forward.

To me, it’s intriguing that Schachter says the future for juniors is not so much in big Resource Plays in the near term. These are the tight oil plays like the Bakken, the Cardium, the Alberta Bakken, etc. that have a much larger size and lower risk than conventional, old-style pools of oil/gas. They have been the bread and butter of the junior energy sector in North America for the last three years. Companies couldn’t get financed without one.

“There is a future for the juniors but it’s in lower cost plays.” He says stock valuations are so low now that financing with new equity (issuing shares) is too expensive and dilutive. And these resource plays have voracious appetites for capital.

“New technology is really making a difference. (High cost) Horizontal wells have increased the “ante” of playing in the fairway. The main plays are not entry level plays for the juniors anymore. It’s now a science play, and who pays for that?

“When well costs in the Montney (a high-profile, liquid-rich gas play on the BC Alberta border—ks) are $6-$10 million, and these juniors have market caps of $30 million, they can’t do it. One bad well and you’re hurting, and two bad wells and you’re done.

“You need to find lower cost plays, where well costs are $2 million all in, that produce 75-100 barrels of oil a day.

“It’s a treadmill, slow process now; it’s not a home run game anymore. (Management teams should be saying) let’s spend 70% of budget for conventional slow production build and take 10-15% for the home run swing.”

Here are his four top junior stock picks, and he warns they could get cheaper before they get expensive:

Delphi Energy Corp (DEE-TSX; DPGYF-PINK)—“It’s liquid rich, and has new Montney wells this month, and lots of runway (large area of undeveloped land with low-risk drill locations—ks), and new (production) facilities they’ve put in. They’ll exit 2012 at 9500 bopd exit, maybe 10,000. DEE will have 28% of their production in Natural Gas Liquids.”

Guide Exploration Ltd (GO-TSX; GLNNF-PINK)— “They have 30% oil and Natural Gas Liquids, heading to 40%.”

Niko Resources (NKO-TSX; NKRSF-PINK)—“Niko has a big Indonesian portfolio (they’re starting to drill) now and have a chance for resolution of some issues in India, and they’re financed for 2 years. The wells, if successful, could be worth more than stock price. Everyone hates India and they’re excessively negative. To me it has low downside and upside into $70s in a good market.”

Western Zagros (WZR-TSX)—“They’re drilling the TLM zone. They’ll test it through the summer. I’m pessimistic on the market short term, but this could outperform. It has already doubled this year. The politics are still up in the air, but pipelines in Kurdistan Regional Government will be built to Turkey and they’re protected by Turkey. All that is helpful to the story.”

Pelletier offers a different tack for investors to consider.

He says the first movers in the energy sector will be the beaten-up large cap stocks. Small caps likely have another 6-12 months of living within their means—which means slower growth, because they can’t raise money to fund expansion.

He likes to actively manage his risk in energy stocks, and suggests there are two fairly simple way for retail investors to create a profitable trade, based on their own beliefs:

“At times oil and gas stocks will factor in a premium or discount to their commodity. For example, we calculate that oil companies are factoring in a $20 to $30 per barrel discount to current oil prices.

“So if you believe that the oil market is set for a recovery, then the cheaper buy is clearly Canadian oil stocks rather than owning oil itself.

“But if you’re worried about the broader market—and in particular oil prices—then you can short the spread. That means owning oil focused companies while shorting crude oil prices through an ETF. In a falling market, both oil prices and oil stocks will fall, BUT oil prices will fall faster than oil stocks. This will give you some downside protection to your portfolio.

“So if you want to own oil, it’s cheaper to own the stocks. You can do this trade by using ETFs—on the Toronto Stock Exchange, you would buy symbols XEG (a basket of senior energy producers that mirror the TSX index–ks) or COS (Canadian OilSands) which pays a very attractive 6% dividend) and buy HOD (that’s double levered).

“Investors can also do this exercise for natural gas versus natural gas focused companies as well. For example, Encana, is now trading at  a 15-20% premium to the forward curve on gas prices.

“So if want to play a recovery in gas prices, it’s better to own the winter gas ETF on the Toronto Stock Exchange—HUN. Then you could short Encana to play the spread.”

I asked Pelletier to give readers one junior energy stock they should go do some of their own research on—and he repliedSurge Energy (SGY-TSX; ZPTAF-PINK).

“Whenever we look at a company, we break it out into 3 categories People, Assets and Value.

“This is a very technical team with strong track record of growth. This year they are estimating to increase production over 40%. Their assets are moving beyond exploration stage, so there’s more predictability going forward. And they’ve got a big incremental upside from waterflood at some properties.

“We estimate that it is trading at roughly a 25% discount to its oily peers on a cash flow multiple basis, and 20% discount on 2P reserve basis.”
by +Keith Schaefer

Disclosures: Keith Schaefer does not own any of the stocks mentioned. Pelletier’s TWC Risk-Managed Canadian Energy fund owns Surge Energy—SGY.  Schachter owns Delphi—DEE.

by +Keith Schaefer

How To Trade Today’s Oil Markets

By
1940bkg
-
0

What’s the biggest lesson retail investors need to learn to increase profits in these markets?

It’s knowing how and when to trade volatility.

The professionals say trading volatility really is the only way to make money in a flat to down market, which the energy sector (especially the juniors!) has gone through since February 2011—a full 16 months ago.

“A flat bear market can give flat performance, but with a lot of volatility,” says Martin Pelletier, Managing Director at Trivest Wealth Counsel of Calgary. “Fifty per cent to 100% swings either way are quite common.

“Unfortunately investors have reacted incorrectly—buying the tops of secular bull markets and selling the lows of secular bear markets.”

Josef Schachter, President of Schachter Asset Management Inc., says “the oil and gas sector has been good to investors—just sell during euphoria and buy during duress.”

Now of course, that’s easier said than done, and to a large degree that separates out the wealthy investors. But Schachter—who is bearish on oil for the next 3-5 months—says there are some turning points investors should look for in the Toronto Stock Exchange Energy Index.

TSX Energy Index - 5 Years

TSX Energy Index 5-year chart

TSX Energy Index 1-year chart

TSX Energy Index 1-year chart

“Given how devastated the S&P TSX Energy Index is, if it goes below 180 then it’s a great buy. We would then switch from being bears to being bulls again.

“I look at the market internals. We’re in a bounce wave now. It could go up again, but then it could go below 200 down
to 180 maybe. I expect the timing on that to be the 3rd or 4th week of October.”

Are other sectors as volatile as energy?

“From a broader perspective, if you overweighted telecom, utilities and financials you would have best risk weighted return,” says Pelletier, but adds “over the last ten years, if you were willing to accept a little more risk to get better returns, then energy is the best space to invest.”

And that means a little more active trading—even in the senior producers’ stocks.

“Just look at large cap Canadian energy stocks like Suncor (SU-TSX; NYSE) and Canadian Natural Resources (CNQ-TSX; NYSE). Both have shown a lot of volatility through the year, but there’s nothing good for those who bought and held the stock over the past 5-6 years.

suncor

“It’s been even worse for junior oil and gas have even more volatility given their greater capital demand. They typically spend 2-4x their cash flow on exploration.

“Therefore buy and holding juniors is not the way to play them AT ALL—you have to trade them to manage risk,” because when the market turns down, they can’t raise money to bridge the gap between exploration spending and cash flow—so the junior stocks get hit really hard.

The junior oil and gas market has definitely turned down—but for how long?

Schachter says, “If they (national governments) face the music (on their debt issues), we could see a multi-year bull market in energy through to 2015-2016 and set all-time highs. But if they just continue to kick the can down the road, then the market malaise could drag out with trading rallies and year end bounces, and you’ll need a trading mentality, as we’ve had a good year then a bad year.”

Pelletier believes there is another 2-3 years to go before the next secular bull market in the major indexes and energy markets—it’s a traders market until then.

But the juniors will once again have their day, says Pelletier.

“Juniors will outperform when the market returns to normality especially those with good management teams with attractive growth profiles.

“Interestingly, there is an opportunity among those who have sold off from their financings. We think these companies will be able to take advantage of this market environment and consolidate. And there are some other stories well liked among my peers which we think are attractively valued—we think it’s important to own stocks everyone likes that are backed up by strong fundamentals.”

In Part II, both Schachter and Pelletier will share some of their favourite investment ideas going into the last half of 2012.

by +Keith Schaefer

How the Shale Boom Is Causing a Drop in the NGL Price

By
1940bkg
-
0

The shale oil boom is causing a steep price drop in Natural Gas Liquids (NGLs) in North America, hurting gas producers.

Natural Gas Liquids are the raw, associated gases and liquids that come up along with oil and natural gas from the well.  NGLs are very important—vital even—now for regular, dry gas (methane) producers, as they are separated and sold as more expensive products like ethane, propane, butane and condensate.

But for shale oil producers—especially in the new prolific Texas oil shales—they’re just a byproduct.  The oil pays for the well and the NGLs are just gravy.

For the last two years, many natural gas producers have been acquiring and drilling gas plays with high liquids content. NGLs are typically valued as a percentage of crude oil prices, and are worth 2-10x what dry gas is worth.

In fact, junior Canadian and American gas producers have been desperately trying to portray themselves as “liquid rich” gas producers.  Analyst reports from brokerage firms promote their increasing NGL production.

The problem for the gas producers is—the oil producers have been acquiring and drilling them, too.

Between oil and gas NGL production, supply has overwhelmed the petrochemical industry, which uses most of these NGLs as feedstock.

Prices have rebounded from lows seen in late June, but are still down a lot from last year:

  • Ethane at 31 cents/US gallon is down 61% from last July
  • Propane at 85 cents/US gallon is down 44%
  • Butane at 121 cents/US gallon is down 31%
  • Condensate at 192 cents/US gallon is down 24%

Profitability is down even more—add another 15% to each of those numbers. (This means ethane profits are down 70% or more.)

These prices come from Mont Belvieu, Texas, which is the main pricing hub for NGLs in the US.  What Cushing is to oil in the US, Mont Belvieu is to NGLs.

Even these numbers don’t tell all the pain—some gas processing plants aren’t accepting ethane at all, which of course lowers the price to crazy levels—the 2nd NGL hub in the US, in Conway Kansas, has seen ethane prices fall to 8 cents a gallon.

Here’s a rough guide on these products.

The “C2” type number you see beside each entry is how many carbon atoms a molecule of each product has, and the industry interchanges the names Ethane and C2 (Propane and C3 etc) all the time.

Ethane (C2) – Demand is primarily driven by the ethylene production industry, which uses ethane to meet nearly half of its feedstock needs to produce chemical compounds used in making plastics.

Propane (C3) – Propane use is predominantly split between heating, which is seasonal, and for certain petrochemical applications.

Butane (C4) – Demand for butane is usually quite robust since it has a wide range of uses. It has both industrial and residential heating uses and is often blended with propane to produce liquid petroleum gas. Butane pricing is most similar to that of crude oil.

Pentanes or Natural gasoline (C5-C9) – The heaviest of the non-condensate liquids. It’s frequently used as a fuel additive and blended with regular gasoline as well as a petrochemical feedstock. Receives a premium to crude oil at times.

Condensates (C10+) – It is basically equivalent to crude oil with many of the same end markets. Its pricing is also similar to crude oil.

As juniors—and even seniors like Encana (ECA-NYSE; TSX) and Chesapeake (CHK-NYSE)—have tried to increase NGL production, the market has not been impressed.  The stock prices of these gas producers has not improved much of the last year.  My experience is that until the juniors have reached about 70% oil and NGLs of overall production, the market doesn’t care.

This huge rise in NGL production is primarily due to the Shale Gas Revolution—especially in Texas where a lot of the new “oil” plays are really 25%-35% gas and NGLs.

Then there’s also the Marcellus and Utica shale gas plays in the US Northeast and the Granite Wash play in western Oklahoma that have NGLs, along with Canada’s Montney and Duvernay plays on the BC/Alberta border… which are also NGL rich—and just ramping up.

In 2011, NGL production hit a then record of about 2.2 million barrels a day. The U.S. Department of Energy estimates that in March of this year (the latest data available), NGL production rose to 2.3 million barrels a day. This figure is a jump of nearly 50 percent from January 2009 levels.

In fact, NGL output in the first quarter of 2012 accounted for a record of almost 30 percent of the U.S. oil production. At the beginning of this decade, according to industry estimates, this figure was only 20 percent.

It looks like the shale boom will only make the pricing situation worse in the years ahead.  Bentek Energy estimates NGL production will increase by more than 950,000 barrels a day to over 3.1 million barrels a day by 2016, adding to the NGL surplus.

BENTEK’s Jack Weixel adds that “as (NGL) pricing continues to decline, operators will continue to pursue even oilier plays, with the activity in the Utica being the best example of this.”

The US is exporting more NGLs to help relieve this production glut.  About 220,000 bopd are exported, mostly to Latin America, and by 2016 BENTEK expects that to be 400,000 bopd of mostly ethane and propane.  Canada is doing its part, as US condensate exports to the US—where it’s used to dilute heavy oil; make it flow better—have increased 10x in the last year.

However, Weixel adds “the real constraint is domestic demand.  While several world scale ethylene crackers have been proposed, until facilities are actually built that can use product such as ethane and propane, we’ll continue to see downward price pressure.”

US public companies whose stock prices are tied to NGL profitability include Targe Resource Partners (NGLS-NASD) and Enterprise Products Partners (EPD-NYSE).

The bottom line here is that the NGL surplus looks set to be around for several years, which is good for the petrochemical firms but bad for gas producers. Wells Fargo Bank, one of the biggest lenders to the U.S. natural gas industry… with intimate knowledge of the industry, recently sounded a pessimistic note. It warned that the price downside for NGLs had a “few more legs” to go and that “the pain could continue into 2013.”

by +Keith Schaefer

Investing in Oil: 5 Questions To Ask Company Management

By
1940bkg
-
0

The North American oil market is going through a fundamental change that will affect the price of oil for the rest of this decade—fast-rising shale oil supplies from North Dakota and Texas.

(Other shale oil plays will contribute as well, but none will come close to the revolution happening in those two states.)

This could mean lower oil prices for the next several years.  I don’t foresee the collapse in oil prices like what happened to natural gas, but even a 30% permanent drop to $70/barrel from $100 will impact junior and intermediate producers who spend all their cash flow.

And folks, almost all of them spend all their cash flow.

To me, this situation has two outcomes:

1. The juniors/intermediates will reset to a lower valuation/lower multiple to take into account lower profitability from lower oil prices. That is happening now and is almost done, IMHO.

2. Balance sheet will become more important than it was in a bull market, when juniors could raise money with no problem to fill the gap between cash flow and spending.  Now the financing market is very fickle—one day it’s open; the next—no way.

With this in mind, here are a few questions for you to ask management teams in your research.  Most of these answers can also be found in the middle of the Management Discussion and Analysis (MD&A) in the quarterly financial statements.

QUESTION #1 –
What price deck are they basing their cash flow on?  Because if it’s above $75, I would expect downward revisions this year. OK, maybe they can use $80, but that would be, IMHO, a bit optimistic (especially north of Cushing, Oklahoma, which includes all of Canada ;-)).

The price of oil in 2012 may average better than that, but moving forward from now, it’s tough to see North American oil improving much more than $10 a barrel (i.e., over $80-$85) for the next 18-24 months.

I hope I’m wrong and we all make buckets of easy money in the next year at $95 oil, BUT the fast-growing supply in the US is competing with Canadian oilsands for pipeline and refinery capacity, which is already close to being full. Whoever is willing to take the lower price gets to sell their oil.

QUESTION #2 –
What is their net cash/net debt? Make sure you use the word NET, as the number you get could be GROSS… as going into this downturn, in April, the market was still focused on growth and the income statement. Now it will be focused on the balance sheet. That’s a BIG change, especially for Canadian producers who for the most part spend AT LEAST 100% of cash flow… often up to 150-200%.

The “growth at any cost” mantra of a bull market could mean that some high growth companies that got premiums in their stock in the past will now have their valuations lowered by the market.

QUESTION #2b –
What is their “total liquidity”—how much money do they have available to them?  This would be how much room they have left on their debt capacity, plus any net cash they have.  If they have $10 million net debt on a $50 million line, they have totally liquidity of $40 million.  With $10 million net cash, the total liquidity is $60 million.

QUESTION #3 –
What is their debt to cash flow ratio at $70 oil? Anything over 1.5:1 in the juniors will get punished a bit, and over 2:1 will get punished a lot. Institutions will buy those stocks last in any new bull market, and without institutional liquidity those stocks will not move up.

QUESTION #3b –
With the yield stocks, the same question is phrased like this—what is your all-in, payout ratio at $70 oil? When you put their drilling budget and dividend payouts up against cash flow, if it’s even over 100%… that’s bad news now.

As reference, every single one of the 10 companies in a most recent Macquarie Capital weekly energy update showed payouts higher than cash flows. 10 of the 17 US mid-cap producers were scheduled to spend more than their cash flow. It was 8 for 14 in the Canadian mid-caps, and all 12 of the small caps were spending more than cash flow. You get the picture. Spending cutbacks this year must happen, which will reduce growth.

QUESTION #4 –
Will they reduce their spending to meet their new lower 2012 cash flow? As I said above, there is almost NO FREE CASH FLOW in the Canadian junior/intermediate energy patch—they regularly spend more than they cash flow.

And in a declining price environment, the market gets more sensitive about energy producers spending within their cash flow.  If the oil price declines so much that their cash flow goes down below what they plan to spend, they may have to cut back drilling—slowing production growth.  Slower growth means a lower multiple in the stock.

That makes companies NOT want to cut back spending/drilling.  But once The Market KNOWS a management team must cut back, it starts to price all that in, anyway.

Investors will punish a stock quickly when it announces a spending cut (despite the fact that saving the money and preserving the balance sheet is the right thing to do)… and punish it slowly if management doesn’t quickly cut back spending.  So the stock either does a quick cliff dive when management does the prudent thing, or it drowns slowly until they do cut spending or everyone thinks the price of oil will stay high.

The reality is, they won’t tell you that. By law, they have to say “no” even as they are sending out the press release that they are indeed reducing spending (“lowering capex” is the industry jargon)… because that’s a material fact, and they need to make disclosure to everybody at the same time via a press release.

QUESTION #5a, b, c and d –
How much production do they have hedged now—at what prices? (i.e., how much future profits have they locked in?) What percentage of their production is that?  And when do the hedges run out? Not many companies have hedged production at higher prices, but those who have will get rewarded with a slightly higher valuation—especially if it’s a Tier One junior.

So what kinds of stocks should I be investing in as the market adjusts to this new, lower oil price scenario?

1. Those with net cash, then those with very low debt ratios (less than 0.5:1)

2. Oil focused (there are only 4-5 gas stocks worth looking at in Canada now)

3. International stories that get Brent pricing, which is based out of London, England—it is now $10-$15 above WTI, the US benchmark oil price.

by +Keith Schaefer

Floating LNG: The New Revolution in Offshore Natural Gas

By
1940bkg
-
0

A decade after hydraulic fracturing, or fracking, started the shale revolution and ended high natural gas prices, another revolution is set to rock the industry—Floating Liquified Natural Gas—FLNG.

It’s the leading edge of the natural gas world, and it could impact Canadian and US hopes for huge LNG exports. A full 10% of the LNG world is expected to be sourced from offshore LNG by the end of this decade, with costs potentially as much as 40% lower than onshore projects.
floatinglng1 3
You see, there isn’t a single FLNG terminal/ship producing anywhere in the world—but they’re coming. But Royal Dutch Shell’s $10-$12 billion Prelude Project will be the first in 2017 when it anchors down 200 km off the northwest coast of Australia at the 3 tcf Prelude field—its home for the next 25 years.

Prelude will be—by far—the largest floating vessel in the world—and could produce LNG for just 60% of what onshore facilities do. While it will only produce 0.5 bcf/d of LNG, some industry players are forecasting rapid growth for FLNG around the world.

flng tanker 2
Shell estimates there is a mind boggling amount of stranded natural gas underwater, all over the world—some 240,000 billion cubic feet—and much like onshore shale gas, the industry knows where a lot of it is, but hasn’t had the technology to produce it at a profit.

So is there potentially ANOTHER huge amount of cheap, clean natural gas available to the world? Yes, but unlike onshore shale gas, however, the capital costs are so high that only a handful of companies have the capital and expertise to do this. While this is THE leading edge in the natural gas space, I’m not expecting serious FNLG volumes until the end of this decade.

Shell’s General Manager for FLNG, Neil Gilmour, told the Financial Times he thought FLNG could follow the same growth path of floating oil production ships, which were introduced in 1977. There are now over 150 around the world.

And the growth curve is already starting. In addition to Shell, other companies like Brazil’s Petrobras, BG Group in the UK, Repsol in Spain and Portugal’s Galp Energia are placing orders for ships, albeit with smaller projects offshore Brazil.

Shell itself has other FLNG vessels on the drawing board for projects in East Timor, South America, Indonesia and East Africa. Shell has specifically stated the smaller environmental footprint is a big selling point in geopolitically sensitive areas like East Timor.

Forecasts from most energy analysts are that by 2015, the liquefaction capacity of FLNG projects around the world will be 6.7 million tons per year or about one-tenth of global capacity. If Prelude is successful, FLNG usage will expand even faster.

I’ve written several times on how the global market for LNG is growing quickly. LNG is forecast to be the world’s fastest growing fuel market (growing twice as fast as regular natural gas) through 2030, says BP’s chief economist Christof Ruhl. He adds that LNG is already 25%-30% of internationally traded gas and makes up 9% of global gas demand.

——————————————-

Have You Heard of the “Other” Bakken Oil Play?

It’s not on most investors’ radar screens.

But a very special situation is quickly taking shape in the play. Not only are drilling results getting better with each new set of results… but the next set could validate a huge new area of production — and turn it into one of the top plays in Canada.

And for my # 1 junior company in the play, the best news may be just ahead.

That’s why insiders have been scooping up shares lately… and why this junior could be the break-out oil trade for the rest of 2012.

Learn all about this opportunity here in my full research.

——————————————-

The International Energy Agency forecasts that within a few years, LNG imports will meet about a fifth of the total incremental demand in the world for gas. In 2010, LNG accounted for about 10% of the total global demand for natural gas. This implies a double-digit growth rate for LNG over the next few years and possibly even longer with most of the demand growth coming from Asia and the Middle East.

FLNG ships like Prelude reduce both the project costs and environmental footprint of LNG development. Despite their massive size, they’re still only one quarter the area of an onshore LNG plant.

(But it will still be longer than four soccer fields put together, and will hold 175 Olympic swimming pools of LNG.)

But there is no need for long pipelines to shore, no compression platforms to push the gas to shore, no nearshore works such as dredging and jetty construction, and no other buildings and roads. Shell expects Prelude will produce 15% less carbon dioxide than an onshore LNG facility.

For $10-$12 billion, Prelude will, according to Shell’s estimates, produce 110,000 boe (barrels of oil equivalent) per day (my math comes out with slightly different numbers), which is roughly broken down like this:

  1. 1.3 million tons per year—or 35,000 bopd—of condensates
  2. 400,000 tons—or 12,700 bopd—of liquefied petroleum gas (propane)
  3. 3.6 million tons per year of LNG. (1 million tons of LNG = 48.7 billion cubic feet of natural gas, so 3.6 MM x 48.7/365=480.3 mmcf/d, or just under 0.5 bcf/d, or 86,454 boe/d)

Despite the initial cost, some industry experts are suggesting LNG costs will be in the $550 to $700 per metric ton range versus the $1,200 to $1,500 per metric ton range for onshore LNG projects.

There are obviously huge risks with a project this size—huge storms, long-term economics, capital costs, etc.

But if Prelude works, FLNG has the potential to do for stranded gas offshore what fracking has done for trapped natural gas onshore.

by +Keith Schaefer

A Price Shock for Canadian Natural Gas?

By
1940bkg
-
0

Will Canadian natural gas producers fill up Canadian storage for the first time ever this year?  And does that mean Canadian gas prices completely collapse to zero? Who decides how much gas a producer can ship to market in that case?

Canadian gas storage market is very close to being full right now—much earlier than normal  in the gas injection season, which lasts from mid-spring to late fall.  Gas withdrawal season is from fall through winter and early spring, when heating demand uses much more than producers can bring upThis chart from Calgary’s ARC Financial Corp. weekly Energy Charts tells the tale:

Alberta Canada Natural Gas Storage Levels

In the US analysts are talking about theoretical full storage just before withdrawal season starts.  But in Canada, the issue is more immediate—still hypothetical, but certainly still possible..

“If storage did get full, it would only be for 1-2 months in a worst case scenario,” says Geoff Ready, an energy analyst at Haywood Securities in Calgary.  “The market will correct itself but there could be some price shocks.”

Canada produces 12-14 billion cubic feet per day (bcf/d) of natural gas (down from 17 bcf/d five years ago), and exports roughly 6 bcf/d to the US at this time of year.  It currently uses 3 bcf/d in-country, for a total of 9 bcf/d.  That means roughly one third of Canadian gas production would need to get shut in, in a worst case scenario of full Canadian gas storage.

But even though only one third of the gas is shut in, that would take the pricing for the rest of the market down to an unknown number—potentially close to zero.  (Processing and transportation costs are already taking profit margins close to, or even under zero, for some Canadian producers.)

However, several trends are working in the Canadian producers’ favour recently.

  • One is that exports to the US trend up during the summer to help with the air conditioning/power demand there.
  • Second is that while natural gas production in the US has risen steadily for a few years, and remained steady in the face of lower prices, Canadian production has been declining for years, and just this year, production has already declined over 2 bcf/d so far.
  • Third, there is private storage of gas that is not accounted for in official statistics, and that is being used as well.  There is thought to be 400 bcf of gas storage in Alberta, where most gas is produced.
  • Fourth, Canada is already shipping a lot of gas into US storage.

But just like in the US, Canadian gas producers sometimes don’t really want to shut in production, says Ready.

“Economics should determine whether more production is shut-in, however optics sometimes win over economics.” He says some public companies don’t want to show a production decrease on their quarterly report and will produce or even drill uneconomic wells to avoid this.

To illustrate the optics effect he points to Whitecap Resources (WCP-TSX) as doing the prudent thing—reducing capital expenses (capex, the industry calls it), and lowering production guidance.  Economics says the stock should have gone up by doing the “right thing” in the face of weakening commodity prices —but it went down as much as  16% after its announcement.  (Whitecap is even one of the junior market darlings.)

Another sign Canada is getting closer to full storage is that the Canadian AECO price differential is widening from the US gas price at Henry Hub (The US has several natural gas “hubs” where prices are set).  AECO was only 25 cents per mcf (thousand cubic feet of gas) lower three months ago; now it’s 50 cents lower.

Canadian brokerage firm National Bank explains: “…with Alberta storage levels still well ahead of last year’s levels at this time of year, more Alberta gas has to make its way to export markets, which means Alberta gas has to price itself at a greater discount to those export markets to incentivize the transportation.” (italics mine–KS)

But there’s a small likelihood of seeing huge gas shut-ins in Canada without full storage.  That doesn’t bode well for Canadian producers, as prices will continue to sink.  How low does the price go in advance of this?  Canada has already seen just over $1.60 per thousand cubic feet of gas (mcf). Processing and transportation costs can eat up most if not all of that for producers, leaving them with no positive cash flow just on operating costs.

If you amortize all-in costs per mcf, the industry needs triple that price to make money.

For now, full storage is theoretical, even in Canada.  But what happens to them when the underground storage caverns can’t hold a single more molecule of gas… and basically one third of Canadian production potentially can’t find a home?

(Gas storage is so expensive — it’s only used by big utilities and consumers of gas; it’s only used by the large producers, and even then not a lot.)

Angle Energy (NGL-TSX) President Heather Christie Burns said the recent strike at Canadian Pacific gave the industry a dry run (pardon the pun) on what would happen.

“Some products, like natural gas liquids, get to market via rail transport.  Had the strike gone on any longer, we would have seen production curtailment mandated by processing facilities declaring force majeure.

“They tell you they will use their best efforts (to take whatever production they can) and (producers) have to shut in field production.  This strike was short-lived, so no impact to production was experienced.

“In the storage situation, the producer shut-ins mandated by facilities and/or pipelines would be similar.  Also, in the hierarchy of gas production the government would prioritize associated gas from oil wells over gas wells.”

Dave Haskett is the President of Alberta based Patriot Energy Marketing Inc. Junior and intermediate level producers contract with companies like Patriot to get the best price they can for their gas in the market every day.  He says the industry has been here before, but adds that everybody is watching storage in both Canada and the US very closely.

“In the event the markets for natural gas are increasingly limited, and storage facilities are full, then producers would be forced to shut in. Every producer and producing field has price points.  The decision to shut in wells or shut in an entire production field is based purely on the financial metrics of individual companies,” says Haskett.

“While we have not seen a situation where all storage facilities are completely full, we will, in all likelihood be going into this winter with storage at record levels.”

Haskett adds that the other significant impact will be to pipeline companies such as TransCanada Pipeline Company (TCPL) — whose mainline from Empress Alberta into the East has been well under its capacity.

“This was a terrible winter for TCPL in terms of its volume delivered into the Eastern Canadian and US markets. Looking ahead it would appear that TCPL will have another dismal year in terms of the utilization of its pipeline capacity unless we get a very cold and early winter.

“With respect to a completely full storage scenario in my 32 years we’ve never had a season where that happens.  We’ve never filled every cavern to the brim,” he says. He added, however, that if Canada gets a mild winter like the one just past, the storage situation “gets really ugly.”

Junior producers are the most vulnerable if they are weighted primarily to natural gas.  They will most likely be forced to shut in more production — particularly if their production is behind a third-party gas plant and the operator elects to shut the plant in due to economics, or the junior has a small working interest and his larger partner elects to shut in wells or a producing field.

For now, this situation is hypothetical. But it’s not a scenario that anyone in the industry wants to see occur. The impact is enormous for storage operators, pipeline companies and natural gas producers, which all employ thousands of people.

Oil Field Services: 3 Ways To Invest in the Oil Sands

By
1940bkg
-
0

By guest writer Michel Massad, publisher of Beating The Index.com

Energy stocks across the board have been hit hard in the last quarter—both producers and service companies.  Stock charts have been laid to waste. Neither sexy resource plays nor respected leadership were enough to stem the bleeding.

But shareholders of three energy services companies—Gibsons Energy (GEI-TSX), Black Diamond Group (BDI-TSX) and Horizon North Logisitics (HNL-TSX)—are laughing all the way to the bank, as their stock charts are at or near all-time highs. (See OGIB story on Black Diamond here.)

And strangely enough, they are all oilsands related.  I say strangely because analysts have not been kind to the producers, warning investors that lower Canadian heavy oil prices could stay for a couple years, impacting profitability.  And there is no close resolution on increased pipeline capacity to handle any increased oilsands production.

On the services side, Canadian securities firms like National Bank and Raymond James have been telling their clients to sell oilfield services stocks for weeks.

The first 2 oilfield services companies are Black Diamond Group (TSX-BDI) and Horizon North Logistics (TSX-HNL), which derive a substantial percentage of their revenue from business related to Alberta’s oilsands.

They provide a turnkey-style Camps and Catering service offering, including manufacturing, transportation and installation, servicing, as well as catering. These companies basically make money from renting beds to oilsands workers, including charging them for management and catering. The work camps are equivalent to small villages with a population exceeding 3,000 souls in some instances.

Black Diamond Group
black-diamond-group 2

Horizon North Logisitics

But oilsands stocks have been even worse performers than the energy sector, so why do these two oil sands-related stocks have the best charts in the North American Energy sector?

Because the market pays for certainty.

The catering/camp management business enjoys a side the market loves, and that’s the predictability of the recurring revenue base. When a contract is signed, it’s typically for a 2- or a 3-year period. This means that the market sees the current weakness in commodity pricing as temporary since these companies will be able to weather any violent storms in the near term as they continue to grow.

There’s also another way for seeing things.  According to the Canadian Association of Petroleum Producers’ annual forecast, Canada could emerge in the top 3 producers in 2030. Bitumen will dominate production growth and is expected to more than triple to 5 million bopd by 2030 from 1.6 million bpod in 2011.

The market is clearly looking towards billions of dollar in capital expenditures required to add more than 4 million of barrels of oil in production. More barrels require more manpower which equals more work camps. Just imagine how many beds will be required in order to accommodate this growing workforce!

Welcome to the bed business.  And it’s a huge market, judging by the number of beds in the Ft. McMurray/Conklin region… which currently stands at  58,499 beds with 12% of these beds greater than 15 years in age (replacement coming up). To put it bluntly, these companies are building cash flow by increasing the number of beds they rent.

HNL estimates new oil sands project capital spending in this market could exceed $100B through 2016 with future additions totaling more than 21,000 new beds.

This business is not limited to the oil sands industry; accommodations are in demand for infrastructure projects, unconventional oil and gas operations and mining camps… which diversifies the customer base.

BDI estimates more than 50,000 beds will be needed over the next 5 years between oil sands, Northern BC, NW Territories and Eastern Canada. What’s not to like about a visible pipeline of beds? It’s more like a visible pipeline of profits.

Besides the camp business, both companies are active in the oilfield services by selling anything from matting to a full array of nuts and bolts required on a drill site.

HNL pays an annualized $0.20/share (payout ratio of 19%) and has recently posted an all-time record quarterly EPS. Its 2012 capex program has been increased by $20mm to $120mm with $85mm dedicated to expanding its bed rental fleet by 1,800 units. Analyst targets vary between $8.25 and $9.50.

BDI pays an annualized $ 0.72/share (9% increase in 2012 with a payout ratio of 25%).  Its 2012 capex program has been increased by $25mm to $95mm. Analyst targets vary between $24.00 and $27.50.

Our third stock is Gibson Energy (TSX-GEI), which IPOed on June 15, 2011. GEI is an integrated energy infrastructure company with 5 business divisions: truck transportation, terminals & pipelines, processing and wellsite fluids, propane distribution, blending and marketing of crude oil, NGLs and refined products.

gibson

Gibson’s business segments allow the company to earn revenue, several times, from a barrel of crude oil during its life cycle.  I would say it’s THE most vertically integrated companies in North America that is neither a producer nor a refiner.

Its terminals at the heavy oil hubs of Hardisty and Edmonton, which have lots of room to grow, give it a big touch to the oilsands.

Its marketing segment purchases the crude from the producer at wellhead, transports the barrel via truck transportation and stores it in a Gibson Terminal. Gibson has one of the largest trucking fleets in Canada, and one of the largest for-hire independent trucking fleets in the US.  And the truck market has become tight, with pipelines out of Canada and the Bakken basically full.  Analysts are expecting rate increases here.

Revenue is received from selling condensate to blend the barrel (a heavy oil barrel has to be blended with condensate in order to meet pipeline specification as it makes the oil easier to move – less gooey). The product is then moved downstream to a refinery — such as Gibson’s Moose Jaw refinery — to be processed.

processing-oil 2

And when the company is not “touching” a barrel of oil during its lifecycle, it is making money from the volatility and widening differentials in Canadian oil prices as a marketer. Contrary to E&P companies that suffer due to lower realized price per barrel sold, widening differentials present GEI with an opportunity to capture higher marketing margins.

Its pipelines segment also profits from capacity constraints due to fast production growth. In order to capitalize on rising production volumes across North America, Gibson is working on several projects including terminals and refinery expansions. The market loves organic growth which when coupled with opportunistic acquisitions results in a growing cash flow and a higher dividend.

Gibson shares have risen 30% on the back of meeting or exceeding expectations on a quarterly basis since the company’s IPO. The company reported record quarterly revenue for Q1-12 and increased its dividend 4.2% to $1.00/share paid annually. Its diversified asset base across North American oil basins forms a balanced cash flow stream and offers leverage to liquids infrastructure rather than natural gas.

While oil and gas producers and field service companies adjust to a shrinking cash flow, a few continue to deliver a strong performance from their base business.  It’s a business that doesn’t have much sex appeal (renting everything from toilets to high speed internet to oilsands workers?)… but that has sure contributed to forming great-looking charts.

– Michel Massaad
BeatingTheIndex.com

HNL Consolidated Revenue

hnl revenue

GEI Profit Breakdown
profit breakdown

Calling the Rise in Natural Gas: Butler on Business Interviews Keith Schaefer

By
1940bkg
-
0

Interview was conducted on June 19th by the Butler Radio Show out of Atlanta. Full audio clip is here.

Interviewer 1: On the phone with us now is Keith Schaefer, publisher of Oil and Gas Investments Bulletin. For more information, www.oilandgas-investments.com. Keith, you called the rise in natural gas. Hats off to you.

Keith Schaefer: Oh, thank you. Everything was beaten down so badly there, you know, it was really looked like a rebound was due. The big key here was the power burn. You know the electricity industry has really picked up its use in switching from coal to gas, and that’s still the story of the day on gas here. It’s still a huge power demand by the electricity sector that’s really carrying gas prices today.

Interviewer 2: Well, Keith, yesterday natural gas was up 7.4%. Yesterday alone. What was the reason for the big jump?

Keith Schaefer: Heat, and lots of it. You’re seeing Chicago at 90 degrees today. You’re seeing Phoenix at 110. So those air conditioners, they got to start turning today.

Interviewer 1: Now, doesn’t natural gas historically trade lower in the summer and then start to climb back up in the fall?

Keith Schaefer: It depends on the season. Often times that’s true, but what’s happened lately, let’s say in the last decade, is you’re seeing the Aircon burn in the summer come close to rivaling the winter burn for heat. Really the weakest part of the year is really April, May, and September, October, what we call the shoulder seasons. So right now, we’re seeing a pretty big burn happen on the natural gas front because of all this heat. There’s also a big political pressure to move off of coal and on to natural gas. So you’re seeing with these really low prices – even though gas is up now to $2.75 per 1000 cubic feet, that’s up from a $1.75 to $2.00 only a month and a half ago – huge new demand out of the electricity sector that you just never saw in previous years.

Interviewer 1: Keith, I know I’ve asked you this before, but not everybody listens to us all day long. NatGas, UNG, is UNG a good vehicle to trade natural gas?

Keith Schaefer: No, I think it is, but the best way to trade is going to be from the short side come later this fall. You’re looking at a sector right now that has what’s called a huge contango. That means that the price in the future is quite a bit higher than the price of it today. What happens with these ETF’s is whenever they have to roll over their monthly contracts in natural gas, if you sell something at $3.00 or $2.75 and you have to buy the next month at $3.25, you’re losing $0.50 a contract there. That impacts the price of that ETF. On this rollover from month to month, you lose value for the shareholder in UNG. So to take it as a long trade, to buy it and think it’s going to go higher, you’ve really kind of got the cards stacked against you a little bit. But if you get short that trade. Of course when you’re short you have to do that at the right time and it’s a very risky trade and it’s not for everybody. Then you actually get that going for you. So my thinking is come early to mid August, when most of the heat is out of the way, then investors, the smart trade would probably be to get on the short side of UNG.

Interviewer 2: Keith, I was looking into natural gas and some of the exploration and production companies yesterday, and I was a little surprised. Typically at least, I would expect to see when a commodity rises, when natural gas was up 7% yesterday, that you’d also see the exploration and production companies following. But, just looking at a broad proxy, for instance the XOP, it was off 2.5% yesterday. Is there any reason in your mind for this split between the price of the commodity and what we’re seeing in the price reflected in some of the exploration and production companies?

Keith Schaefer: Absolutely. I think there’s a couple of factors at work here. I think the big thing is that the guys who are investing in the stock market are a bit different than the guys investing in the commodity and the futures. There’s only really a handful of pure natural gas producers in the United States with any real size. The big producers are actually oil companies. Exxon is the largest natural gas producer in the United States.

Interviewer 1: Even more so than like a Chesapeake, or?

Keith Schaefer: Yeah. Chesapeake’s like number two or number three. And of course Chesapeake has had it’s own legal issues lately with some of the management issues that they’ve been going through. Even in the top ten, most of those companies are either foreign companies or mostly oil companies. So really if you want to play the natural gas game in the United States you have to move down market a little bit to some of the smaller companies. With all the macro stuff that’s going on in Europe right now, investors don’t want to do that. They don’t want to play smaller companies. They want to play the leaders. Chesapeake was the leader and I guess still is, but investors don’t really want to play that stock until they see what the issues are with management get played out. I think regardless of what’s happening in the commodity, the natural gas stocks are really going to be pressured still. I think that most people are looking past the summer, into the fall, and thinking, you know what, I just don’t see a lot of chance for a higher price here just because there’s so much continued production here. We’re back up to almost record production this week.

Interviewer 2: Well, Keith . . .

Interviewer 1: Go ahead, Tom.

Interviewer 2: I was going to say let’s talk a little bit about liquid natural gas because that’s something that you’ve argued in the past can really be a game changer for us. Can you explain just what liquid natural gas is, and what the benefits of LNG are over the gas form?

Keith Schaefer: Sure. Well, the whole idea behind LNG is that it could now be shipped across the oceans, just like oil. It would make natural gas a global commodity. Up until now, it has been a continental commodity. Wherever you are in the world, natural gas stays on your continent. But now when you put natural gas into liquid form, you have to cool it and it compresses itself into one six-hundredths of its normal shape. That’s a huge reduction. What happens is that you can now put that on a tanker and these things, these tankers, are so big now, they hold about 3 billion cubic feet of gas. To give your audience an idea of how big that is, 23 of these ships could supply the United States with all their power needs every day. So if 23 ships came to the coastline, we wouldn’t need to produce any natural gas at all. So these guys are big. What’s happening now with all the turn away from nuclear – in Asia, particularly in Japan after the natural disaster there last year with the earthquake – the price of natural gas in Asia has just gone through the roof. You’re seeing here in the United States, it’s $2.00 to $3.00. Now it’s $3.00. The contracted price in Japan and Shanghai is $10.00 to $12.00 and sometimes even $14.00. And in the spot market you’re seeing prices as high as $18.00 to $22.00. So there is a huge arbitrage there, a big gap that a very entrepreneurial American company could grab.

Interviewer 1: Keith, that roughly 25% move in one day on May 14, was that a short covering rally?

Keith Schaefer: Yes.

Interviewer 1: OK. So that little bit of pull back, and then we spiked up yesterday.

Keith Schaefer: Yep.

Interviewer 1: We’ve gone from . . . I’m looking also at . . . Again, I’ve got UNG. We’ve gone from $15.45 to almost $18.40 in the span of three sessions.

Keith Schaefer: Yep, that’s pretty big! That’s pretty big. And the guys who were lucky enough to time that trade, God bless them. For me, it’s just difficult. I’m looking at all the fundamentals in this market and seeing, wow, we’re still not seeing any big movement here because once we get to $3.00 and a little bit over that, you see the power companies start to turn back to coal. They seem to be doing that with stunning ease which really doesn’t make sense, but that’s what we’re seeing in the statistics. One thing I think that you’re audience needs to remember is that gas really needs to go to $4.00 or really $5.00 before these stocks start to make money. You look at how much money they paid for their land and you amortize in all the costs, throw in everything including the kitchen sink, and all these guys need is still $4.00 to $5.00 gas to break even. It’s still a bit of a losing proposition for the industry even with these prices having moved up 50%.

Interviewer 1: Well, for anybody out there who wants to learn a little bit more on how to navigate the energy space, how they can navigate the oil and gas in particular, you should check out the Oil and Gas Newsletter. That is www.oilandgas-investments.com. Keith Schaefer is the publisher and we certainly thank you for your time today.

Keith Schaefer: Thanks guys! Love being on.

Interviewer 1: Well, we love having you. Thank you very much. When Jason and I come back we will be joined by Atlanta’s own Bob Harwell. We’ll talk a little gold and silver with him. We’ll see you in a couple of minutes.

 

1...767778...119Page 77 of 119
© Copyright 2023 - Profit Prospects