Market Turmoil Puts Pressure on Small E&P Firms to Consolidate

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Several exploration and production companies both large and small have become appealing targets for consolidation as a result of falling market valuations and uncertainty surrounding oil's prices in the future.

According to the IHS Herold Oil and Gas Perspectives Report, many smaller companies who list their shares on London's Alternative Investment Market (AIM) Index are in the pre-production stage. Since they are not yet generating revenue to sustain their future operations, these companies are dependent on funding. In order to reach production, they must either sell new shares in their operations or contract out partial interests in their licenses, Oil & Gas Financial Journal reports.

The AIM index has dropped 40 percent from its most recent high, and a company wishing to raise funds would need to issue 70 percent more shares than a few months ago to generate the same amount of money, the news source reports.

Potential farm-in partners are less optimistic about future oil prices, and will demand better terms for participating in projects, according to the media outlet.

Alternative Investment Market is a part of the London Stock Exchange that caters to small-to-medium-sized businesses. Since its founding in 1995, more than 3,000 companies have listed their shares on the index in order to raise capital.  

SEC Inquiring into Fracking Methods Used by Oil and Gas Companies

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The Securities and Exchange Commission (SEC) is asking that companies utilizing hydraulic fracturing, or "fracking," provide additional information on their methods. The SEC is collecting information on this technique along with other federal agencies such as the Environmental Protection Agency (EPA).

The SEC has historically focused on regulating other areas of the financial markets, but officials state they want investors to have more information about the potential risks associated with investing in oil and gas companies, according to The Wall Street Journal.

The agency's inquiries have triggered criticism on the part of industry participants that the efforts could create too much regulation. "While our industry absolutely supports common sense disclosure and transparency measures, such duplicative inquires that may fall outside of an agency's core mission, are troubling and counter to what our nation needs at this time," Kathryn Klaber, president of Marcellus Shale Coalition, told the media outlet.

A recent demonstration during a speech at a Colorado Oil and Gas Association conference has been interpreted by many to be a response to public concern about fracking methods, The Associated Press reports. A company executive reportedly drank from a container containing Haliburton's new fracking fluid to illustrate its safety.  

San Leon Energy Acquires Realm Energy for $139 Million

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Realm Energy International Corporation (RLM:CN) was recently acquired by San Leon Energy plc (SLE:LSE) for $139 million.

The agreement will see San Leon gain all of Realm's issued and outstanding shares and will pay each Realm shareholder either C$1.30 or 3.30 ordinary shares in San Leon's capital for each share he or she holds. Realm is a British Columbia-based shale gas exploration company.

Realm shareholders will control about 36.9 percent of the new venture as a result of the deal.

San Leon's Board of Directors said that it made the move in part to create a more focused shale acreage position in Poland's Baltic Basin. In addition, the board said that it might gain even more access to shale if Realm's applications for licenses in France and Spain are accepted.

The newly formed venture will have 28 licenses and concessions in seven different countries, with Poland, Albania and Morocco being the focus areas.

Natural Gas for Europe reports that the gears for this acquisition were set in motion last May when San Leon retained the services of GMP Securities to “identify, examine and consider a range of strategic alternatives available in connection with its interests in Poland.” Realm held a 100 percent interest in the Gniew concession in the Baltic Depression and 50 percent interest in both the Ilawa and Wegrow concessions.

EnCana Corporation Upgraded to OUTPERFORM by Raymond James

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Investment dealer Raymond James updated its rating of gas producer EnCana Corporation to OUTPERFORM based on the potential of a higher return for its stock. This update happens as the company has announced plans to divest in its gas-producing assets that exist in Texas. This intended sale is part of a larger divestiture program that intends to raise proceeds of $1 billion to $2 billion in 2011. The company's stock has dropped 15 percent since EnCana released 2Q results on July 21 and a recovery to the new target price of C$31 will translate to a 26 percent return.

The new target price of C$31 is based on estimated NAV for 2011 and a 5.0x multiple of 2012 estimated cash flow. The cash flow multiple has been reduced to accommodate expected changes in gas prices for 2012. Since the stock is now trading at a 4.0x multiple of market consensus for 2012 estimated cash flow per share, the investment dealer states that the stock price already takes the lower gas prices into consideration.

EnCana Corporation opened at C$25.00 on Thursday, August 25 after closing at C$24.89 the previous day. In the last 52 weeks, the company has hit a low point of C$22.92 and reached a high of C$34.25.
 

Oil Stocks & Relative Strength: What To Look For

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Here’s Part 2 of Cory Mitchell’s report, in which he explains what investors should look for in individual stocks to best profit. (Click here to read Part 1 of this story.)

Individual Stocks: What To Look For

Oil and stock indexes (such as the TSX Composite) are gauges that can be used for picking individual stocks. Since certain stocks will perform better than these benchmarks, and other stocks will perform worse. We want to find the ones which show the most promise. This is done by comparing the price action of individual stocks to oil and stock indexes.

Oil and stock indexes are highly correlated (move with each other) over the last decade. This was not always the case, pre-1999 oil and stock indexes had a very tenuous correlation, often moving inversely. By using both oil and stock indexes we can improve our chances of picking quality stocks.

What I like to see when oil and the TSX Comp are falling is an individual stock that has sold off, but is no longer dropping. If it is no longer falling as oil and overall stock market continue to fall it is a good sign. This phenomenon is known as “relative strength.”

Here is a recent example: Canadian Energy Services (CEU.TO) has performed better — in percentage terms — than oil and the TSX Composite over the last year. Recently when the oil and stocks declined rapidly in early August, CEU.TO sold off as well. The interesting thing is that while the TSX and oil made new lows for the year, CEU.TO did not even make it to the low it saw in June. (Disclosure: CEU is an OGIB stock, and Keith Schaefer owns shares).

Figure 3 shows this visually. CEU.TO is the green and red bars, oil is the purple line and the TSX is the yellow line.

Figure 3 – CEU.TO vs.TSX and Oil

Source: Freestockcharts.com, August 17, 2011

Figure 3 shows an example of the type of action we are looking for. By finding stocks with similar patterns over the long-term, positions can be taken for when equities and oil begin to trend higher once again. That trend may be some months away as there exists the potential that stocks and oil continue to move lower over the next several months.

CEU.TO is a short-term example, but as the stock market and oil continue to decline (in my opinion) what are we looking for down the road? In the 2008 decline CPG.TO showed great strength as oil and the TSX Comp continually made new lows. Figure 4 shows CPG (red and green bars) vs TSX (yellow line) and Oil (purple line).

Figure 4. CPG.TO vs TSX and Oil

Source: Freestockcharts.com, August 17, 2011

CPG made lows in early December of 2008 (circle labelled “1”), and oil and stocks continued to decline into February and March respectively. The fact CPG would not go lower as these two benchmarks went lower was a signal to buy the stock.

Be afraid of stocks that have been hit and hard and continue to fall. Love stocks that have fallen and stopped falling as oil and the broader market continue to decline. This shows selling is exhausted and any positive news or push higher in oil prices, stocks or the sector will raise the price of the stock.

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The Fracking Technology that Doesn’t Need Water

It not only rids the fracking process of costly and environmentally-unfriendly water…

Its fracking fluids can also be recovered quickly and easily.  And — when the fracking is completed — oil producers can increase the amount of oil produced by using this company’s unique technology.

That’s why a prominent North American financial services firm maintains an “outperform” rating on this company.

Learn all about this company — the “horsepower” behind one of the world’s fastest-growing sectors — here in this free video.

CLICK HERE TO WATCH.
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Exploration/Production or Services – Is there is there a return advantaged sector?

On a final note, I wanted to look at the performance of the Oil Services Sector and the Oil Exploration & Production Sector to see if there is an edge to be had by one or the other.

Going back to January 2007 (the starting point of the trend which brought $100+ oil) there are several points of interest:

Both sectors are highly correlated to each other and to oil. The only real difference is slight-moderate variations in performance.

In early stages of an uptrend in oil prices the Service sector performs very well. At the major low price in oil prices in January 2009, the Services hit bottom first (December 8, 2008) and showed early strength. Exploration/Production bottomed 3 months later but caught up and two sectors moved in virtual lock step to the recent April, 2011 highs in oil and the sectors.

From when Services bottomed in 2008 Exploration/Production outperformed just slightly, but that can be a bit deceiving…

Over the last 12 months and also year-to-date, Services have been outperforming, indicating a shift may be occurring and Services may begin performing better during all stages of the oil trend.

Any stock can outperform at a given time, but there is evidence there may be a slight performance edge in the Oil Services sector. Not only does the sector as a whole usually bottom first, but it is now performing well across all stage of oil bull markets. Stocks that bottom early and stop falling as oil continues to decline are exactly the type of stock you are looking for to buy.

Investor Take Away

Oil and the stock market are correcting and there is potential of a recession. This provides a great opportunity over the next several months to begin looking for oil related stocks which are no longer moving lower, even though crude prices and the stock market indexes may continue to decline. This is called “relative strength.” It is a sign that this stock is strong and if it can’t fall even when market conditions are unfavourable it means the next likely direction is up. The more companies we see that start to show relative strength to crude and stock market indexes falling the closer the markets are to a full reversal.

The Oil Services sector as a whole generally bottoms before oil prices, therefore looking for stocks within the sector that hold their ground will likely provide positive returns when oil and stock indexes begin to move higher. Regardless of where oil prices or stock indexes go, it is always advantageous to buy stocks which have relative strength.

– Cory Mitchell, CMT

Disclaimer: The information provided is as of the date above and subject to change, and it should not be deemed a recommendation to buy or sell any security. Trading involves substantial risk and may not be right for everyone. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete.

Disclosure: Cory Mitchell does not own shares of any companies mentioned, nor does he have a current position in the oil market. Keith Schaefer owns share of CEU.TO.

Halliburton Exec Drinks New Fracking Fluid at Conference

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An executive for Halliburton recently took a drink of new fracking fluid in a demonstration of the safety of the liquid used to extract natural gas from the earth.

Much has been made about the risks posed by fracking, properly known as hydraulic fracturing, which involves the use of liquids and sands to break open rock to release natural gas.

Some contend that the process can imperil drinking water but a Duke University study found that fracking itself does not pose risks and rather this potential contamination occurs because of shoddy well construction.

The actions of the Halliburton executive who took a sip of the company's new fracking fluid at an industry conference may further show the safety of the process.

"The thing I took away is the industry is stepping up to plate and taking these concerns seriously," Ken Carlson, Colorado State University environmental engineering professor, told The Associated Press. "Halliburton is showing they can get the same economic benefits or close to that by putting a little effort into reformulating the fluids."

The executive took a sip of CleanStim, which Halliburton says is made with ingredients sourced from the food industry. 

West Virginia Files Emergency Rule Affecting Marcellus Shale Drilling Operators

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The West Virginia Department of Environmental Protection filed an emergency rule on August 22 that will impact natural gas extraction from the Marcellus shale.

Companies engaged in horizontal drilling activities in the Marcellus shale will now be required to submit a sediment and erosion control plan, site construction plan and a well site safety plan with their work permit applications. These rules will affect applications for sites that involve three or more acres of surface area.

The rule will go into effect after its approval by the Secretary of State and will remain in effect for 15 months.

Governor Earl Ray Tomblin said that the development of West Virginia's natural gas resources is important for the state but added that safety was also a concern.

"Still, we must work hard to make sure our efforts to capitalize on opportunities such as the Marcellus Shale are regulated responsibly and done in ways that protect our citizens and the environment," he said in a statement.

Shale gas – such as that found in the Marcellus formation – has played an increasingly important role in America's natural gas production. The Washington Post reports that it now accounts for almost 30 percent of the natural gas produced in America, compared to less than 2 percent in 2001.

Canaccord Genuity Maintains BUY Recommendation for Canadian Overseas and Increases Target Share Price

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Investment banking firm Canaccord Genuity reaffirmed its BUY recommendation for Canadian Overseas Petroleum Limited (XOP:TSX) and increased its target share price for the exploration and production company to C$1.20 from C$1.10. This revision in the company's target share price was largely based on new information related to the 206/5a-3 exploration well, which increased the company's portfolio NAV.

The well was drilled to a total vertical sub-sea depth of 7,711 and aimed to reach the Fulla prospect, the media outlet reports. The well was drilled to utilize Clair and Whiting reservoir sands, which could potentially yield oil. Average porosity of the reservoir was measured at a better-than-expected 23 percent. Oil samples have been extracted and will be assessed in Canadian Overseas' onshore lab.

Canaccord Genuity estimates that Fulla will generate as much as C$0.29 on an unrisked basis and C$0.14 on a risked basis.

New York Mercantile Exchange (NYMEX) gas scheduled for delivery in September increased 3 percent to close at C$3.99 Tuesday, Canaccord Genuity reports. NYMEX crude scheduled for October delivery increased 1 percent to C$85.44.  

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