In
Part 1
of this series, posted on my Instablog, 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, and 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," according to Schachter. 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.
Says Schachter:
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 (DPGYF.PK):
"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 (GLNNF.PK):
"They have 30% oil and Natural Gas Liquids, heading to 40%."
Niko Resources (NKRSF.PK):
"Niko has a big Indonesian portfolio (they're starting to drill)
now, and a chance for resolution of some issues in India, and
they're financed for two 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
the $70s in a good market."
Western Zagros (WZGRF.PK):
"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 that 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. 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 recommended
Surge Energy (ZPTAF.PK).
According to Pelletier:
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.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
See also
A New Aspect Of Real Estate Investing: Risk
on seekingalpha.com