Alexander Montano: "Technology Is Key" with E&P
Source: Brian Sylvester of
The Energy Report
Alexander Montano, managing director of the Corporate Finance Group
with California-based C. K. Cooper & Co., puts a lot of faith
in technology when it comes to making oil and gas plays pay. Alex
sees major opportunities for new technology in old oil basins and
suggests some names making good on that thesis in this exclusive
The Energy Report.
The Energy Report:
Alex, oil traders seem to be showing a growing confidence that U.S.
economic growth will rebound next year. This is evidenced by the
fact that they're taking advantage of the gaps between the current
prices for crude and the six-month contracts, which are due early
next year. Is C. K. Copper seeing similarly bullish prospects for
the U.S. economy and oil prices in general in 2011? What's your
Well, we understand that oil prices are to some extent linked
directly to economic growth. But we think that more and more the
outlook for oil prices is going to be less dependent upon U.S.
economic growth and is going to become more a factor of global
growth. We are not extremely bullish on the U.S. economy in 2011.
We believe the recovery is happening, but we expect it to be slow
and drawn out. We don't think it's going to be much fun.
But we believe that global demand is growing. We believe that
the macroeconomic picture looks very strong. We remain bullish on
oil into 2011 with a price between $70 and $85 a barrel.
In which regions of the world do you see growth occurring?
We think that it's going to continue to come from China and India.
We think Latin America is going to remain pretty strong. We think
that a lot of the emerging players are whetting their appetite on
oil and that appetite is going to continue to grow.
Along those lines, OPEC, the Organization of Petroleum Exporting
Countries, turned 50 last week. Its control of the oil market is
obviously less substantial than it used to be. What impact is OPEC
having on the market now?
Well, I think you correctly said that its direct impact in the
supply/demand equation has been watered down over the last couple
of decades. But I think that from a market leadership standpoint,
they are still the clearest voice out there. I think that when OPEC
establishes what they believe the oil price should be, whether it's
directly a result of their production or not, the oil markets
generally adapt to that. As far as short-term swings in production
and the ability to fill necessary gaps go, OPEC remains the primary
supplier. It's an organization that's been up and down, but I think
they continue to be the leader as far as sentiment on world oil
prices. I think people still respect that position.
OPEC leaders are on record saying that they consider the current
oil price "ideal" and that they will try to keep the oil price
where it is. Do you think that they still hold enough influence to
keep oil in the $80 range?
I do. We're believers that demand growth is going to continue. I
think if you couple demand growth with OPEC's willingness to
basically manage supply better than they have historically, then we
think that that price target is doable. If you could have a
relatively defined price range and the commodities stay within that
range, it is a win-win. It's a win for the industry. It's a win for
the consumer. We understand that and believe in what they're trying
What's your investment philosophy when it comes to oil and gas?
We focus on technology. We believe that this is a much more
technology-driven industry than anything else. Here in California
there's a lot of heavy oil. Heavy oil has become a very fundamental
piece of the supply picture in the United States. You take a look
at what's happening with the heavy oil from the oil sands in
Canada. Technology is revolutionizing the economic threshold there.
We believe that there are lots of known reserves that will have a
meaningful impact on the market in the future. It'll be technology
that will make those resources work.
We, generally, try to target companies that are going to apply
proven technology in areas that have not been subjected to that
technology before. We believe that as these companies are
successful, they become an attractive target for larger companies.
We tend to focus on companies with a market cap of $1.5 billion or
less that we believe have some core thesis that's going to drive
their share price. We believe there are companies working in
certain geological plays that are hopefully bringing a proven
technology to unlock the value there.
Are you talking about things like old oil basins that are no longer
economic with vertical wells, but that could perhaps be economic
again through horizontal drilling and other newer extraction
Yes, horizontal fracking, water floods and tertiary recovery. The
amount of knowledge in the industry is increasing quickly. A lot of
times it's just a question of applying the right technology.
What are some names that have found the right technology in some
Evolution Petroleum Corporation (
is a company that, in our opinion, developed and put together a
play for a CO2 flood at the Delhi Field in the southeastern U.S.
They were able to turn that over to
Denbury Resources Inc. (
. They got a pretty nice upfront payment, and they have a
production royalty. That was four or five years ago. Denbury has
since basically developed the project to a point where it's a
solid, safe annuity.
Evolution just came out with year-end reserves in the
neighborhood of 9 million barrels, and it's a little company.
Here's a company that's got a base value, but at the same time
they're going into the Austin Chalk to apply new technology there
and hopefully increase value. And they've got this new "artificial
lift" technology that they're applying to uneconomic wells in
Texas. With Evolution, the downside is protected because of their
Delhi Field with Denbury, and all the other stuff is upside. If
you're an investor and you've been waiting for three or four years,
that risk has been basically removed and you're in a position to
reap the upside.
What's their position in the Delhi Field versus Denbury's?
They basically have a back-in option after Denbury recoups its
investment. That's somewhere between 20% and 25%. The reserves they
booked are based on that deal. Our equity analysts have a target
price in the $9 range for Evolution. They believe that the company
is already worth $7 or $8, and the stock's still trading at a
discount to that.
Is there another investment thesis you like that's being applied
and that looks appealing?
Like I said, we like the idea of somebody buying an asset,
unlocking its value and having another company buy them. That's why
we like a company called
Miller Energy Resources (
They probably did the deal of the year in 2009 when they
acquired the assets of a Canadian company called Pacific Energy.
Pacific had bought those assets from
Forest Oil Corporation (
and probably invested in the neighborhood of $500 million in them.
But when the credit crunch hit, Pacific was overleveraged and it
ended up in bankruptcy.
Basically, through tenacity, Miller bought the cherries of
Pacific's Alaskan assets for $5. Their fair market value is
probably somewhere around $300 million. It's almost too good to
believe. But as Miller restores a lot of the production that was
shut down or fixes wells that aren't producing at maximum rates,
the market is really going to take notice. We think Miller's fair
value is in the $12 range; it's currently trading somewhere just
below $5. There's very little institutional ownership at this
point. We think it's one of those companies where somebody is going
to come along and say, "Thanks guys, you really cleaned up these
assets. We'll take it from here."
Among the micro-cap stocks on a list I saw recently, Miller is
listed as fourth in terms of return on assets over the last 12
months. Obviously, they're getting a lot out of those assets
already. But what about their being in Alaska?
While Alaska may be maturing, I still would characterize Alaska as
a bigger company kind of play. I think that Miller pulled off a
small miracle, but to develop everything that's there is going to
take really, really deep pockets. I think there will be a point
where somebody with a lower cost of capital than Miller is going to
buy it. I don't know if that's in two years or six years, but I
think that is the ultimate exit strategy.
All right, so buy and hold Miller Petroleum. What are some other
E&P plays that you're excited about?
Domestically there's a smaller company that we like called
EnerJex Resources Inc. (
We made a decision about four years ago that we thought oil was
a better commodity to invest in versus gas. If we could find oil in
proven, safe locations, then that was the place to go and bet that
technology could make it work. So we like Canadian production. We
like U.S. production. EnerJex operates only in eastern Kansas,
which is maybe not recognized as a leading hydrocarbon region. But
Kansas is among the top eight oil-producing states. The thing about
eastern Kansas is that it's older production, so ownership is very
fragmented. I think there's something like 10,000 different
operators in Kansas with the majority producing 50-80 bpd.
EnerJex basically said: "We're going to acquire those
mom-and-pop shops and aggregate them." Most of these operations are
so small that they aren't water flooding. They aren't down spacing.
They aren't using artificial lift; they aren't using any kind of
horizontal-drilling technology. Enerjex believes that they can
apply these technologies and take production from their current 200
or 300 bpd to 3,000, 4,000, 5,000 bpd over the course of four or
five years. At that point they become a nice target for
There's very little exploration risk. It's more of a
manufacturing process because we know the oil reserves are there.
It's just a question of getting them out economically by achieving
economies of scale.
But that premise depends largely on the acquisition costs. And how
is the company going to afford to buy many of these assets? They're
going to have to dilute their equity, and that reduces value.
They can use bank credit pretty effectively because there's very
little risk. They're good assets to leverage. They have also found
that so many of these assets have been neglected that in many cases
the producers are also the landowners. It might have been a farmer
that drilled two or three wells just because that's what everybody
was doing 20 years ago. EnerJex has had some instances where people
are willing to give them the well leases on the condition that they
will go and drill it out because the royalty revenue would be
greater to that landowner than what they're getting currently. I
think that if they can maintain a certain pace of activity, then
that starts to create the traction. In 2007 and 2008, they took
about $9 million of capital and turned it into $40 million of
It's certainly an interesting business model. But what about
exploration drilling costs?
Their biggest issue isn't the exploration risk. The biggest
sensitivity in the company is operational leverage. Right now
they're producing 200 or 220 bpd. Their fixed costs associated with
that don't really change if oil prices go down. Could they produce
400 or 500 bpd without really changing their cost structure? They
probably could. But they have tended to be very sensitive to
commodity prices. When oil prices went down in late 2008, it really
hurt them. But if they can add mass, then their operating margins
will improve and their sensitivity to commodity prices will
Alex, you talked earlier about the global market for oil. Are there
some companies that C. K. Cooper likes that are not based primarily
in the United States?
Yes, there are, although we try to shy away from political risk. We
think that's a risk that cannot be quantified or that you can't
factor into a model.
Well, you can use a steeper discount.
Yes, but how do you discount what Hugo Chavez might do in Venezuela
next month? We're basically looking for plays in what we believe
are politically stable regions with strong markets. One company
that we like is a natural gas player called
FX Energy Inc. (
. They are focused on natural gas production in Poland.
Poland normally imports the bulk of its gas from Russia. And as
we've seen over the last couple of years, gas can become more of a
point of leverage if the Russian government chooses to utilize it.
That means there's a ton of pressure in Europe, and in Poland in
particular, to develop alternative supplies of natural gas. It's
not that Poland doesn't have the reserves, it's that they're just
underdeveloped. We think that FX got in early. They have a huge
land position there. It is one of these plays where they have so
much land under lease that anything else positive that happens in
Poland indirectly benefits them.
FX has gone from the incubation stage to a program of steady
drilling. They're starting to become more of a production and
development company. We think that if Eastern Europe experiences a
really cold winter, they could become a very attractive takeover
Possibly by Russian company?
I doubt the Poles would support that. Their partner is the Polish
National Oil Company, so I'm sure they would have some say in
But you're seeing a lot of transactions that are effectively
technology transfers. A lot of companies in Europe are trying to
bring U.S. and Canadian drilling and completion technologies to
apply on their unconventional plays. I think that as that starts to
gain traction, people will look for low hanging fruit, companies
with proven assets and a decent reputation. I think FX fits the
Moving over to natural gas, the U.S. Department of Energy expects
total natural gas consumption to increase 4% this year. That means
an extra 65 billion cubic feet of gas per day. And the CEO of one
of the majors,
Royal Dutch Shell Plc (NYSE:RDS.A)
, recently said that Shell will be more gas than oil by 2012.
What's that telling us about the natural gas market, and should
investors be taking long-term positions there?
We think that natural gas is the fuel of the future for the United
States. You can't look at the abundance of it, the infrastructure
that's generally in place and reach any other conclusion. I think
in the long term, you absolutely need to have a position in natural
gas. The problem is that there's been such an advancement in
technology in developing gas out of unconventional plays that
there's an oversupply of gas in the market. And there probably will
be for the next 12 or 18 months. While we favor oil in the short
term, we believe that you can selectively add natural gas companies
to your portfolio and you'll do well. But in the meantime, there's
going to be a rough period as the market adjusts to the new
Are there some predominantly natural gas plays that our readers
might be interested in?
We really don't have any that are at the top of our list. We like
particular plays. We think that the Eagle Ford Shale is going to
make sense. The Marcellus obviously is going to make sense. There
are a lot of companies that are positioned there, but there's
nobody near the top of our recommendation list that is really gas
But are you recommending that investors should be cautious when it
comes to plays in the Marcellus, given that there's a moratorium on
fracking in New York and there's growing concern about a similar
ban in Pennsylvania?
Yes, absolutely. But I think that in the long term, economic
necessity is going to outweigh those issues and technology will
continue to improve.
A lot of gas development, in my opinion, is about a land grab. I
mentioned that none of the companies near the top of our list are
focused on gas. That doesn't mean they don't have gas or don't have
exposure to gas. They're just not putting a lot of money into
If you've got companies that have large acreage positions in
places like the Marcellus, but aren't being forced to drill it to
defend those acreage positions, it's like having a long-term
annuity. Those positions are going to be worth something in the
But we will likely see some consolidation because companies may
have to take writedowns on those acreages, and that will result in
shrinking share prices.
Well, it either makes them targets or it drives them to go out and
acquire assets elsewhere where they can do something over the next
two or three years. I think that a lot of companies that maybe made
a push into the Haynesville or the Marcellus have their acreage
positions and can manage that land. The question becomes: Where can
I go and buy something that I can sell to the Street for the next
two or three years? To us, the opportunity lies in these more
proven oil basins.
Are there some companies that have sizeable positions in the big
shale plays that are looking to diversify?
I think a good example is
Goodrich Petroleum Corp. (
. They spent a lot of money to push into the Haynesville in
northern Louisiana and eastern Texas over the last couple of years.
I think they kind of realized: "Hey, this isn't bad stuff, but we
don't want to have all of our eggs in this one basket." Now you've
seen them go out and start moving aggressively into the Eagle Ford
Shale, which has a lot more oil in it.
Another company you can look at is
EXCO Resources Inc. (NYSE:EXCO)
. They aren't abandoning their gas plays, but they're trying to
diversify their asset portfolio either through acquisitions or JVs.
If they fail, then they will likely become targets.
Do you have some parting thoughts on the sector today?
Well, we would say that technology is the key. With lots of plays,
when capital is relatively tough to come by, you want to be able to
manage your capital budget. Most of the time, that means long-term
lease positions-acreage held by production. If you have that, you
can wait. . .let technology develop. Let guys with deeper pockets
develop new completion or fracking techniques. You basically
benefit through serendipity. Those are the companies we target.
Alexander, this has been great. Thanks.
Alexander G. Montano is managing director of the Corporate
Finance Group for
C. K. Cooper & Company
, a full-service investment bank. Montano has been responsible for
the development of the firm's investment banking practice,
including cultivating client relationships, strategic planning and
transaction management and execution. Prior to joining C.K. Cooper,
since 1991, Montano was an equity analyst, and focused on smaller
exploration and production companies starting in 1995. His comments
and analysis have been quoted in such publications as
Hart's Oil & Gas Investor,
magazine, Standard & Poor's Platts Oilgram News and various
regional newspapers. In addition, Mr. Montano was rated a 5-Star,
All-Star Analyst by Zacks Investment Research in 2002 and top oil
The Wall Street Journal
in May of 200
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1) Brian Sylvester of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
2) The following companies mentioned in the interview are sponsors
The Energy Report:
Enerjex and Shell.
3) Alexander Montano: I personally and/or my family own shares of
the following companies mentioned in this interview: None. C. K.
Cooper & Company owns equity of EnerJex Resources, Inc. I
personally and/or my family am paid by the following companies
mentioned in this interview: None. However, C. K. Cooper &
Company has provided investment banking services to EnerJex
Resources, Inc. and FX Energy, Inc. and may solicit investment
banking business from other issuers mentioned herein.
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