Chris Pikul Favors 'Oily' Names; Cautious on Gas
Source: Brian Sylvester of
Morgan Keegan Analyst Chris Pikul is bullish on oil and soft on gas
but believes you can still "win the game" by being a discriminating
investor in oil and gas E&P companies. "You need to be really
focused on gas companies with the best quality assets and strong
balance sheets. . .you really have to pick and choose," says Chris,
a big picture value investor who never stops thinking about how
different market factors will influence the equities he covers. In
this exclusive interview with
The Energy Report,
Chris' impeccable attention to detail is on display as he picks
a few of his favorites in the E&P space. . .just for you.
The Energy Report:
In a recent research report, you said: "While we can endlessly
debate the direction of short- and long-term gas prices, we think
the argument for oil remains more visible and fundamentally
appealing for E&P investors." Have recent events such as the
Gulf Oil crisis, China's slower growth and Greece's sovereign
bailout changed your thesis?
Well, that's an insightful question. Broadly speaking, we've
discovered quite a bit of new gas supplies here in the U.S. I think
there's a consensus among industry personnel that $4, sub-$5 and
possibly up to $6 gas is not a high enough price to satisfy the
market on the longer term. Obviously, I think there's a supply and
demand imbalance that could certainly result in lower prices. We
need to be cautious of gas prices and how they're going to impact
On the oil side, we're still growing our demand; China is
certainly a big part of that. I think the oil market can still be
characterized as, perhaps, supply challenged. That's in sharp
contrast to what has happened in the U.S. gas market, which is
domestic and not quite as subject to global influences, at least
not just yet.
Has that thesis changed? I would have to say, "not really,"
though the difficulty with the oil side of the equation over the
past couple of years has certainly been how the commodity trades in
relation to the dollar. It's created quite a bit of volatility. The
dramatic change in oil prices from $30 to $150 hasn't really been
supported one way or the other by dramatic changes in supply or
demand. You're seeing a lot of assets move around as investor
preferences change asset classes in relation to perceived risks in
currencies, such as the euro as a result of, as you mentioned, the
Greek sovereign debt. That can certainly create some swings in oil.
So I wouldn't say I am any less bullish on oil, but this sector is
giving us opportunities to pick and choose good entry points, and
it's been a trader's market. I would say in the longer term that
our preference for oil remains unchanged.
Any sort of limitations on deepwater drilling has the potential
to be modestly bullish for both gas and oil prices. But, again, the
U.S. is really a marginal supplier of oil; so, perhaps less impact
on oil, potentially bigger impact on the domestic gas supply.
The report I referred to earlier was published in January. In that
report, your 2010 price projections for oil and gas were $70 and
$5.50, respectively. Why were you lower than consensus from the
Well, that's also a very interesting question. I think it is
important to establish to investors a reasonable price deck that
people should be willing to buy into. If you're going to start
buying into very optimistic futures strips, and buying into the
$85-$90-$100 oil argument to justify equity investments when prices
are between $70 and $80, I think that dramatically increases your
risk exposure. I'm really trying to be less predictive of these
prices and more interested in determining a reasonable rate range.
And certainly in the case of oil, I simply wanted to be
conservative; but with gas, I felt that there was some potential
weakness that could find its way into that market. We have
certainly seen that; I think it bounced up close to $6 at the end
of the year, and then we wandered down to $4.
The problem is while we definitely had a weaker gas price in
2009, some of the gas stocks certainly participated in the market
rebound; so, you had a decoupling of gas market fundamentals and
equity performance. To me, that also increased the relative risk of
owning gas companies. And we have certainly seen some more
definitive outperformance from the oil names than the gas names
this year; so I think the gas stocks are slowly starting to reflect
perhaps some changing investor sentiment as to the pace of or
timing of any real recovery in natural gas prices.
What is that investor sentiment?
I think people believed fewer operating gas rigs were going to have
a big supply impact. I think a lot of people were a little
surprised that never seemed to find its way into the domestic
production numbers last year. Meanwhile, oil prices are giving a
much better margin in the group. I think this notion of a pending
gas recovery has sort of kept people involved on the equity side.
You're starting to see some of that diminish. The luster is coming
off that argument, so you're seeing people gravitate more towards
the oily names.
What are your oil and gas projections for 2011?
I'm at $75 and $5.25, respectively, for 2011. Clearly we've seen a
little rally in gas prices here for various reasons, but I think
that $5.25 could even be a little aggressive. Consensus is still
$5.75 for gas; I don't quite know how much faith to place in these
consensus numbers, but it still seems like a recovery is baked into
some people's expectations of the gas market. I am about as
aggressive as I want to be on the gas side.
In another report, you said: "Based on our view that natural gas
prices will display much less volatility in 2010. . .We think
margin and cost control will become even more important tools for
investors to help differentiate between E&P companies." At the
same time, you rated
Petrohawk Energy Corporation (
as an outperformer, even though it had the lowest margin of any
company on your list. Please explain that decision.
As Petrohawk starts to ramp up production in its Haynesville Shale
play, you're going to see company-wide margins improve; and,
really, their margins are more a function of pricing right now.
The problem that the market is having with a lot of these gas
names-and certainly one that I wrestled with-is that for the first
time we're looking at a tremendous resource potential beyond what a
company already books as proved. In Petrohawk's case, they're
talking 30 TCF; that's a 10x plus multiple to where they are
proved-clearly that resource is worth something.
We understand that investors are only willing to pay forward for
so much of a resource, but this is sort of a new paradigm for
people. In the past, if you had two, three, four, or five times
proved in inventory, that was considered quite a multiple of
resource to proved. I would expect to see relatively stronger
multiples for these gas companies. This inventory is worth
something; $4 or perhaps it's not worth that much. People don't
think it will be worth that much but it's an important factor. I
think that's part of the reason we didn't see these gas stocks
necessarily directly track gas prices last year because, while gas
prices were wandering lower, well results were continuing to get
better and people were proving up more resources. It was creating a
little bit of a conflict for investors.
When I say "less volatility," we think increasing supply that
would perhaps temper the market, albeit in the $4-$5 range, but
rather than relying on gas-price upside, which remember
pre-Haynesville, the gas market was still considered supply
challenged. So, the prospect for high prices or permanent $7 plus
sort of pricing was part of investor psychology, and pricing upside
does create a lot of the upward justification for equity investment
in some of these companies.
In a $4-$5 price environment, investors are going to have to
shift their focus when considering investing in a gas company;
certainly operating margins are going to be a more important
component. In an area like the Haynesville, you have very
productive wells and generally low lifting costs. As more and more
of Petrohawk's production shifts into Haynesville production, we
should see company-wide margins improve. To their credit, they had
among the lowest lifting costs in the group; so, you're seeing
their overall net margins compressed more by pricing than by
Earlier you said that investors will have a
preference for some of the more oily names. What are some of the
more "oily" names you like?
Here at Morgan Keegan one of our top picks for the year was
Whiting Petroleum Corporation (
, a company that has a nice footprint in the Bakken Shale play. Let
me just say there's much less oil focus with smaller cap and
E&P companies, so the sandbox is a little smaller when it comes
to identifying oil companies. A little harder to find but within my
specific coverage group right now I have
Berry Petroleum Company (
Concho Resources Inc. (
was a recent addition,
Continental Resources Inc. (
, and certainly
Kodiak Oil and Gas Corp. (
in the smaller caps.
These companies certainly stand out. And as the preference for
oil seems to have increased, we're certainly seeing outperformance
in many of these companies. But Whiting is one that I like for the
footprint in the Bakken, and it has an interesting exploration
program where the company's had some pretty good success on a
fringe area of the Bakken it's calling Lewis & Clark. It has a
very big footprint there of 200,000 acres; that's one that can be a
catalyst for the shares. Whiting's evaluation didn't typically
reflect the high multiples that people are willing to pay for
high-margin oily growth from peers, like Continental, which has a
much bigger acreage footprint-over 600,000 acres in the Bakken.
What's your target price on Whiting?
Well, officially, we don't have target prices at Morgan Keegan so
I'll probably have to defer that question; but we have fair value
ranges that tend to change based on fluctuations.
Tell us about the other companies you mentioned, perhaps Berry.
Berry is a heavy oil producer and it's kind of in a unique
position. The company benefits from low gas prices to generate
steam for their thermal recovery operations in California. So
they're benefiting on both sides-lower gas prices
higher oil. We think that stock trades relatively cheaply, less
than what we think their proved reserves are worth (in other words,
what they've already discovered). The stock seems to have found a
range below $35 that we peg as what their reserves are worth,
granted that is forecasting another year of reserve growth. Berry
should appeal to a lot of value investors, even though it's still
growing at a decent, respectable rate of about 10%.
You mentioned a couple of others-Concho and Kodiak; how about
Concho operates in the Permian Basin, which typically has been
viewed over the past several years as a tired, mature basin. But
this is a place where oil is still being produced. Concho has been
a consolidator; it bought some decent acquisitions late last year.
This is a company that is primarily oily and has a very good growth
profile. For investors looking for a lot of oily exposure, this has
been a popular name. You're seeing a fairly robust multiple there;
but if oil stays at these levels or reaches the $80-$85 or $90
consensus number, there's certainly a lot of upside to the assets.
That's sort of a simple story, but people are looking to the
Permian, people wanting to acquire assets. This is an area that can
certainly be ripe for additional growth through M&A activity
Is new technology basically making resources available in older
basins that were not available previously?
Oh, very much so, and you really saw it on the gas side. The
technology was developed for the Barnett Shale in terms of
horizontal drilling. As the industry found better ways to expose
the drill bit to more rock and to more efficiently stimulate that
rock, we transitioned into the overpressure Haynesville. And now
the Marcellus and the Granite Wash-this new drilling completion
technology-certainly opened a tremendous wealth of gas resources,
which is still being digested by politicians and investors alike.
There are some arguments that certainly gas should feature a more
prominent role in the nation's energy future, though that hasn't
gained a lot of traction until just recently.
And, generally speaking, though the process and the technologies
are a little different, what we're seeing in the Bakken in terms of
10,000-ft. horizontal laterals, is 18 stages of completion-that
same sort of technology is helping to open up oily plays as
Earlier you mentioned that gas-company stocks had experienced
dramatic rises last year even though the gas price did not
experience much of a rise at all. What's the outlook for gas
companies for the remainder of 2010?
I think part of the reason for the outperformance last year was
because we were coming off a very distressed equity market; in some
cases, stocks traded quite low for a brief period of time. On a
calendar-year basis, you certainly saw gas equities participate in
the overall energy and broader market recovery; although looking
forward, I think gas prices could very well be between $4 and $5
this year. I think that's probably incrementally negative to what
investor perception may be. Most companies have fairly attractive
hedges still in place that are supporting cash flows. The problem
some of these companies are facing is that these higher-priced
hedges put in place a year or two ago-call it $6.50 up to $7-roll
off in 2011, even though they're growing production sometimes in
the neighborhood of 30%-40%.
Cash flow is growing much less because the realized pricing is
going to be down in 2011. So for companies still bootstrapping a
new shale program, they're outspending cash flow. You need to be
really focused on gas companies with the best-quality assets and
strong balance sheets to ensure they can develop these assets in
this kind of price environment. You really have to pick and choose.
I think it gets a little harder to do that on the gas side. There
are still quality companies out there with very attractive,
Speaking of "long-term potential," which E&P gas names are you
following that have attractive, long-term potential?
One of the easiest cases you can make is for
Range Resources Corporation (
. We've seen a lot of joint ventures in the Marcellus, where
they're one of the biggest acreage holders-deals between $10,000
and $14,000 per acre just to get into these plays. There have
certainly been some transactions for less, in the $5,000-6,000
range, but we see Range as the first mover in this play with
ramping production. They're over 100 MMcfe a day now; they're in a
liquids-rich portion of the play, which increased margins.
Marcellus, for the time being, gets a small premium in pricing in
the Northeast vs. Henry Hub. Marcellus has a lot of attractive
features, so that's drawing a lot of investors from other E&P
If you apply some of those acreage metrics to Range-call it
900,000 in the Marcellus Fairway-you can get into some pretty
dramatically higher equity prices. So, if you're going to believe
in something north of $10,000 an acre, you can get to an $80 stock
pretty easily. Right now, I believe the stock is probably more
reflective of a $5,000-6,000 an acre implied value on their
Marcellus stuff. And that doesn't really apply much value to any of
the other assets the company has in the Barnett outside of what
they've already proven. I think that's one gas name where even
recent transactions in a relatively weak fundamental environment
suggest the long-term outlook will be fairly bright.
What about some other names?
Well, Petrohawk, like I said, they have a very attractive Eagle
Ford Shale position, which has a liquidy component. It seems to be
trendy to be liquidy and, make no mistake, Petrohawk is certainly
very levered to gas prices at this point-but from an asset
perspective and from where they trade vs. what we think their
proved NAV is worth, which again I am pegging at year-end 2010 at a
$5.70 benchmark price, somewhere in the neighborhood of $15.
They're trading at a premium to what they've already proven, but
with such large resource potential behind what they've already
proven, I certainly think that a healthy premium to what they've
already proved is in order despite a gas market that has some
pricing risk over the next 6-12 months.
Again, asset quality and the balance sheet are very important
considerations in any gas investment in this environment. I think a
company with a little bit of a different twist on the gas component
Bill Barrett Corporation (
, a company I recently upgraded. Traditionally, the Rocky Mountains
has been a region compromised by natural gas prices due to pipeline
infrastructure issues that have resulted in sometimes dramatically
lower gas vs. national prices. With the pullback in drilling,
especially in the Rockies, Bill Barrett actually has very strong
margins and good liquid production from their Piceance play. And
with that pricing disadvantage gone, certainly for the time being
and perhaps over the longer term, I think that makes their assets
more attractive. They traded at really a rock-bottom valuation
compared to the group. They have some legislative issues that may
be resolved this summer, which will allow them to reaccelerate
drilling in one of their core properties. That could result in some
very strong production growth in 2011. So, that's a much cheaper,
much more palatable way to play the gas market. They certainly
don't have the kind of resource potential that companies like Range
and Petrohawk represent, but I certainly don't think you're paying
for it in this environment.
Are there any other even smaller names that you like?
Kodiak, as I mentioned before, has about 30,000 net acres in the
Bakken. It's a little bit of a smaller player but one that will be
growing production rapidly. They, potentially, could double
production this year. They also have some potential in the Three
Forks/Sanish area, which various companies are in various stages of
proving up. Both of these formations could be productive areas of
the Bakken. This is very much a growth vehicle, but one that is
more palatable to small-cap people.
Any thoughts you'd like to leave our readers with?
This is an exciting group to follow. A lot of factors can influence
the equity prices here; and with the problems in the Gulf going on,
there are a lot of different ways to analyze this group. Right now,
the volatile swings give you some opportunities to periodically dip
in and own some very good-quality companies. We're seeing anywhere
from 10%-20% moves in a week or two. It hurts to be on the wrong
side of these; but, if you're timing your way into quality
companies, I think you could really look back at this as a quality
time to be adding select companies. It's challenging, but it gives
you a chance to win the game.
Chris Pikul, CFA, joined the firm in 2007 as a senior equity
research analyst covering the energy exploration and production
sector. Pikul is based in Denver, Colo. Prior to joining Morgan
Keegan, Pikul was an analyst with A.G. Edwards for seven years
covering small and mid-cap energy stocks. He also worked for four
years at Invesco Funds. A chartered financial analyst, Pikul
received his bachelor's and master's degrees in finance from the
University of Colorado.
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1) Brian Sylvester of
The Energy Report
conducted this interview. He personally and/or his family own the
following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors
The Energy Report:
3) Chris Pikul: I personally and/or my family own shares of the
following companies mentioned in this interview: None. I personally
and/or my family am paid by the following companies mentioned in
this interview: None. *See Morgan Keegan disclosure.
*Morgan Keegan Disclosure:
Morgan Keegan & Co., Inc. has managed or co-managed a public
offering of equity securities for these companies in the past 12
months: BRY, CXPO, EXXI and HK.
Morgan Keegan & Co., Inc. has received compensation for
investment banking services from these companies in the past 12
months: BRY, BPZ, CXPO, EXXI and HK.
Morgan Keegan & Co., Inc. expects to receive or intends to
seek compensation for investment banking services from these
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