Eric Nuttall: Look for Underlying Oil/Gas
Source: Brian Sylvester of
Eric Nuttall, portfolio manager of Sprott Asset Management's Energy
Fund, believes there are opportunities in both oil and gas,
regardless of commodity prices. "I'm entirely agnostic when it
comes to the commodity price. It all comes down to the valuation,"
Eric explains. He seeks companies with existing production priced
at a reasonable multiple and, as he puts it, gets all the
exploration upside for "free." Eric talks about some companies that
fit that bill in this exclusive interview with
The Energy Report.
The Energy Report:
Eric, please give us an overview of what's been happening in the
oil and gas sector since we last talked with you in May.
Last time we spoke
, I was pretty cautious on the space both because of the
macroeconomic data points that we were getting and a pretty
negative outlook on both natural gas and oil pricing. That's
remained relatively constant. It's an extremely difficult
environment to navigate when you're looking for strong
Generally, I still think there's quite a bit of headwind for oil
and natural gas stocks. Most of the data points that we see seem to
suggest that there's a deterioration in the overall economic
well-being in the United States and globally. That has a profound
impact on the demand for crude oil. We've seen oil prices soften
from the mid-$80s down into the mid-$70s. I think for the next year
to two we're looking at a pretty tight range, with a floor of about
$70 and a ceiling about $85, because of weak global demand,
multi-decade high inventory levels in the U.S. and OPEC sitting on
roughly 5.6 million barrels a day (bpd) of spare capacity.
Roughly speaking, you would need about a 12% expansion in global
GDP to bring that 5.6 million barrels a day number down to a more
reasonable 2.5 to 3 million barrels. It's my guess that that would
take another two years or so. Until then, I think there's a
plentiful amount of oil. Any time oil approaches the mid-$80s, OPEC
will just turn on the taps and bring on more oil to an already
It's really a call on global GDP expansion. That's what you
need. It's more a demand question than it is a supply question.
The outlook for non-OPEC supply growth beyond the next year is
pretty cloudy. A lot of non-OPEC projects have been brought on this
year; we're looking at about a 700,000-bpd increase in 2010 from
non-OPEC sources, which is pretty strong, certainly stronger than
people would've anticipated a year or two ago. However, we still
continue to believe that we're going to be hard pressed to increase
global production beyond 87 to 90 million bpd.
In terms of natural gas, there's some opposition to exploration
fracking in some states, especially in New York and Pennsylvania,
where there are some large shale plays. Can you comment on those
concerns and how they could affect the gas price?
I think it's really important and it's impacting some producers in
some of the northeastern states, such as New York, where there's a
fracking moratorium, and in Pennsylvania, where there are growing
concerns. But we need to separate fact from fiction. Politicians
are not involved in the industry, so they're obviously somewhat
amenable to suggestions from the lobby groups countering the oil
and gas business.
I'm not an engineer, but about 98% of fracking fluid is water
and sand. Beyond that, there are some chemicals in diluted
Secondly, the distance of separation between the zones being
fracked and an aquifer often surpasses 5,000 ft. Sometimes the
distances are as high as 8,000 ft. It's somewhat beyond me to
imagine that a vertical frack plane can permeate that much rock
when no producer has permeated more than 200 ft., let alone 2,000
It's my initial impression that there's a lot of overhype and a
lot of ignorance. That just means the public needs to be educated
about fracking. I know the industry's working hard at that, but
it's going to take time. For politicians, it's much easier for them
to have a moratorium or to slow down development until they have
100% of all facts.
Perhaps, but perception is often reality. Could those fears impact
the gas price?
Potentially, but I really don't think they will. We've mostly seen
concerns in the northeastern U.S., where it would impact
development of the Marcellus Shale. We're seeing that now in New
York, where the Marcellus is totally on hold. However, in other
states, such as Louisiana, which has a slightly more mature oil and
gas business, I don't think you're seeing nearly as much
And it's not just pollution in groundwater. There are concerns
about emissions from the drilling rigs and that type of thing.
Personally, I think it's overblown. Is it going to impact the
overall short-term supply? I don't think it will. We're certainly
not seeing that. The most recent data I have is for the first week
of September, and natural gas production's up about 4 billion cubic
) a day in an already oversupplied market.
What are your gas projections then over the short term?
I'm more bearish on natural gas at least from a historical pricing
perspective. I think there's been a total paradigm shift, which
still isn't being appreciated by the market in terms of the
changing economics and the price needed to bring on reasonable
amounts of supply. Historically, we would've thought that a $7.00,
$8.00 price was required for a reasonable rate of return. Take
Encana Corporation (TSX:ECA; NYSE:ECA)
, a company that is the number-one independent natural gas producer
in America. They're responsible for 4% to 5% of total production.
They suggest that they need a price of $3.85 on their total
portfolio to earn a 10% or 12% rate of return. Many other companies
have suggested similar numbers. There are two reasons. One has been
the evolution of technology: the ability to drill horizontally and
then be able to place multiple stages of fractures into the
formation to stimulate much more meaningful amounts of gas. The
second reason is an overall change in fiscal regimes in some states
and in some provinces in Canada. There have been pretty large
incentives to do
The overall required price threshold has dropped to a ceiling of
$5 and then a lower band of about $4 in short-term pricing. NYMEX
pricing is at about $3.56. Canadian gas is in the low $3s. I don't
think that's sustainable. But until we see more discipline from
producers in terms of reducing the rig count, I don't see any
upward pressure on the price of gas-certainly not above $5, which I
think over the next two years is probably a very reasonable
In your last interview with
The Energy Report,
in reference to
Tethys Petroleum Ltd. (
you said: "The market is highly anticipating a follow-up well from
their original well. Management thinks they could be sitting on a
very material oil discovery in the hundreds of millions of barrels"
in Kazakhstan. What's the update on Tethys?
We're still waiting for a material update. There was a press
release out about a week ago where they announced a delineation
well that encountered hydrocarbon showings in the primary
reservoir. But I'd be more comfortable once we get a flow rate. It
seems like their drilling program is progressing quite nicely. I
think over the coming weeks and the coming months as they get a
test rate on this one well and are able to drill a sidetrack and
several subject wells, we'll have a better feel for the total size
of the accumulation. But it certainly seems to be one of a very
In terms of percentage what's your position in Tethys?
For our Energy Fund it'd be about 2%.
Tethys' largest project is in Kazakhstan, but they are undertaking
exploration in some other countries surrounding Kazakhstan. Could
those be catalysts for growth?
In my view, the real upside is Kazakhstan. Everything else is
Another company you talked about in that interview was
Corridor Resources Inc. (TSX:CDH)
. Corridor recently posted a $2.2 million loss in the second
quarter. Its operations are based in the province of New Brunswick
where banning fracking has become a provincial election issue. Is
this a buying opportunity or should investors just say goodbye?
Corridor's last quarter results are pretty immaterial. The real
catalyst that we're waiting on are drilling results from
Apache Corporation (
on their Frederick Brook Shale gas program later this quarter. It
was announced last week that Apache had finished drilling the first
horizontal well. We're just awaiting fracture stimulation later
this fall with very, very important results to be published in
early 2011. That's really what's going to move the needle on the
story. If Apache is successful in achieving economic flow rates, it
could be sitting on 50 trillion cubic feet (Tcf) net of resource
potential, which is just unbelievable. That kind of compares to the
major natural gas producers on the continent. Their current
operation is really irrelevant when compared to the upside from
their shale gas program. I would still define it as somewhat of an
exploration story because the current production doesn't backstop
the current share price. However, if they're successful, you could
see this stock increase several times over.
They also recently received approval to do some exploration in the
Gulf of Saint Lawrence on the Old Harry prospect. Could that be a
catalyst for further growth?
They got approval to do some sub-sea observations, but I didn't see
approval on drilling. They've been waiting for several years. I
don't think drilling would occur for another year and a half to two
years, but that would be a very, very significant catalyst. They
think it could be a tremendously large oil or natural gas
What about the CEO who is retiring this fall? What sort of impact
might that have?
Norm Miller is retiring. Norm has been with the company since its
inception. I think he's done a good job of putting together a
really attractive land base. The company is looking for a successor
who can carry the torch so to speak. I don't see it as a negative
by any stretch.
So if investors have a position in Corridor, they should probably
stick with it?
I would. I would view it as a medium- to a higher-risk story,
typically the type of investment that I'm looking for. I'm looking
for the ability to purchase a company on existing production at a
reasonable multiple and get all the exploration for free. In
Corridor's case you're not quite getting that because you probably
have core net asset value (
) of about $2.00 to $2.50 based on their current operations. But
this could be easily a double-digit share price, if they're
In our last interview you also liked
Rock Energy Inc. (
, a heavy oil producer in Alberta. The company at that time was
testing gas targets. How are those tests going and what are Rock's
In October, Rock will be studying their first Montney delineation
well. In Alberta, it was an extraordinarily wet spring and summer,
not just for Rock but for almost every company. A lot of the
exploration activity in Alberta was postponed or delayed. Rock,
along with everybody else, is just getting back at it. We should
have results by late fall.
Rock's trading at around 4.5 times next year's cash flow using
$75 oil. If they're successful at delineating this Montney
resource, it has the ability to triple their reserves. Again it's
the type of story where you're not paying for the upside because
it's already trading at a pretty reasonable cash flow metric.
Are there any other catalysts that could propel that stock?
They're testing some different technologies to increase the
recovery rates on their existing heavy oil acreage in Lloydminster.
But the real company maker would be if they're successful proving
up their Montney acreage.
In June they added Ken Severs to the board. What did you think of
That was fine. It's really a competent management team with strong
technical expertise with a good resource base. We're hoping they
can finally get at testing the gas upside.
What are some other companies you're bullish on?
Before I give individual recommendations, I need to state that I'm
pretty cautious on the overall environment both in the general
market and especially for the oil and gas sector. In the short
term, I think you will see continuing weakness in North American
gas pricing and in oil. While we may see a rebound into the low
$80s in oil, I think it's range bound. It's very, very important to
focus on companies that have a balance sheet that will allow them
to weather low commodity prices, be it gas or oil. You want to
avoid companies that were overly aggressive and leveraged up the
I continue to like
Bankers Petroleum Ltd. (TSX:BNK)
very, very much. They recently did a large financing that shored up
the balance sheet. They can now weather a lower natural gas price
and, because they are something of a heavy oil producer, they are
somewhat vulnerable to heavy oil differentials. Their oil is
discounted off of Brent, but it's trading at essentially a discount
to the NAV of its proven and probable reserves using $80.00
Bankers is delineating a resource onshore in Albania. Yet at the
same time, they have enormous potential to grow their reserves by
four to five times if they're successful delineating the resource
using horizontal wells. Your downside is limited because it's not
trading at an egregious multiple. Yet at the same time, it has
enormous upside through the delineation of the reserves. That's one
Another small name that would be somewhat high risk is
Renegade Petroleum Ltd. (TSX.V:RPL)
. It's about a $175 million light oil company. Ninety-seven percent
of its current production is geared towards light oil, the
economics of which are roughly three times better than natural gas.
It's stewarded by a young, driven management team that I like.
They've got a good land base in southeastern Saskatchewan. What's
interesting is that a lot of the light oil plays in Saskatchewan
are being held by a few of the large companies. But because of
Renegade's size, they're able to pursue much smaller deals that
simply wouldn't be material to a large company like a
Crescent Point Energy Corp. (TSX:CPG)
PetroBakken Energy Ltd. (
. Renegade has been very successful at accumulating acreage.
Now that the weather has dried things up, they're going to be
initiating a very, very active drilling program. We're looking for
Renegade to potentially double production in 2011. I think it could
be trading at under four times enterprise value cash flow using
$75.00 oil. So it's trading at a cheap multiple and yet it has
In terms of an investment thesis, are you looking for companies
with an oil and gas mix or leaning more toward the oily names?
I'm entirely agnostic when it comes to the commodity price. It all
comes down to the valuation. What's important, especially for
natural gas companies right now, is that they absolutely have to be
low-cost operators. They also need some critical mass because
there's been an evolution in the nature of the wells that we're
drilling. Typically, a horizontal multi-stage frack well is going
to cost around $3.5 to $4.5 million. If you're a little company,
you can only afford to drill a few wells a year. If that's the
case, you better hope that they all hit. I'm trying to target
companies that if they're going to be "gassy" are producing around
10,000 barrel of oil equivalents (
) a day, because they'd better be able to generate enough cash flow
to fund an adequate drill program. But when it comes down to
whether I favor oil or gas, it's pretty irrelevant. It comes down
to each individual opportunity.
Do you have some parting thoughts on the sector that you'd like to
leave us with?
There are times to be offensive and times to be defensive. Now,
given the level of uncertainty when it comes to both the economy
and the underlying commodities, I think it's time to be somewhat
defensive. My fund is currently carrying a healthy cash weighting
of about 17% and then a short weighting of about 5%. I'm seeing
opportunities in shorting. But at the same time it's important to
distinguish that you don't have to be a bull on the underlying
commodities to be bullish on individual investment opportunities.
We still see quite a few opportunities in that small- to mid-cap
space where the companies aren't totally relying on the commodity
price increasing to get the share price moving. You need to focus
on stocks with underlying catalysts, either the ability to grow
production or delineate some type of resource that will get the
stock to appreciate.
Eric Nuttall is a portfolio manager with
). He joined the firm in February 2003 as a research associate and
was subsequently promoted to research analyst in 2005, associate
portfolio manager in 2008, and then to portfolio manager in January
2010. Eric is co-manager of the
Sprott Energy Fund
along with Eric Sprott, and also co-manages the
Sprott 2010 Flow-Through Limited Partnership
with Allan Jacobs. In addition to his responsibilities for those
two funds, Eric supports the rest of the Sprott portfolio
management team with identifying top performing oil and gas
investment opportunities. Further, Eric contributes towards
internal macro energy forecasts, and his insight into emerging
unconventional plays has been covered in several financial
publications such as
The Wall Street Journal, Asia
Eric graduated with high honors from Carleton University with
an Honors Bachelor of International Business
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1) 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
The Energy Report:
Tethys and Rock Energy.
3) Eric Nuttall: I personally and/or my family own shares of the
following companies mentioned in this interview: Rock Energy,
Bankers Petroleum, PetroBakken Energy. I personally and/or my
family am paid by the following companies mentioned in this
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