Sweet Spots in a Patchy Oil Price Landscape: Frank
Saldana
Source: Zig Lambo of
The Energy Report
(4/10/12)
http://www.theenergyreport.com/pub/na/13050
A variety of geopolitical, economic, technical, regulatory and
transportation factors are having some confusing effects on U.S.
prices for oil, natural gas and gas by-products. In this
exclusive interview with
The Energy Report
, Frank Saldana, senior E&P energy analyst at C. K. Cooper
& Company, explains how these various factors impact the
domestic producers of oil and gas products and talks about
several attractive investment opportunities in the current market
environment.
The Energy Report:
What's your analysis of the U.S. oil market, and do you expect
sharp price differentials to continue far into the future?
Frank Saldana:
It certainly is confusing and volatile, not just to average
investors but to professionals as well. On the oil front,
conflict with Iran has taken oil prices higher in this election
year and caused speculators to get even more involved in the
game. West Texas Intermediate (
WTI
) oil has disconnected from the price of Brent and some people
argue that WTI isn't as relevant a benchmark as it once was.
Increased Canadian heavy oil production, as well as surging
Bakken production has resulted in robust storage levels at the
Cushing Oklahoma terminal. Cushing has limited distribution to
certain refiners on the Gulf Coast that have had to import oil
that is priced off premium Brent crude. Louisiana light, for
example, often receives a substantial premium. One of the
companies I cover,
Saratoga Resources Inc. (SARA:NYSE.A)
, gets crude pricing based on Louisiana light, which is at times
$20 or more above WTI.
If the Keystone Pipeline ever comes to fruition, it will
alleviate some of the problem. A nearer-term partial solution
would be the reversal of the Seaway pipeline, which
Enbridge Inc. (ENB:NYSE)
announced last year. That could cause a net differential of
300,000 barrels (bbl) of oil out of Cushing into the Gulf Coast.
Some refiners have instituted capital projects to process heavier
crudes from Canada. As they gain more access to these discounted
crudes, they should have less need to buy crude that is priced
off Brent, which could also eliminate some of the price
differential between WTI and Brent.
Natural gas is a whole other story. The fundamental landscape
is terrible right now. Even a normal injection this season would
cause gas in storage to hit capacity limits-there could literally
be nowhere for the gas to go.
Some big natural gas players, like
Chesapeake Energy Corp. (CHK:NYSE)
,
Encana Corporation (ECA:TSX; ECA:NYSE)
and
Ultra Petroleum Corp. (UPL:NYSE)
, have announced that they
intend
to cut back production, but I don't think it's happened yet to
the extent that makes investors comfortable that the market can
recover within the next 12-24 months.
TER:
How does the big differential between oil prices and gas prices
influence the focus of your research?
FS:
A lot of investors are focusing more on companies with oil rather
than natural gas. One element that has helped some natural gas
producers has been natural gas liquids (NGLs), which are
by-products of the gas stream. NGLs, such as propane, butane and
ethane, tend to receive average pricing of about 40-50% of WTI,
which amounts to about $40-50/bbl. This has greatly enhanced the
economics, given the weak natural gas prices we've seen
lately.
Exploration and production (E&P) companies that are oil
focused are getting better valuations now, especially if they
have a lot of acreage on some of the hotter oil shale plays, such
as the Eagle Ford and the Bakken. Companies with NGL components
to their production are also getting better valuations.
TER:
You mentioned Saratoga, on which you've recently initiated
coverage. What's the story on that company and why did you decide
to start covering it when you did?
FS:
Saratoga is a conventional company in an unconventional world.
Everybody nowadays is shale driven and horizontal driven, for the
most part. You don't see too many companies anymore that are
still focusing on conventional plays with vertical drilling.
Saratoga is one of those.
It was under the radar for a lot of investors, but has had
pretty nice production ramp-ups with a good mix between natural
gas and oil on both production and reserves. In Grand Bay, one of
the company's key areas, there have been over 60 historically
productive zones. On deeper exploratory tests, the abundance of
pay zones allow for what Saratoga calls "bailout" prospects, or
shallower sources that can potentially make up for any deeper
exploratory failures.
In November, the company announced production at 3,500 barrels
of oil equivalent per day (boe/d), of which 60% is oil. The
late-March production rate is up to 4,200 boe/d. The market likes
the oil component in its production even though 60% of its
reserves are natural gas.
Saratoga also has some promising prospects that it's going to
try to develop using a joint venture (JV) partner. One of these
prospects, Long John Silver, is near some potentially lucrative
acreage held by
McMoRan Exploration Co. (MMR:NYSE)
, and Saratoga is actually in JV negotiations with McMoRan. Even
though it's mostly natural gas, these prospects are big enough
that even if only 10-20% comes in as oil, that would make a
material difference to a company the size of Saratoga.
In early December, the company announced it was in
negotiations with McMoRan, and the stock had a huge run-up of
about 25%. I initiated with a price target of $10, and we
recently upgraded our price target to $11.50 based on our NAV
estimate of $11.70.
TER:
Does it produce from multiple pay zones at one time?
FS:
No, it produces from one zone for a little while, and then it
pulls up and produces from another zone. It does not typically
commingle zones.
TER:
After last year's big disaster in the Gulf, what's the current
regulatory situation for offshore drilling? How does that affect
companies like Saratoga?
FS:
This doesn't affect Saratoga because its acreage is in the
transition zone on the Louisiana coastline, and is subject to
state regulation only.
That said, the Gulf is a frustrating environment. A report
late last year by a group out of New Orleans said the Bureau of
Ocean Energy Management, Regulation and Enforcement (BOEMRE)
approved only 35% of oil-drilling plans year-to-date in 2011.
They used to accept about 75% of drilling plans in the region
prior to the BP incident. The average time to approve or make
decisions is 115 days, compared to 61 days previously.
There is more rigorous testing now for blow-out preventer
equipment and companies have to develop more rigorous
environmental contingency plans. In shallow water there's been
some improvement in the drilling permit approval, but in the deep
water, I read that they're allowing five permits per month,
whereas before the BP disaster they were approving something like
six per month.
TER:
What are the prospects for gas producers these days in the
current pricing environment and how do you decide which ones look
attractive under the circumstances?
FS:
The switch over the last 10 years from conventional E&P
strategies to shale-based, acreage-based ones required time to
gather the science and the acreage and to figure out the best
drilling and completion techniques. That's what's referred to as
a learning curve. The Eagle Ford and Bakken, for example, have
worked out well for the majority of E&Ps involved there. Even
the smaller E&P companies have done a good job of gathering
the science and learning how to complete wells more
efficiently.
When I look at a company, I want to see the acreage in the
right areas. But companies can't simply do location math based on
spacing and calculate potential recoverable reserves according to
what other companies are saying. They eventually have to show
some acceptable results from their own drilling efforts or the
market will punish them sooner or later.
I look for an attractive inventory of drilling locations, as
well as production that is ramping up at a reasonable pace. I
want to see the wells exhibit shorter drilling periods and
increasing initial production rates over time. Companies that the
market favors tend to have these characteristics in conjunction
with acreage and an inventory deep enough to last several years.
And, of course, oil versus natural gas also helps a lot in this
environment.
All in all, I tend to take an asset-value approach. Initially,
some of the metrics are going to look rich, whether it's
price-to-earnings or price-to-cash-flow. However, as companies
start ramping up, the multiples should compress to more rational
levels. In the meantime, if a company can just keep proving
itself along the way, the market should continue to give it the
benefit of the doubt.
TER:
What are some stories that you like at this point?
FS:
One I really like is
Approach Resources Inc. (AREX:NASDAQ)
. It's a West Texas play that was initially gas-heavy, but it is
getting a lot oilier, with a nice NGL component as well. Its big
play is Wolfcamp Shale, an oil play, as well as the Wolffork
Shale, where the company is pursuing a vertical strategy.
Approach fits that mold I was just talking about, with over
140,000 net acres out in the Wolfcamp/Wolffork. It's in the same
backyard with the likes of
ConocoPhillips (COP:NYSE)
and other large players such as
EOG Resources Inc. (EOG:NYSE)
and
BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK)
. Its acreage position is sizeable enough that it could move the
needle for some of these larger companies.
It's had some nice horizontal results in Wolfcamp. The first
four pilot production tests averaged 377 boe/d. By Q311, it had a
set of three pilots that averaged almost 900 boe/d. The latest
four wells, which they announced recently, averaged 919
boe/day.
So it's really shown improvement and it has a deep inventory
with almost 400 more locations in the horizontal Wolfcamp. We
estimate each location has the potential to hold 330,000 boe on
average, post-royalty. At an estimated in-ground present value of
approximately $7.50/boe, we think the Wolfcamp could be worth
almost $1 billion.
Approach's Wolffork vertical inventory is also deep. I'm only
giving it credit based on a 10-year drilling program of 211 net
vertical locations, whereas the company says it has 1,800 gross
locations out there. In this case, we're using about a $9.50/boe
present value. Our all-in NAV is $55 per share. If a major or
large independent were looking to acquire Approach, it could
drill both the Wolfcamp and the Wolffork targets quicker, which
would enhance the present value of these wells. If we were to
start giving more credit to the entire vertical program in the
Wolffork, it could potentially add another $15-20.
The stock has done well and it tends to run up into the
earnings call because investors are anticipating the release of
its latest horizontal Wolfcamp wells. Management is moving at
just the right pace relative to my expectations.
TER:
Are there any other companies you like?
FS:
Another area heating up is the Niobrara play in the Rockies. The
area with the best exposure to the Niobrara has probably been the
Wattenberg, which is a mature field with historical success rates
of about 99%. If you poke a hole, you're going to get something
there. Now companies are focusing on the Niobrara zone, along
with the Codell zone, within the Wattenberg.
Anadarko Petroleum Corp. (APC:NYSE)
,
Noble Energy Inc. (NBL:NYSE)
and
Petroleum Development Corp. (PETD:NASDAQ)
are some of the E&Ps ramping up activity in the Niobrara
portion of the Wattenberg. They've issued some impressive
estimates of potential reserves per horizontal location in the
Niobrara and Codell zones. These estimates currently range from
300,000-600,000 boe per well. One company we cover that is right
in the heart of that play and is partnered with Noble and
Petroleum Development on some horizontal wells is
Synergy Resources (SYRG:NYSE.A)
. It has over 10,000 net acres in the Wattenberg. I've got a NAV
of $6.50 on it.
For the most part, Synergy is focusing on vertical wells even
though it's right in the heart of what is becoming a horizontal
play. It's participating in some horizontal wells, but still
taking a vertical strategy to drilling these wells. As the
results start coming in from some of the other major players like
Anadarko and Noble, investors could start looking at the
prospects for Synergy as if they were valued on a horizontal
basis rather than a vertical basis. Synergy has yet to indicate
it plans to implement a 100% horizontal drilling approach to this
play, but if it did, I could see the NAV showing some nice
improvements, assuming horizontal results come in as expected
from industry players.
Right now it's just poking holes and seeing some production
momentum. The stock's been in the $3-3.50 range lately, but as
the horizontal results keep coming in from the likes of Anadarko
and Noble, among others, you'll see more attention focused on
Synergy and what it could be worth if it were valued on its
horizontal potential rather than vertical.
TER:
What about companies in the services businesses? They can always
make money regardless of oil and gas prices.
FS:
Right. There's been incredible demand and tightness for fracking
services as more and more E&Ps drill horizontal wells that
sometimes involve 25-40 fracking stages per lateral well. The
smaller E&P guys have suffered in terms of access to services
because these service companies want to be able to get long-term
contracts with substantial repeatable work so that they can
concentrate their efforts geographically and lower their
costs.
I've heard recently that the Haynesville shale experienced
about a 70% decline in proppant sales because everyone's bailing,
given the gas price situation. Many of these service companies
are now trying to reallocate their fleets and their resources to
areas that are oilier or have NGLs in the gas mix, and pricing
has come down a little bit.
TER:
So who do you like in
that
business? Obviously they've got to be making some money these
days.
FS:
Well, I don't cover services specifically, but I do cover
Unit Corp. (UNT:NYSE)
, which is a hybrid energy company. It has an E&P arm, a
mid-stream business and its own rig fleet that is, for the most
part, contracted out to other E&Ps. It hasn't seen any
drastic reduction or change to its rig fleet utilization, which
has been hovering around 60-65% for some time. Pricing has held
up as well.
TER:
Is this the old Unit Rig and Equipment Company from many years
ago?
FS:
It is. And I cover the stock thinking that the sum of the parts
is obviously greater than what the market indicates. I don't
think it has ever really seriously looked at breaking up the
company, but I have a $75 price target on it. Its mid-stream
business is growing, as it has been focusing on areas where
operators have been growing NGL production. I see a valuation
disconnect with Unit. Either the reserves are priced right, or
the rigs are priced right, but not both. If that ever corrects
itself, I think it's a $70-80 stock.
TER:
What general thoughts would you like to leave with our readers on
how to best play the current oil and gas markets?
FS:
I think investors should focus on oil situations trading close to
the proved NAV with potential upside from acreage in the right
shale plays. As mentioned, companies that have impressive
inventories and core acreage should do well, provided they show
operational efficiency.
As far as natural gas is concerned, there's always been a
self-correcting mechanism in the natural gas market that
typically corrected itself much quicker than we're seeing now.
The old saying is, "the solution to low prices is low prices and
the solution to high prices is high prices." There's going to be
some pain, but eventually the situation will correct itself.
It'll be tough to time it, but if you can, there's some nice
money to be made on the natural gas side. There are some E&Ps
with a natural gas focus that are really solid, with seasoned
management teams. We've seen some people even looking for dry gas
acquisitions in this environment. That tells me that maybe the
smart money is getting ready to get involved in a serious way.
But it's a horrible picture right now and it's going to take
longer than usual to turn around.
TER:
Thanks for your insight today.
FS:
I appreciate the opportunity.
Frank Saldana
is a senior E&P analyst for CK Cooper and Co. He has over
11 years of experience covering energy stocks, both on the buy
side and sell side. He got his start at Credit Agricole and
then Credit Lyonnais, focusing on E&P companies. He has
also covered energy at several hedge funds, including Bonanza
Capital, where he was a director for energy and natural
resources.
Want to read more exclusive
Energy Report
interviews like this?
Sign up
for our free e-newsletter, and you'll learn when new articles
have been published. To see a list of recent interviews with
industry analysts and commentators, visit our
Exclusive Interviews
page.
DISCLOSURE:
1) Zig Lambo of
The Energy Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
None.
2) The following companies mentioned are sponsors of
The Energy Report:
Saratoga Resources Inc. Streetwise does not accept stock in
exchange for services.
3) Frank Saldana: 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. I was not paid by Streetwise
for participating in this story.
4) At the time of this report C. K. Cooper & Companyhas not
provided investment banking services to Saratoga Resources, Inc.,
Double Eagle Petroleum Corp. or Unit Corp. within the past 12
months. C. K. Cooper & Company may solicit future investment
banking business from the companies covered in this report, which
could result in the payment of investment banking related fees.
As of the time of this report, the covering analyst and or his
family does not have an ownership position in Saratoga Resources,
Inc., Double Eagle Petroleum Corp. or Unit Corp. As a policy, C.
K. Cooper & Company does not allow its analysts to own the
securities they cover. C. K. Cooper & Company does make
market for Saratoga Resources, Inc., Double Eagle Petroleum Corp.
or Unit Corp.
Streetwise -
The Energy Report
is Copyright © 2012 by Streetwise Reports LLC. All rights are
reserved. Streetwise Reports LLC hereby grants an unrestricted
license to use or disseminate this copyrighted material (i) only
in whole (and always including this disclaimer), but (ii) never
in part.
The Energy Report does not render general or specific
investment advice and does not endorse or recommend the business,
products, services or securities of any industry or company
mentioned in this report.
From time to time, Streetwise Reports LLC and its
directors, officers, employees or members of their families, as
well as persons interviewed for articles on the site, may have a
long or short position in securities mentioned and may make
purchases and/or sales of those securities in the open market or
otherwise.
Streetwise Reports LLC does not guarantee the accuracy or
thoroughness of the information reported.
Streetwise Reports LLC receives a fee from companies that are
listed on the home page in the In This Issue section. Their
sponsor pages may be considered advertising for the purposes of
18 U.S.C. 1734.
Participating companies provide the logos used in The Energy
Report. These logos are trademarks and are the property of the
individual companies.
101 Second St., Suite 110
Petaluma, CA 94952
Tel.: (707) 981-8204
Fax: (707) 981-8998
Email:
jluther@streetwisereports.com