Mutual Funds for Dummies …U.S. Funds at War — Too simple? (Monday, June 4, 2012) … (Photo credit: marsmet545)
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.” 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.
“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 (DEE-TSX; DPGYF-PINK)—“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 (GO-TSX; GLNNF-PINK)— “They have 30% oil and Natural Gas Liquids, heading to 40%.”
Niko Resources (NKO-TSX; NKRSF-PINK)—“Niko has a big Indonesian portfolio (they’re starting to drill) now and have a chance for resolution of some issues in India, and they’re financed for 2 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 $70s in a good market.”
Western Zagros (WZR-TSX)—“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.”
Schachter On Sterling Resources
The stock is now cheap again in the $1.16 range, and the company is going to be bringing on production from the
North Sea project where they own 30% and RWE, the big German utility, owns 70%.
There has been some cost overruns and that is why the stock has gone down. But the initial production starts up at
the end of this year, November/December, it ramps up over time so some time by Q2, Q3 of 2013, which effectively is a
year in the future, the company will be producing quite significant amounts of gas in the hundreds of millions of gross
net to them. You could be looking at $0.30 to $0.40 cash flow given the commodity price, which will be in the $9-$10
an mcf. Remember, UK process are those lofty prices which we don’t have in North America and if you look at some of
the announcements like Talisman and others, they have been getting $9.80 $9.90 in Q2 of this year as the reports are
coming out. So that $9-$10 number is pretty good.
They have hedged some of it, so you may want to put in a blended number of maybe $8.50 in your numbers, but that
still gives you pretty decent cash flow a year from now.
Secondarily, the company is planning to drill two wells in offshore Romania, one of them in October/November period,
Ionia, which is going to be with the jack-up rig and to add more resources so they can move that project forward and
sanction it for development phase.
Also, they are going to be drilling the oil play called Eugenia, which will be drilled in November/December. So
heading into the end of the year you have some exploration zizzle, you have cash flow kicking in materially by Q2/
Q3 of 2013 and then with the significant amount of cash flow coming in, some of it can be used for further development activity in Britain, some of it will be used because of course the banks want to get paid back for the project financing and then some of the money can be used for
new exploration plays which they do have a large inventory of.
The stock, after being beat up, is now in the cheap category, again we’re not thinking you have to urgently
buy it right now as that exploration drilling doesn’t kick in for a couple of months and we think that there might be
some weaker markets into that October/November tax loss window, and again this stock was sitting at $2.38 at
the high this year, and in Q1 of 2011 when we said to sell, it was $4.90
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 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 as well. 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.”