A Golden Era for Well-Positioned Junior Oil and Gas Producers
by Bill Powers, Editor, Powers Energy Investor. May 21, 2009
The tremendous volatility of the energy and general equities markets over the last year has caused major upheavals in the energy equity landscape. What is truly remarkable is the absolute devastation the drop in oil and gas prices has had on the share prices of smaller oil and gas producers. It has gotten to the point where many well run small-cap producers are now trading at a fraction of their net asset values (NAV) as defined by the present value of their proven reserves. When companies trade at below the value of their reserves in the ground, a tremendous opportunity exists for patient investors. I believe we have the near perfect environment for today’s junior producers to thrive over the next several years.
The most important reason well-positioned juniors will grow into much larger companies is that tomorrow’s winners have already been chosen. Companies of all sizes, who have access to projects with large inventories of undrilled locations, will grow into much larger companies and the remaining, who are looking for access to projects, are going to have a very tough time finding them. Large companies such as XTO Energy, Range Resources and EOG Resources have sent acreage prices in emerging shale plays such as the Bakken in North Dakota, the Marcellus in Appalachia and the Haynesville in Louisiana, into the stratosphere. The only smaller players who have even a toehold in these exciting regions are junior companies who owned leases targeting conventional zones prior to the arrival of the larger companies.
Not only has access to acreage become more expensive, the cost to drill wells has risen dramatically in recent years, even with recent pullbacks in oil service expenses. While larger companies can afford the learning curve of a few misses or disappointing wells early on in a new area, smaller companies must be more selective. For example, it is not uncommon for wells to cost anywhere from $6 to $9 million when targeting unconventional formations. High costs such as these have excluded the nearly one thousand small operators in Appalachia from pursuing the Marcellus shale. Even the costs of pursuing conventional zones have risen dramatically. Diesel (used to power the drill rigs) and steel (used to case wells) are only two of many oilfield costs that are still significantly more expensive than five years ago, even with recent price declines. While the price of oil and gas has risen sufficiently to provide ample rates of return for efficient producers, today’s high cost environment has greatly reduced the margin of safety for producers with small production bases.
One of the side effects of today’s credit crunch is that it has closed the doors of many weak juniors who lacked the capital to develop their projects. Additionally, it has forced numerous juniors to merge in an effort to reach critical mass. The consolidation of the industry, not just on the junior level but at all levels of the exploration and production (E&P) industry, is having a very positive impact on the remaining companies. With fewer competitors vying for investor attention and projects, we are likely to see sharply higher share prices for the remaining junior producers.
Probably the most exciting aspect of finding well-positioned junior producers is the large share price appreciation I expect from the group over the next five to eight years. This is truly the beginning of a golden era for those who can identify these opportunities. With current valuation metrics at multi-year lows and significant investor apathy towards small-cap producers, there is plenty of room for share price appreciation. I believe investor apathy towards the group is due in large part to market volatility over the last 18 months, the opinion that current commodity prices will not increase, and a general distaste for small-cap stocks. I have seen this movie before however and I expect well-positioned junior producers to again emerge from this lull in investor enthusiasm in great shape. Consider the following.
Since the beginning of the decade, several micro-caps have emerged into large multi-billion dollar enterprises. It was less than a decade ago when Mike Watford took over Ultra Petroleum (NYSE:UPL) and grew the Vancouver Stock Exchange listed company from a market capitalization of under $50 million to over $12 billion without ever issuing a single share in a secondary financing. Most importantly, Ultra Petroleum enjoyed share price appreciation of nearly 100 fold in the span of less than a decade. The story of Ultra is by no means the only company to have seen such a large share price increase. Similar situations unfolded at XTO Energy (NYSE:XTO), Range Resources (NYSE:RRC) and at Canadian Natural Resources (NYSE:CNQ) over the last decade.
I view it as my mission to find the next emerging Ultra Petroleum and to provide coverage on more established companies that are also well positioned for growth over the next decade. I have used my extensive experience and wealth of contacts to identify the junior producers with outstanding growth profiles and expect this will produce outsized returns over the next several years. I have included several of these smaller, growing companies in my new publication, the Powers Energy Investor, which will begin publication on June 1st.
© 2009 Bill Powers