The Energy Report: The last time you spoke with us in January, you were expecting oil prices to stay in the $80–100/barrel (bbl) range, which they pretty much have. Where do you think they are headed now?
Tim Murray: We still believe this range is realistic for the remainder of this year and into 2013. The last downturn in crude seemed to stem more from negative sentiment than a change in the supply-demand balance. West Texas Intermediate (WTI) bounced off ~$76/bbl recently, which was the low back in October, so this is a level we will be watching very closely if it were to be breached.
TER: What effect is the move back down into $80/bbl going to have for oil companies' exploration and development plans?
TM: Companies are definitely going to have to reassess their exploration and development budgets, if they are budgeting anything close to $100/bbl WTI. Most juniors in the Canadian space use cash flow plus debt to manage their future drill programs. We've already seen several companies in my space cut their capital programs. Whitecap Resources Inc. (WCP:TSX.V) trimmed its capital program, as did Bellatrix Exploration Ltd. (BXE:TSX), Second Wave Petroleum Inc. (SCS:TSX.V), Raging River Exploration Inc. (RRX:TSX) and Longview Oil Corp. (LNV:TSX). We expect others will probably have to do the same and we don't see any junior or small-cap companies expanding programs at this time. Most midcaps have a lot more balance sheet flexibility and we don't envision midcaps in general needing to cut budgets unless we see a sustained oil price closer to $75/bbl.
TER: Do you think a lot of companies were beginning to think that $100/bbl was the new base and planning around that or were they skeptical as to how long that was going to last?
TM: Most were still using around $95/bbl oil, and hadn't been putting $100/bbl in their internal budgets. I don't think anybody was saying that it's the new base, as most are accustomed to the large swings in commodity prices.
TER: Natural gas, on the other side, has been the sick sister. After peaking in 2008 over $10/bbl, it's been hanging around the $2-2.50/bbl level, about as low as it's been for the last 13 years. Is anything on the horizon to cause much of an improvement or is it stuck in that range?
TM: For the summer, we feel an average Henry Hub price of $2.50–3 is realistic and natural gas has been trading higher than that recently. We need to see storage levels come off before price levels appreciate materially into the fours. Storage levels are running at all-time highs in Canada, and in the U.S. as well. Drilling has eased in Canada and the U.S., which will help reduce the supply equation; however, a lot of the oil resource plays have gas associated with them. Natural gas is really a landlocked commodity in North America and until the means are available to reach other markets such as Asia, prices will remain relatively depressed. Looking longer term in Canada, we may see the first LNG facility at Kitimat, which would give producers access to the international market. But this isn't expected until 2017.
TER: Other than the ongoing financial problems in Europe and whatever the crisis du jour is in the Middle East, do you see anything on the horizon which could cause oil or gas prices to move much in either direction?
TM: Middle East tension is always the biggest wild card, and the ongoing debt situation in Europe will continue to grab headlines. The one other wild card that people are aware of but have a difficulty putting a time frame on is the duration of the European embargo on buying Iranian crude that started July 1. We're also watching crude supply levels, which are quite high. From a North American standpoint, in the last two to three years, the spread between Brent and WTI has favored the Brent markets. Long term, we do think that spread will close, but it could take anywhere from three to five years.
TER: Companies in the oil and gas services business have to be affected by what is going on in this market. Are there some interesting opportunities out there or do you think that the impact is too negative on them at this point?
TM: Definitely, the service sector traded down as oil moved lower, which is not a big surprise. Our oil and gas services analyst here has been recommending Precision Drilling Corp. (PD:TSX) between the $6–7 range. The stock has been fairly volatile the last month and is currently north of $8.
TER: So, generally, the service business is not a hot market opportunity these days.
TM: It's not as hot as it was before. The good thing in this cycle is that the balance sheets of the Canadian service companies are generally good, giving them the ability to ride out a lower pricing environment. Many are paying small dividends that can easily be increased if activity levels ramp up. It may not be the hottest space, but there are definitely a lot of good valuations on many of the stocks.
TER: So what's your outlook at this point for oil stocks in general?
TM: Our theme really hasn't changed. We still continue to look for good management teams, good balance sheets and asset bases that can show per-share growth for the next three to five years. The other key is liquidity, as investors and larger institutions don't want to be stuck with a stock that they cannot unload. For my coverage universe, I prefer my small-cap names over the juniors as they have bigger production profiles, generally better balance sheets and liquidity.
TER: Back in January, you talked about a number of midcap and small-cap companies. Can you give us a little update on what's happened with them since then?
TM: My two favorite names then were Whitecap Resources and Spartan Oil Corp. (STO:TSX). Spartan is up this year, about 10% compared to the GMP Junior Oil & Gas Index, which is down ~17%. Whitecap is down ~15%.
Strategic Oil & Gas Ltd. (SOG:TSX) is down almost 35%. Torquay Oil Corp. (TOC.A:TSX.V; TOC.B:TSX.V) is down almost 50%. The junior names have underperformed because capital tends to move to the larger, more liquid equities in volatile times. If I were to benchmark Strategic to its junior oil group, it has outperformed—the group on average is down ~45%.
TER: Do you think that these are all decent buying opportunities at this level?
TM: We continue to favor the small-cap space over the junior space. I still like Spartan and I prefer Whitecap at these levels. A new name that I cover that looks very interesting at these levels is Pinecrest Energy Inc. (PRY:TSX.V). It has one dominant asset in the greater Red Earth area targeting the Slave Point resource play. It is one of the most active operators in the play, and with 250 net sections, it could have over 10 years of drilling in front of it, if well results continue to come in positive. It plans on drilling 30 wells this year and if it can demonstrate similar production adds in the back half of this year, as it accomplished last year, we should see the stock react very positively.
TER: You also cover Equal Energy Ltd. (EQU:TSX; EQU:NYSE)? Do you have any thoughts on that one?
TM: Equal is in strategic review right now. The stock is really going to be pretty quiet for the time being until we get some news on how that strategic review process is going. I don't foresee one buyer for the entire company, as it has assets in the U.S. and Canada. If anything, I could see it selling its Canadian assets or its U.S. assets, potentially both, but probably not to the same parties. It definitely will get interest on its Viking and Cardium light oil resource-focused assets in Canada.
We expect to see some news by the end of the summer, at least some guidance on what's going on with the strategic review process. Equal has definitely been hurt by the liquids pricing at Conway, which is trading at very depressed levels. The pricing discount could stay in place for another 9–18 months until there is some de-bottlenecking to get more takeaway capacity.
TER: Among the companies you've talked about today, which one or ones would be your personal favorites, if you had to pick?
TM: If you're bullish on oil and you think it is going to stay at these levels, I don't think you can go wrong with Whitecap. It has a big production base for a small cap and probably a dividend coming by year-end. It has a strong management team, good light oil-focused assets and it's an active acquirer. In addition, it has some good hedges in place for the remainder of this year and into 2013, which gives us more certainty on completing its capital program. At these levels, Whitecap makes really good sense.
I also like Pinecrest sub-$2 and become much more aggressive as it approaches $1.50. The stock is a little more volatile and has recently moved 8–10% in a day. This stock is also very liquid, which I have mentioned earlier as being important for institutional investors.
I also continue to like Spartan, which is more range-bound with less volatility. If people are a little concerned about oil drifting south, then I think Spartan is the way to play the space right now. I don't think it will be hit as hard as the other two in a falling commodity environment due to its very strong balance sheet and net asset value, which we valued at ~$3.75/share.
TER: To summarize, what do you suggest for people to be doing strategically and tactically to play these current markets and hopefully benefit from them? When do you think we're going to see some higher commodity prices that will take everything up?
TM: We think a good group to be in is the small-cap space as it is trading at a discount to the longer-term averages on cash-flow multiples. Most names in this group have good liquidity, which is important in volatile markets. We don't believe that ~$90 WTI is a bad number and if pricing remains around those levels, we believe the valuation gap should close. Higher commodity prices will most likely return if the market is reassured that the European debt crisis has run its course and if developing countries look to be expanding, as they provide the biggest increase in demand for crude and refined products.
TER: Thanks for your thoughts.
TM: Thank you.
Tim Murray joined Desjardins Securities in July 2011. Prior to this, he was an oil and gas analyst for almost six years at several investment boutiques covering junior and mid-cap companies. He also spent over a year at AltaGas Income Trust performing risk and credit analysis on natural gas and power assets for the company's midstream business and served as an investment advisor for three years. Tim was awarded the CFA designation in 2003.
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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 in the interview are sponsors of The Energy Report: Equal Energy. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Tim Murray: 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 Reports for participating in this interview.