Jason Wangler: It was a very nasty flood and all the companies on the ground are working hard to assess the damage. There have been reports of tank leakages and other problems. But the wells were turned off during the flood, so drilling operations were not affected much. The questions that remain are how much work is necessary to fix the roads? And when can the drillers safely turn the wells back on?
TER: Given the ever-present possibility of natural disaster, what type of emergency preparations do oil and gas drillers typically take?
JW: In the past, production companies could not do much to avoid the impacts of major earthquakes and floods. But now, our cellular and software technologies can turn off, edit or suspend wells from remote locations. Noble Energy Inc. (NBL:NYSE) is one of the largest players in Colorado. It can remotely turn off wells without having to put boots on the ground. The world needs safer oil and gas operations and there is a clear demand for improved information technology (IT) in that arena. In addition to advancing IT response capability, most companies have a select group of firms on-call to respond to rig fires and explosions, such as Wild Well Control Inc. (private) and Halliburton Co. (HAL:NYSE).
TER: What are the main operational constraints for companies looking to ramp up exploration in the ever-expanding shale oil fields?
JW: Improving infrastructure and training workers are vital to developing the fields in North Dakota, West Texas, South Texas and in the Ohio-Pennsylvania fields, where the majority of growth is occurring right now. Getting the oil to the surface is one thing, but then it has to be transported to markets in Oklahoma, the Gulf Coast, the West Coast and the East Coast. Sourcing fresh water and sand for drilling is also an issue. The most successful exploration and production companies (E&Ps) have ample capital and liquidity to support growth without constraining themselves too much in case of a downturn.
TER: Are lenders interested in solving these types of infrastructure and transportation problems by shaking loose some capital?
JW: Absolutely. In particular, the private equity markets are stepping up in a big way to fund infrastructure and transportation start-ups. There is a lot of private money out there looking to capitalize on aspects of the shale opportunities that the public markets sometimes do not bother to look at. The public market likes to step in when the infrastructure is already built and earning revenue, with solid earnings before interest, taxes, depreciation and amortization (EBITDA). Often, the privately financed facilities are sold to publicly traded master limited partnerships (MLPs). But you do not see public capital building much in the way of infrastructure from scratch. Public companies are more interested in acquiring already-producing fields linked to accessible markets. After they see cash value pumping at the wellhead, they will jump in to capture returns from producing facilities and pipelines. That is why private equity is increasingly fundamental to early-stage development and where it goes, investors can follow.
TER: How does oil field infrastructure in the U.S. compare to the international E&P space?
JW: Stateside, we are still looking for oil and gas, even though prices are depressed. There is no telling exactly when that will turn positive. And although the infrastructure in the States is not perfect, it is ample and largely available. Internationally, the explorers are hunting for elephants. Again, one of the biggest constraints is understanding how much a company will have to spend to build out enough infrastructure to bring new energy to the market. Internationally, gas prices are much more robust, so finding gas in underdeveloped areas is not a bad thing, because there is such an upside to developing new sources. Companies are focused upon finding large, economic plays for oil, gas or even natural gas liquids (NGLs). There is risk in exploring and developing a region so that the cash can flow. But the rates of return can be phenomenal.
TER: What companies are you following internationally?
JW: One small firm that we like is called Harvest Natural Resources (HNR:NYSE). It has assets throughout the international space. In Venezuela, Harvest is attempting to monetize a major asset. It has a handshake agreement to that effect with a company called Pluspetrol in Argentina. It also has some assets in offshore Gabon, West Africa, and a shale play in Colombia, and several promising assets in Indonesia and China. If it sells the Venezuelan assets, it will be able to focus more on its Gabon wells, which have a lot of prospectivity. For instance, there was recently a Total S.A. (TOT:NYSE) well in the same area that had a very nice result. Harvest is looking to have the Gabon production online in the next 18–24 months, which would be a quick turnaround with potentially significant gains, and Harvest is looking for help to finance its Gabon growth.
International assets are generally a tough sell to investors because investors have a hard time valuing foreign assets. In the States, an investor can look at what firms are producing next door to a certain well, and have a degree of confidence, but it is more difficult to make that kind of assessment internationally. Of course, the international space has many great assets, and Harvest has the expertise to find and develop profitable wells.
TER: What is the shape of Harvest's debt:equity ratio and cash flow?
JW: Its cash flow is effectively zero. Harvest has producing assets in Venezuela, which it is selling because the Venezuelan government has asked it very politely not to take any money out of the country. It does not get to repatriate the cash flow. The Gabon asset is close to generating cash flow, however.
Harvest's debt:equity ratio is not bad. It carries $80 million ($80M) in debt. The equity value is $200M. So its debt:equity range is 25–30%. The company intends to pay off its debt with cash from the Venezuelan sale. But the current cash flow, in my opinion, is not the best way to value Harvest, because the true value is in it assets—either for development or for sale.
TER: How can investors make money off of Harvest?
JW: Right now, the stock is trading in the $5-and-low-change range. If the deal with Pluspetrol goes through, Pluspetrol will take over Harvest Natural Resources, and pay about $6/share in cash—and every other asset will be spun off into a new company. So $5.14/share means $6 in cash and a spun-off asset of everything but Venezuela, which has had its share of headaches, anyway. Again, $6/share in cash and about $3/share in new stock is a good return. Obviously, Harvest has to complete the deal in Venezuela, which is not necessarily a walk in the park, but there is ample upside to it.
TER: Why does Pluspetrol, an Argentinean company, want to buy a Venezuelan operation?
JW: In July 2012, Harvest tried to sell the asset to a company called PT Pertamina, the state-owned Indonesian company, for $715M. One of the contingencies of the agreement closing was that PT Pertamina and Indonesia and Venezuela sign off on the deal. But the Indonesians walked away and the stock fell from $10–11 to the $3–4 range, where it languished. It recently popped on the news of the $373M Pluspetrol deal, which is tax friendly because the ability for Pluspetrol to buy Harvest as a whole means that the entire $373M can enter the States. Harvest then can pays off its $80M debt. After fees, there will be $240M left for the equity holders, which, with 40M shares outstanding is $6/share in cash. At that point, the shareholder is responsible for the taxes. This allows the shareholder to get a much larger amount of capital or cash while still having all the other same assets in a more tax-friendly situation.
TER: What other acquisitions or sales are in play with companies that you follow?
JW: Gulfport Energy Corp. (GPOR:NASDAQ) is one of my favorite names. It has a sizable oil sands position through a 25% interest in a company called Grizzly Oil Sands ULC (private). It is expected to bring production online for its SAGD project in Canada before year-end. That will unlock a lot of value and allow Gulfport and its partners to monetize assets through an initial public offering or an outright sale of the company in a year or so.
Bill Barrett Corp. (BBG:NYSE) is taking competitive bids on three different properties—gas assets in the Piceance Basin and the Uintah Basin and oil assets in the Powder River Basin. It plans to monetize one of these three assets to pay down debt in order to keep its liquidity position strong and to reform its balance sheet. It started the year at a debt level of $1.1 billion ($1.1B), and it has vowed to not let that level move any higher from Dec. 31, 2012 to 2013 through utilizing an asset sale.
In the Denver area, Triangle Petroleum Corp. (TPO:TSX.V; TPLM:NYSE.MKT) is diversifying into services under the leadership of Peter Hill, who used to work at BP Plc (BP:NYSE; BP:LSE). Hill saw that hydraulic fracking services are tough to get, especially for a smaller company. Midstream fracking services are effectively nonexistent in the Bakken. Hill decided to expand production and acreage position in the Williston Basin while investing in building infrastructure to move oil to the market. Triangle runs a portfolio approach, which is a bit of a rarity within the industry. There are a few companies that do something similar, but usually they are larger than Triangle. Triangle itself is a self-contained company. It rents rigs and equipment while drilling its own acreage. It has midstream pipes for transporting water, gas, and oil. It fracks for itself and also for third parties.
TER: How is its stock performing?
JW: In the last six months, Triangle's stock has doubled. It has grown its acreage position. It has continued to see better and better returns on both the fracking business and the midstream transport business. Investors get excited about an asset when it starts producing revenues, cash flow, EBITDA and earnings per share numbers. All of the Triangle segments now produce positive EBITDA. That is a huge win for the small conglomerate.
TER: Are there any other companies that investors should pay attention to?
JW: Resolute Energy (REN:NYSE) has a nice legacy asset in Southern Utah called the Aneth field. It has been producing for a very long time. It gets great oil production out of it. Resolute is free cash flow positive, which is a rarity in this day and age, and a high growth rate in the 5–10%/year range. The company is in the Permian basin and it has purchased 22,000 net acres in both the Delaware and Midland basins, where it is drilling horizontally under the radar of the boom. It should have results in the next couple of months.
TER: Thank you for spending time with us today, Jason.
JW: You are welcome, Peter.
Jason Wangler has over five years of equity research experience focused on the exploration and production and oilfield services sectors of the energy space. Jason previously worked at SunTrust Robinson Humphrey and Dahlman Rose & Company before moving to Wunderlich Securities. He also previously worked at Netherland, Sewell & Associates, Inc. as a petroleum analyst. He received his Masters in Business Administration from the University of Houston where he was also named the 2007 Finance Student of the Year. He received his Bachelor of Science degree in Business Administration with a focus on Finance from the University of Nevada where he was named the 2003 Silver Scholar award winner for the College of Business Administration. In 2010 he was highlighted as a "Best on the Street" analyst by The Wall Street Journal and has been a guest on CNBC.
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