The Energy Report: With oil prices firming
up over the past couple of months and the spread between West Texas
Intermediate (WTI) and Brent Crude narrowing, what are your price
expectations for the remainder of 2013 and into next year?
Phil Juskowicz: While I don't spend a lot of time
predicting commodity prices, I personally see relatively stable
short-term oil prices. Intermediate or long-term prices may weaken,
assuming no supply disruptions arise from political upheavals, while gas
prices may strengthen based on supply/demand fundamentals. We've seen
continued oil supply growth and the short term market seems to be pretty
range bound, having developed a good base around the $100 per barrel
($100/bbl) level.
TER: Where do you see some of the best investment opportunities in the oil and gas business?
PJ: Micro-cap exploration and production (EP) stocks
have severely underperformed the SP Small Cap EP Index since the second
half of 2011 (H2/11). However, the definition of "small cap" depends on
who you're talking to. The Small Cap EP Index consists of companies
around the billion-dollar range like Approach Resources Inc. (AREX:NASDAQ) and Northern Oil Gas Inc. (NOG:NYSE).
Casimir has a micro-cap EP index, which is comprised of companies with
market caps up to $500 million ($500M) with some names under $100M. That
index level started to diverge in H2/11. Both of these groups consist
of relatively equal gas/oil weightings, so the performance should not,
in our opinion, be attributed to the relative strength of oil prices
over gas that commenced around that time. As a result, we believe that
there are attractive investment opportunities in the micro-cap EP
universe.
Casimir Micro-Cap EP Index (White) vs. SP Small-Cap EP Index (Yellow)
Casimir Micro-Cap EP Index composed of: AMZG, ANFC, CAK, CPE, CXPO,
EGY, EEG, ENRJ, ENSV, FEEC, FXEN, GMET, GNE, HDY, HNR, IFNY, IVAN, LEI,
MCEP, MILL, MPET, MPO, OEDV, PHX, PNRG, PSTR, RDMP, SARA, SSN, STTX,
TAT, TENG, TGC, TPLM, USEG, WRES, ZAZA
Source: Bloomberg; Casimir Capital
TER: How do you choose the companies in your coverage list?
PJ: We look for small companies that have largely
flown "under the radar screen" and are underfollowed. The companies we
cover have strong management teams and operate in premier areas with
good assets that have substantial cash flow potential.
TER: Do you cover any service companies?
PJ: Enservco Corp. (OTCBB:ENSV)
is on our "watch list". The company is the only nationwide provider of
hot oiling, well acidizing and frack heating services generally used to
coax oil out of the ground, for example to counter paraffin buildups.
Enservco experienced healthy margins in Q2/13 despite it typically being
a seasonally weak time for heating services. The company continues
having to turn customers away in some areas while it builds out its
fleet. Management, in our opinion, has a track record of building
successful companies and its regional staff has strong relationships
with EPs. The company is also expanding into other basins and
successfully tapping into new revenue sources.
TER: Why aren't competitors seeing the opportunity here and moving in to get a piece of the action?
PJ: There are regional pockets of mom and pop shops
that will do some of these services, but, a nationwide company like a
Noble Energy Inc. (NBL:NYSE) might turn to Enservco because it already
has a reliable relationship with Enservco's staff in different areas.
Enservco's services account for a very low percentage of total well
drilling and completion costs (it might cost around $100,000 to service a
$7M well) so customers are not as likely to conduct competitive bidding
processes. Instead, they choose to use a company with which the
frontline managers already have existing relationships.
TER: So it has developed a national reputation, which is its competitive strength.
PJ: And it's building out the capacity as we speak.
Enservco is expanding its already large presence in the Marcellus
Formation. In its Q2/13 conference call, management said they were
starting to see the Utica play out a little bit. The Utica underlies the
Marcellus in a lot of areas and Enservco gets some economics of scale
there. [See map] Furthermore, management has been getting the word out
more and also may be contemplating a reverse stock split and listing on
another exchange.
Source: Marcellus Coalition
TER: What EP names on your coverage list look interesting?
PJ: We like Miller Energy Resources (MILL:NYSE; MILL:NASDAQ),
which, in late 2009, captured former Pacific Energy Resources Ltd.
assets out of bankruptcy that were valued at $500M for an outstanding
$4.5M. Miller's entire enterprise value, meanwhile, is just $240M.
Moreover, its infrastructure assets were valued by third parties on
behalf of its lender at $190M. What makes these assets most attractive
is the fact that recent well results indicate that original estimates by
Forest Oil (which sold the properties to Pacific in 2007) may in fact
be correct, which would mean that these Alaskan assets could contain
100200 million barrels (MMbbl) of recoverable oil reserves. Proved oil
reserves presently stand at 8.61 MMbbl.
TER: How was Miller able to buy $500M worth of
assets for less than 1% of their value? Even in bankruptcy, you'd think
that there'd be buyers willing to pay more than that.
PJ: David Hall, a Miller Energy executive who had
worked on the assets even before Pacific bought them from Forest Oil in
2007, was following the Alaskan bankruptcy proceedings. He got in touch
with the CEO of Miller, Scott Boruff, and told him about these assets
that were becoming available.
TER: Why does Miller believe that the original estimates of recoverable oil reserves may, in fact, be correct?
PJ: The thesis is that Forest Oil used the wrong
completion techniques, which is why well performances had dropped off.
The completion techniques Forest Oil used were in fact different from
techniques used for other assets on the McArthur Trend. David Hall
believed that workovers on existing wells, for example, replacing some
electric submersible pumps and making changes to completion techniques
on new wells, could improve production. Low and behold, that's exactly
what's happened.
In addition, Miller just started doing sidetracks of some of these
old wells. It posted a 21-day production test of its RU-2A well several
weeks ago at 1,314 barrels per day, which would indicate that that the
oil's there and it's recoverable. Management has been doing a good job
of utilizing preferred equity to have substantial capital expenditure
programs without diluting the common shareholders. To top it off, it has
about 600,000 undeveloped acres that it's just starting exploration on
as well.
TER: What other names look interesting?
PJ: I like Trans Energy Inc. (TENG:OTCBB),
which is a pure play in the Marcellus Shale. The company holds about
20,000 net acres in the Marcellus, a substantial portion of which are in
the core, liquids-rich part of the play. Operators, including Range Resources Corp. (RRC:NYSE), EQT Corp. (EQT:NYSE) and Gastar Exploration Ltd. (GST:NYSE),
continue to increase their return assumptions for acreage adjacent to
Trans Energy's. The company's production is set to ramp up as soon as
Williams Companies Inc. completes the construction of certain
infrastructure. Trans Energy's acreage is in northeast West Virginia, on
the southwest Pennsylvania border. There's been a lot of success coming
out of that area.
TER: What sort of strategy would you suggest our readers consider?
PJ: I think the micro-cap space, in general, is less
correlated to the market's vagaries. Perceived changes in foreign
interest rates, for example, have a larger effect on large-cap names.
Micro-cap pricing is determined more by company-specific dynamics, such
as anticipated future cash flows. Plus, a lot of micro-cap names and EPs
in general seem to be more active on hedging, and therefore should be
less susceptible to changes in commodity prices. As a result, investors
that exercise due diligence should be rewarded for accurate cash flow
predictions. If you want to find companies where your hard work can
actually pay off, then the micro-cap space is a good place to look.
Micro caps seem to be getting more active in reaching new investors,
and some of the management teams have regrouped from previous lives and
are starting up very successful new companies. I think Bonanza Creek Energy Inc. (BCEI:NYSE) is a great example of management hailing from one company and getting back together and starting all over again.
TER: Thanks for talking with us today and giving us some interesting input, Phil.
PJ: I appreciate the opportunity.
Philip Juskowicz,
CFA is a managing director in the research department at Casimir
Capital, a boutique investment bank specializing in the Natural Resource
industry. Juskowicz began his career at Standard Poor's in 1998, where
he was one of the first analysts to recommend Mitchell Energy, credited
with discovering the Barnett Shale. From 2001-2005, He worked with a
former geologist in equity research at both First Albany Corp. and
Buckingham Research. At Buckingham, Juskowicz was promoted to a senior
oilfield service analyst position, leveraging his extensive knowledge of
the EP space. From 2006-2010, he was an insider to the oil and gas
industry, serving as a credit analyst at WestLB, a German investment
bank. In this capacity, Juskowicz was responsible for $500M of loans to
energy companies and projects. He earned a Master of Science in finance
from the University of Baltimore.
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