Disclosure: The following represents my opinions only. I am long AAV.TO, AMI.V, AOI.V, ARX.TO, ATH.TO, ATU.V, CJ.TO, CPG.TO, CPI.TO, ERF.TO, NSE.V, POE.V, RBY.TO, TAO.V, TGL.TO, TOU.TO, TXP.TO, VLE.TO, WCP.TO, and YGR.TO (Image credit to David Mark on Pixabay)
What a difference a few weeks can make. Like a lightning bolt from the sky, energy has become a very hot topic as natural gas, coal, and power prices have rallied to multiyear highs. Oil has also had a nice tailwind after the unexpectedly long outage in the Gulf of Mexico took over 30 million barrels out of oil inventories at a time when they were already being run down. On top of that, oil got a nice lift today to new highs as OPEC+ stuck to its plan to gradually raise output despite calls from the White House to increase output faster. But the real story in the energy markets lately is natural gas. Gas stocks have been creeping higher for a while, but the natural gas market had generally been flying quietly under the radar. That’s usually the case until it isn’t. Gradually, after a series of compounding events, gas is all of a sudden in short supply, confounding a market that had been led to believe that cheap and plentiful gas was here forever. There are too many links in the chain to go through them all in detail, but weather (both hot and cold), energy policy, renewables, LNG market dynamics, carbon reduction goals, and the electrification theme are all part of it. It feels a bit like one of those rogue waves you hear about in the ocean… you know, like the one from the Perfect Storm… where the course is already charted and there’s no time to do anything about it but hope… gulp.
Granted, winter weather is a wildcard… give the northern hemisphere a mild winter and maybe things don’t go more goofy… because they’ve already gone goofy. Energy markets are seeing electricity and natural gas price spikes in China, the western US, and much of Europe. The extreme natural gas prices in Europe are affecting everything from meat supply, to cucumbers and tomatoes, to beer, to fertilizer… never mind the absolutely sky-high bills that energy consumers (i.e., everyone) are seeing. Hopefully Russia comes to the rescue this winter with Nord Steam 2 coming online for Europe. Hmmmm. So Europe is counting on Russia to be charitable with gas supply? Interesting times indeed.
The current situation in the energy markets isn’t something that can be fixed overnight. This isn’t a “well, just get them to open the taps” situation. The end of the natural gas inventory filling season is fast approaching and it takes time to get crews into the field to complete new wells… and there is only so much LNG to go around. It takes even longer if you have to drill the wells, never mind build (or Lord help you, permit) new infrastructure. And where do you get the workers after whittling down the workforce through layoffs and downsizing caused by too many years of poor returns under the “growth at any cost” model? My point is that the natural gas supply response has a lag time to it. Same goes for oil. By the time you see that things are tight, it doesn’t matter. Pick your metaphor; the ship has sailed… the train has left the station… the rocket has left the launch pad. And now, even though the oil and gas stocks are starting to hit more radar screens, they are by no means widely owned, and yet they represent tremendous value propositions in the context of a broader market trading at historically high multiples. To drive that point home, energy was the ONLY sector in the S&P to post a positive return in Q3… that’s the kind of thing that gets portfolio managers thinking.
There has been a lot of virtue signalling by various asset managers who have shunned hydrocarbons as part of some kind of “solidarity” with the climate change movement, but personally, I think they are misguided. In Europe, we are seeing the effects of current “popular” energy attitudes and policies. It costs consumers, impacting the folks with the lowest incomes the most, and exposes the electrical grid to supply failures when policy doesn’t line up with reality. It has cost Europe dearly in that Russia now has Europe by the you-know-whats every winter. It means that the market needs to come to grips with the idea that oil and gas companies may choose capital discipline over volume growth for some time; pushing inflation higher, because energy prices are embedded in literally everything. This idea of shareholders ceasing to reward mainstream energy companies for growth, and instead rewarding them for juicy return-of-capital-to-shareholders policies, is a big change. An equally big change is the massive amount of capital that has been chasing “green” energy projects, leaving “traditional” energy companies to fend entirely for themselves when it comes to funding the finding and development of new resources to replace those which are being depleted.
I think a lot about perception and reality when it comes to the market… and when I think about energy and materials, the gap between the two seems to have grown particularly wide as voters and politicians amp up the green narrative in the name of fighting climate change. The thing is that minds can change faster than the system that modern civilization has built over the last two hundred years. The path to a less carbon intensive future has been mapped, but not yet travelled, and we are seeing the pitfalls along the way in real time — and it’s not even winter yet. While the perception seems to be that you can starve the producers of the bulk of the world’s energy from outside capital, the reality is that they will take their pound of flesh, and then some, while you do. Meanwhile, metals like lithium, copper, tin, nickel, manganese, aluminum, and rare earths are all needed convert the world’s horsepower to electro-power, but no one gets a monthly bill for those, so they don’t attract as much media attention. At least not yet. Give the green push some sustained momentum though, and those metals will make headlines of their own in due course. Goldman Sachs calls this “the revenge of the old economy”. I think of it more like “paying attention to the relationships of a bunch of interconnected moving parts”.
Having said all of that, I am not immune to taking profits and/or trading around my more liquid holdings. When energy stocks sold off to their 200-day moving averages not that long ago, I added to a lot of names quite aggressively. Last week, I did take some of my liquid oversized positions down to more right-sized ones, and that’s left me with a lot of cash that I hope to be able to deploy on another dip in the future (today that’s not working). The thing I wrestle with these days is the fact that, despite the big moves in the stocks, the energy sector as a whole still looks really, really cheap. Heck, the whole commodities sector is cheap relative to the market — the cheapest it has been in a very long time. Regular readers will know that I like gambling analogies and, as Brian Clouse in our office will tell you, craps is probably the best approximation of the stock market that you’ll find in a casino. You “buy” your numbers and play those numbers until someone rolls a seven or makes the point. Any time before the dice are rolled you can place new bets or take old bets off. You also have the option of “pressing” the bets (just letting your winnings pile up on top of your initial bet on any given number) or “getting paid” (taking your winnings up and out of play from any bets you had on the table for any given roll). It’s a real exercise in money management, and everyone has their own risk tolerance; just like the market. So while I’ve taken some big liquid bets down, I’m still very long, and am barbelled with a lot of what would be considered “special situations” as I look for alpha-driven returns.
Oil and gas stocks are being referred to these days as The New Tobacco, which is both a compliment and a disparagement at the same time. I’m not going to wade into the weeds in terms of the validity of that characterization, but the fact is that tobacco stocks have made people a lot of money, for a long time, even after the dangers of smoking were well known, all while the number of smokers continues to decline. I joke about Flavour Country in the title of this post because below I’ll run through a selection of lesser-known energy stories that I think could/will attract attention over the coming quarters as a result of company specific events that could present step-changes in valuations. My list of larger-cap favourites still includes names like AAV, ARX, ATH, BIR, BTE, CJ, CPG, ERF, MEG, TOU, TVE, and WCP, but so does everyone else’s. This post is devoted to some of the lesser-known small caps (mostly oily) that I think will benefit as more money comes into the energy sector in search of outsized returns. These names represent a very different flavour of energy stocks relative to those that I just listed above. They are all microcaps and small caps, so they are higher on the risk curve, but I’ve followed almost all all of them for years, which is why I don’t mind including them in a higher-risk basket as I look for juicy returns.
Altura Energy (ATU.V, last at $0.32)
I wrote about this one recently here, but it certainly falls into the special situation basket. Altura, soon to be renamed Tenaz Energy, is in the midst of a recapitalization, with a vote set for October 7th to approve the new plan and financing. I expect the vote will pass easily, after which the record date for an associated rights offering will be set. The rights offering applies to shares bought in the open market up to the not-yet-set record date which will see ATU holders get 1/8th of an 18c right for every share held that was not issued in the recently completed $29.5 million financing. For every eight shares of ATU held on the record date, holders will have the right to buy one additional share at a cost of 18c. ATU had 109 million shares out before the deal was announced, meaning that around 13.6 million rights will likely be distributed sometime in October that would bring in about $2.4 million of additional proceeds if all of the rights are exercised. After that, the next event will be the capture of Tenaz’s first new asset, which the incoming CEO Tony Marino has already identified. Not knowing what or where the asset is doesn’t bother me much, because I think that Leduc-Woodbend handily backstops ATU’s value where it is today and that I’m getting a free call option on whatever Marino captures over the coming months. The first deal could be announced before Christmas and the first deal won’t be his last. Tenaz plans to lasso 50,000 boepd of production over the next 18 months and has committed to a return-capital-to-shareholders business model. Riding the equity wedge on an acquisition play is attractive to me in this market given that qualified, technically competent, and financeable buyers are hard to find in a world where a lot of asset holders are under pressure to reduce their carbon exposure for non-fundamental reasons. I’ve written more on this here than I’ve intended to already, but suffice it to say that I’m long, and bullish.
Tag Oil (TAO.V, last at $0.38)
I first wrote on TAO over a year ago and with Egyptian Parliament reconvening on Tuesday, October 5th, I think TAO’s wait should soon be over. TAO has kept a rotating senior management presence in Egypt for at least the last six months, and given Mr. Badwi’s most-recent success with his Egyptian-Omani Kuwait Energy (sold in 2019 for US$900 million) I very much look forward to seeing what he and his team pull out of their hats. In a market like this, where folks will be looking for that elusive early stage energy opportunity, I think TAO is well-positioned to catch the market’s eye. I expect to have more to say about TAO in the next 1-3 months. Usually the waiting is the hardest part, but I’ve found this wait quite easy so far.
Yangarra Resources (YGR.TO, last at $1.83)
Not that long ago, I said that I think the market will start to wake up to YGR when they report Q3 results in late October/early November. Well, the market has woken up a little bit, but I think there’s more gas in the tank, so to speak. CEO Jim Evaskevich hasn’t been idle over the last two years… instead he’s been busy making structural changes with respect to YGR’s operations that should see his already-low operating costs stay that way. YGR has around $200 million in debt, which Jim plans to get down to ~$190 million by year-end and into the $150-160 million range by Q2 2022, at which point his debt to cash flow multiple should be around 1x. Attentive readers will notice that implies 2022 cash flow of around $160 million and they would be right (that assumes $30/boe netbacks on 15,000 boepd in 2022). A quick review of YGR’s corporate slide deck will show that the company expects to free cash flow somewhere between $300-500 million (that’s ~$4-6/share) over the next five years at $65 oil and $3 AECO gas. YGR’s current plan is to run one rig, full time, in its Alberta Cardium fairway at a cost of about $80 million per year and to pay out excess free cash flow after every quarter in the form of a special dividend. With only 85 million shares outstanding, and after accounting for a $30 million debt repayment in H1 2022, that implies the potential for $0.65/share of free cash flow in 2022 alone — this is on a stock currently trading at $1.80. Even if production was held flat in 2023 at 15,000 boepd, YGR would free cash flow $1/share. For those paying attention, that’s nearly the entire share price in free cash flow over that two-year period at oil prices $10/barrel lower than where they are currently, and a fairly conservative AECO price. YGR’s year-end 2019 reserves (remember that I don’t even look at year-end 2020 reserves values because that was a scorched-Earth year) showed that PDP reserves alone were worth over $3/share at the time and I suspect year-end 2021 reserves will be at least that much, if not higher. YE 2021 1P reserves values could be knocking on the door of $10/share, but I’ll have to wait and see in Feb/March when reserves are reported. Did I mention YGR is essentially unhedged? The last of YGR’s minor oil hedges (1,000 bbls/d) just rolled off at the end of September and the company has only a little over 730 boepd (4.4 mmcf/d) of gas hedged until the end of 2021. That means that YGR is reaping vast rewards this year from elevated energy prices and that’s set to continue in 2022 and beyond. YGR has had a nice run, but I haven’t sold a share and am unlikely to until I see prices approaching PDP reserve values unless the market turns absolutely upside-down. Right now, an average YGR Cardium well would be expected to pay out in about 6 months and would boast an IRR greater than 300%. Sometimes it’s nice to be small because there’s a lot of torque in YGR in my opinion, and YGR has good leverage to AECO gas, for which I like the long-term outlook.
Pan Orient Energy (POE.V, last at $1.02)
I mention POE because it’s a fairly pure play on Brent oil prices. POE has lowered its operating cost structure in Thailand and improved its sales pricing materially over the last year. Drilling has also gone well. Unless POE gets into the exploration business again, I don’t expect to make a big score here, but I can easily make a case that the stock is worth $2 based on what I know today. POE is an odd story in that twice it has made asset dispositions at prices far in excess of what the market would think is possible and I think this is a good environment for them to monetize should they wish to sell. POE has about 60% of its market cap in cash and is minting money right now from its ~1,300-1,400 bopd of Thai oil production. POE is a small position for me, but I like it.
Condor Energy (CPI.V, last at $0.43)
I was about ready to give up on CPI and then I reflected on its market cap and assets. Granted Turkey, Kazakhstan, and Uzbekistan aren’t on the hot lists of places people typically want to venture, but Don Streu and his team are very well suited to the task. Condor has a few potentially very material irons in the fire and should be drilling a Kazakh oil exploration well this quarter so I own it as a bit of a call option on something good happening. It’s a small position, but it has massive potential upside should the Uzbek gas deal come through or if CPI gets into the LNG/CNG business in Kazakhstan. This is not for everyone, but I’m okay with owning a little as I wait to see what it turns into.
New Stratus Energy (NSE.V, last at $0.30)
Almost no one will have heard of this story, but CEO Jose Francisco Arata is one of the most connected people you will find in the South American energy scene. NSE is working on acquiring assets in Ecuador and completed a $10 million financing recently that caught my eye. Ecuador used to be a no-go for me, but with the market accepting a number of mining stories in the country I feel like the door is open for energy as well. Almost 20 years ago, I used to work in a group focused on Ecuador and one thing that I’ll say is that there’s a lot of low-hanging fruit there. If anyone can get it done, it’s Jose Francisco, so I wish him luck as I ride a small position.
Touchstone Exploration (TXP.TO, last at $1.95)
TXP was my favourite stock of 2020. While the energy world imploded in early 2020, TXP briefly wobbled before coming roaring back as the company’s success with finding gas in Trinidad allowed it to power through a tough market, making a lot of money for those who bought it during the swoon. TXP did a very big no-no when the Chinook “discovery” turned out not to be a discovery at all, at least not the massive gas one that the market, myself included, believed it was based on early drilling results. I’d blown out my TXP balance on the Chinook disappointment, but rehooked some after the recent drilling update out of the very material Royston target. It “appears” to be a discovery, but the market isn’t going to give a lot of credit for it until it’s tested given what happened at Chinook. My TXP cost this time around is in the $1.50 range, which I felt represented low-to-fair value based on what’s drilled and tested at Coho and Cascadura, but if Royston is indeed a discovery, it could be the biggest one yet, which might take TXP back up to $3 territory. This is a small position for me as well, but CEO Paul Baay named the target after his father, so you’ve got to be believe that they’ve liked this one from the start. Royston test results could be available in late October to early November.
TransGlobe Energy (TGL.TO, last at $3.25)
If there’s anything I’ve learned over the last year, it’s that things can move very slowly in Egypt. I’m specifically referring to the ratification of TGL’s new PSC terms, which seems to be taking forever. You could read my TGL notes from last year and they’d be every bit as valid today, but the share price is quite a bit higher now. Given the move in oil prices and TGL’s tight share structure, the stock could have quite a move on ratification day, should that day ever arrive. As mentioned above, the Egyptian parliament sits again on October 5th, so I’m cautiously optimistic. TGL is an odd story, but it’s made me a fair bit of money, so I’m still long a piece of it in the hopes that the new deal is ratified in Q4 as per the company’s recently communicated hopes. Production is rising in Egypt and will be set to rise a lot more if the deal is ratified. I view TGL as a cheap way to play Brent oil prices.
Valeura Energy (VLE.TO, last at $0.48)
Old VLE. After round-tripping this one a couple of years ago, it has fallen so far that it’s now trading at around 70-75% of its cash value. Even if I assume they burn $5 million in G&A for another year, it still trades at about 80% of its cash value. I have mixed emotions about owning VLE given my profound disappointment from its Thrace Basin play, but the discount to its cash value is too large for me to ignore. As of June 30, 2021 VLE had $53 million in cash relative to its $39 million market cap and the company is actively searching for a new asset to sink its teeth into. Here’s hoping they find something that catches the market’s eye and can get it for a fair price. Again, this is a small position for me.
Athabasca Minerals (AMI.V, last at $0.17)
I’ve followed the company for the better part of 15 years. It’s an odd little aggregate producer in Alberta that should benefit from increased oil patch activity and infrastructure improvements in Alberta. If it was just the gravel production, I probably wouldn’t give it a second thought, but the frac sand angle has always intrigued me here. AMI has a proposed frac sand project with none other than Shell as the offtake partner that has yet to be built or sanctioned, but this is a sleeper “ESG” play given its location in the Western Canadian Sedimentary Basin (WCSB). Recall that most frac sand comes from… Wisconsin!! That’s a very long train ride, rife with track congestion and logistical hurdles when it comes to timely delivery. If I was an energy company like Shell, and I need to drill A LOT of wells to fill my Canada LNG commitments, I’d be looking for a local frac sand source to a) lower my sand costs and b) lower my carbon footprint. I haven’t reached out to management recently, but AMI’s market cap is so low that I think I’m paying for the gravel and getting a free call option on the frac sand potential should Shell follow through with its offtake aspirations. Speaking of Canada LNG, that could be a game changer for WCSB natural gas (read, Station 2 and AECO pricing) which would only intensify frac sand demand. It’s a cheapie with a chance.
Africa Oil (AOI.V, last at $1.92)
This is a Lundin-backed vehicle that made a very large oil acquisition in Nigeria that is paying off handsomely so far. Recall that AOI also has an oil development project in Kenya. As part of the covenants of the project acquisition facility, AOI is about 50% hedged through 2022, but it’s still printing money right now. It’s up there on the risk curve given the jurisdictions, but that’s nothing new for the Lundin group. I highlight it because this is the kind of story that gets forgotten in the fog of market disinterest, but it’s a very material piece of business and likely worth multiples of where it’s trading. The chart suggests that folks are starting to figure it out so I’m flagging it as a small position that I think has a reasonable risk-reward profile given the cash that the Nigerian assets are spinning off. That cash is paid to AOI as dividends from a subco and AOI appears to be on a path to have that acquisition paid off by the end of 2022 at which point the cash should really start piling up. I have no specific catalyst on this one, but should the Kenyan oil project come back to life, that could make for a nice bump.
Rubellite Energy (RBY.TO, last at $2.25)
Never heard of Rubellite? You’re not alone. Recently spun-out/sold by Sue Riddell’s Perpetual Energy (PMT.TO, last at $0.32), Rubellite is a pure-play on the Alberta Clearwater. The Clearwater play has grabbed a fair bit of market attention as one of the best oil plays in the basin in terms of well economics. RBY has a large number of $2 warrants outstanding that expired today at noon, so the stock has had a lot of selling pressure out of the gate. I can’t speak intelligently to RBY’s prospects other than to say that the Clearwater gets a lot of attention and the Riddell’s are very well-known in Calgary, so I think this could be worth a punt. I have it trading at around 2-2.5x 2022 EV/CF and it is debt-free. RBY is very small, hoping to grow to 2,000 bopd in 2022 (from ~350 bopd currently) and perhaps 5,000 boepd by 2024. RBY says that its production ramp-up could be accelerated, but as it stands it looks like an internally funded organic growth play. I don’t particularly like the lack of visibility on near-term free cash flow relative to something like a YGR and I really don’t know the assets very well, so it’s a small bet for me, but after letting HWX get away from me at $1.40, I’ve got a little RBY just in case.
Welcome to Flavour Country. Happy hunting.