In the junior oil and gas sector, unless you were invested in SOG or RMP you must have noticed your stocks are currently trading at a very cheap valuation, in some cases reflected in record low stock prices. I am talking about Canadian listed companies operating in the Western Canadian Sedimentary Basin. The valuation metrics simply reflect one thing; the large funds have abandoned the sector.
The juniors are not the only victims here; intermediate producers are also feeling the pinch. Take a look a Surge Energy SGY.TO 3.26 [0.00] for example; do you see anything wrong in the images below?
(click to enlarge)
The snapshot above is from 2010 and the one below is from February 2013.
(click to enlarge)
Did you notice the market cap? It’s lower in 2013 than it was in 2010 even though SGY is producing more boes per FD share. In 2013 SGY has an inventory of 450 net locations versus 154 net locations in 2010. But it’s true that in 2010 SGY was debt free while it currently carries 250M in debt or 2X CF for this year. Not to forget that they missed guidance so if you think this valuation is deserved, we’ll look at one of my favorite juniors, Pinecrest Energy PRY.V 1.12 [-0.02].
We don’t have to go back in time to 2010 to compare valuations; you simply need to look back to February or even March of 2012. Less than 1 year ago the stock was trading over $3 per share or more than 6x CF based on the exit rate guidance of 5,000 boed. Today, the stock is trading at 2x CF based on the exit rate guidance of 6,000 boed. Ballpark numbers? yes, but they do a pretty good job in bringing the point home.
Pinecrest delivered the goods, still has a strong balance sheet with debt to CF estimated below 1.0x. Yet its stock was punished any-ways especially after the last deal fell through.
According to one CEO I contacted, the big money has exited the Canadian oil patch. He put it pretty bluntly, the big funds he met with confirmed they are less than 30% invested in the Canadian energy sector compared to the historical 85%. The balance of the money has moved to the US energy sector.
It’s not the retail investor that moved these juniors, it’s the large funds that abandoned the oil patch.
Nothing has changed for PRY, in his last interview with Cannacord’s David Pescod, PRY’s CEO stated why he still believes in his play:
In terms of our asset base, we don’t have to discover anything new and we are not doing anything that is new.
That’s a good thing. I am a low-risk guy, I have a lot of my personal wealth tied up in here, I don’t want to take exploration risk, and I don’t want to take risk through the drill bit. It’s low risk, repeatable and it has a high netback. It’s cash flow positive even if we have differential impacts on the price of WTI to Edmonton.
…and he put his money where his mouth is buying 400,000 shares recently.
Looking at the big picture from an ETF perspective, we can confirm this info by comparing the discrepancy in the performance of the 2 oldest energy etfs on the market:
We got outperformed by 800% and I think it would have been by much more if it was a junior vs. junior ETF basis.
It looks like the market has stepped back from our sector and I don’t believe it’s just being fussy with high decline resource plays not recycling cash fast enough. I believe it has more to do with our commodity pricing outlook:
Natural Gas prices have not recovered; producers suffer a price discount versus the US with demand and supply totally driven by the weather. Too hot, too cold, warm winter and mild summer; these are the words moving the price of natural gas these days. There is no hope for a resilient recovery in price except when export facilities come online and that is still a few years away.
Natural Gas Liquids were all the rage in the last 2 years. But we have gotten to a point where if your NGL is not condensate, it’s almost worthless. Propane is down 37% over the past two years and Ethane is down 64% over the same period. On the other hand, Condensate is trading at a premium to both Edmonton Par and WTI at a whopping $111 per barrel!
Heavy Oil prices have been deeply discounted, from pipeline constraints to refinery turnarounds and new supply coming online. All the reasons are good to justify the discounts right now.
Light oil prices are the only thing still holding up at a decent level these days despite a small discount. But as you can see, it’s not enough to keep the funds interested in the Canadian oil patch. Are they projecting this to be the final shoe to drop? If this was to happen a la heavy oil, it would devastate many juniors/intermediates, flood the market with assets for sale and accelerate bankruptcies.
Excluding the international producers, there are only a handful of companies commanding respect in this market and these will be covered in a future post. Valuations have become dirt cheap and I believe they could get cheaper before any recovery sets in. After all, we are entering seasonal weakness, spring breakup is not that far off and the summer doldrums will be in the pipe right after.
The uncertainty about Canadian oil prices is the number 1 culprit here in my opinion. The market is rebalancing itself right now; there are new infrastructure projects getting built, Midwest refineries will be coming back later this year with new demand and rail transportation is increasing. But it will take some time before we see more resilient light and heavy oil crude prices with smaller discounts and less volatility. This, in my opinion, will be the prerequisite for the return of the big funds back into the oil patch. The question is, where will the price of oil be by then? and will this recovery appear in the second half of 2013 or much later?
What do you think?