Rafi Tahmazian has a bit of news for Canadian-based junior oil and gas companies looking to raise capital to fund their operations: “The equity markets are closed for business.”
That’s not good news for cash-starved juniors, but it also shouldn’t be surprising. Tahmazian, senior portfolio manager with Canoe Financial in Calgary, says those markets have been closed to juniors since the 2008 global economic meltdown. And management teams running companies in the Canadian junior space shouldn’t expect to be back in favor with investors anytime soon. “I sympathize with this group,” Tahmazian says. “It’s just a nightmare.”
Yes, it’s a challenging time to be a junior oil and gas company in Canada – especially for those operating in the Western Canadian Sedimentary Basin. True, the unconventional revolution has given the WCSB a new lease on life beyond the oil sands. But the high cost of drilling tight oil and gas plays means juniors need more capital than ever to get the work done and grow.
So what strategies can juniors use to convince the markets that their company is worth investing in? It’s a question management in this sector are asking themselves every day, and there are no easy answers.
“I don’t care if you’re a public or a private company; you still have to show that you are allocating capital efficiently.”
In February of 2013, Kelt Exploration Ltd. was formed. In less than two weeks, it raised over $94 million in equity financing from a syndicate of underwriters led by Calgary-based investment boutique Peters & Co. Ltd. In August, Kelt struck again and secured over $211 million in equity financing in two separate deals – an impressive show of market confidence in a new company that produced an average of 4,097 barrels of oil equivalent per day during the second quarter of 2013.
But while Kelt may be new and small, the company is an example of what the markets value most in a junior – a management team with a track record of success. Kelt is led by president and CEO David Wilson and chief financial officer Sadiq Lalani, who held the same jobs at Celtic Exploration Ltd. before it was sold to ExxonMobil and Imperial Oil for $3.1 billion this winter. With the assets ExxonMobil and Imperial didn’t buy, Kelt was formed and with Wilson and Lalani in charge, it’s received a warm welcome on the equity markets.
“Well-thought-of management teams in the marketplace might fetch a higher premium or have a higher valuation, and that’s an advantage,” says Robert Fitzmartyn, FirstEnergy Capital’s managing director of institutional research. “I don’t care if you’re a public or a private company; you still have to show that you are allocating capital efficiently. If you are new and don’t have a track record, it’s just going to take that much longer to demonstrate that.”
Another strategy that can broaden a junior’s investor base is paying a dividend. It’s a model that’s in vogue right now. More investors are looking for income, and companies are responding by paying out dividends that are likely to attract more demand for their shares. “The demand for income is going to continue to be a theme,” says Martin Pelletier, a portfolio manager with Calgary’s TriVest Wealth Counsel Ltd.
“I don’t care if you’re a public or a private company; you still have to show that you are allocating capital efficiently. If you are new and don’t have a track record, it’s just going to take that much longer to demonstrate that.
But Pelletier says going the dividend route is not without its challenges. Juniors attracted investor interest in the past by promising – and then delivering – on high growth rates in the 15 to 20 per cent range. However, growing at those attractive rates require capital, and for companies with assets in tight oil and gas plays like the Duvernay and the Montney, the cost to drill these wells is much higher than conventional plays. That means they need capital to drill enough to generate that kind of growth. But by paying out a dividend, juniors are using up precious cash they need to fund that drilling. “You can get around that through a hybrid of paying a dividend and a little bit of a growth rate,” Pelletier says. “If you can prove you can sustain a six to seven per cent dividend and maybe offer another four per cent growth, you can attract capital and you can do wonderful things with that capital. Companies can get pretty creative when they need capital and reinvent themselves.”
In February, the TSX Venture Exchange put out a press release announcing its “TSX Venture Top 50,” a ranking of the top 50 performing companies listed on the exchange determined by market capitalization growth, share price appreciation, trading volume and analyst coverage. Of the top 10 oil and gas companies on that list, seven of them did not own any assets in Canada. So is a business model that eschews assets at home in favor of ones located beyond Canada’s borders a way to win some love from investors?
The answer is maybe. The chance that a junior might find an elephant discovery in a foreign land can be alluring, but Pelletier notes that some of the companies that made the TSX Venture list – such as Vancouver-based Africa Oil Corp. and WesternZagros Resources Ltd. – have had some drilling success, which has increased their stature in the investment world.
“Investors will go to where that operational momentum appears to be established. They’ll equally move away from companies that are stumbling,” Pelletier says. “Internationally, Niko [Resources Ltd.] used to be a market darling. There have been some slip-ups over there and consequently there has been a lot of capital withdrawn.”
One of the other Canadian juniors on the TSX Venture list is Iona Energy Inc. The company’s focus is on the United Kingdom’s portion of the North Sea, but it’s not looking for big discoveries in this prolific hydrocarbon basin. Instead its assets are either undeveloped discoveries or producing fields where Iona sees potential to increase oil output through redevelopment. The company’s current production is approximately 6,000 boe/d, but has forecasted an average production rate of 17,000 boe/d by the end of 2016. What Iona offers investors is not the prospect of giant finds but steady production growth with almost no risk that projected growth won’t be achieved.
“We’ve got a balance of really good low-risk projects and choosing simple projects,” says Neill Carson, Iona Energy’s president and CEO. “We are drilling wells that are very normally pressured. They are wells that have been drilled thousands of times before. We’ve chosen projects that are fit for our size.”
“Internationally, Niko [Resources Ltd.] used to be a market darling. There have been some slip-ups over there and consequently there has been a lot of capital withdrawn.”
Juniors can also attract market attention by keeping a close watch on the WSCB’s resource plays and the companies involved in them. Tahmazian says the big Alberta land sale bonanzas in resource plays like the Duvernay and the Cardium from 2009-2011 are over and that land has been bought up – much of it by bigger companies that are better capitalized than most juniors.
So how can juniors get a piece of the action? Or if they have a small slice, how can they acquire a bigger piece that can give investors confidence they have the running room to eventually be bought by a larger company at a premium? Bigger companies often have more than one core area they are focusing on. With only a few years in which to drill on their lands before it reverts back to the Crown, companies can get behind on their drilling commitments and a farm-in becomes the only way it can kick-start activity and retain its land claims.
Tahmazian says Tamarack Valley Energy Ltd. did just that when it recently entered into a farm-in agreement with an unnamed major oil company to earn a 70 per cent working interest in up to 113 net sections of land in the Cardium. The farm-in will see the partners drill 31 wells (20 net wells for Tamarack) between now and the end of 2016. The deal gives Tamarack the ability to drill a significant number of wells in the Cardium – something it couldn’t have done on its own. Tahmazian says the farm-in is a coup for Tamarack.
“It went out to the market to raise money for operations and support the farm-in and Tamarack went from a company that was basically nowhere to a company with running room,” Tahmazian says. “But that’s not something that will always be relied upon.”
In fact, no one strategy can be relied upon in an investment environment where energy, and commodity stocks in general, have fallen out of favor. Juniors have to do a lot of things right to earn the trust of investors. “It comes down to the talent and abilities of the management,” Tahmazian says. “Is their vice-president of land networked enough? Is the technical team respected enough by a larger producer that they may be able to do a significant farm-in? Are they capitalized enough so they can ultimately fulfill their farm-in obligations?”
Those are the key components of managing a successful junior.