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-- Posted Friday, 10 September 2010 | | Source: GoldSeek.com
C. K. Cooper Senior Analyst Joel Musante likes oily exploration and production (E&P) names in name-brand plays, especially the Bakken. In this exclusive interview with The Energy Report, Joel talks about how he reaches his conclusions.
The Energy Report: Joel, you've covered E&P companies for more than a decade for various firms. Tell us how you started covering this sector and why you're still doing it 10 years later.
Joel Musante: I started covering the sector when I was with W. R. Huff Asset Management after getting my MBA. At Huff, I was a credit analyst, and I performed due diligence on private equity deals. I think this provided a sound foundation for doing any kind of financial analysis. The E&P sector is probably one of the more exciting sectors to cover. Although economic growth may have slowed in the U.S., the emergence of China and India and some of the other Asian economies has us asking how we're going to meet all this future energy demand. For oil and natural gas, the E&P companies have probably been the best at answering that question, as opposed to the majors.
TER: Given that a number of the companies that you cover have an oil and gas mix, is that something of a hedging/diversification strategy? For example, if oil prices go down, maybe natural gas prices go up? Or is that just a coincidence?
JM: A lot of these companies build up their reserve and production base over a long period of time, and it's not something they can change very quickly. So, from historical operations, many of them have a mix of oil and gas on their books. But if you look at where many of them are investing capital, that tends to be in the oilier plays. So going forward, many of the companies I like are growing their oily prospects.
TER: This week oil came off of an 11-week low, but Credit Suisse says that crude stockpiles are growing and that's not going to stop for at least six weeks. What does C. K. Cooper see in store for the oil price this fall?
JM: Well, crude stockpiles are just one of many factors that influence the price of oil; OPEC supply quotas, economic news, political unrest and the strength of the U.S. dollar are some of the others. I think the prevailing forces are going to keep oil prices trading in the $70–$80 range because when you get below $70, development tends to tail off. And that becomes apparent very quickly because the decline rates are steep. There really isn't a lot of positive economic news to sustain oil over $80. I see it hovering in that $70–$80 range.
TER: When you're building models for the next quarter, where are you pegging oil?
JM: For the third quarter, it will probably come in around $75. For the fourth quarter, I am using $80, but that might change as we get closer to that point.
TER: And in terms of building models, how do you weigh the different factors like commodity prices, reserves, exploration potential, management and cash flow?
JM: Well, commodity prices are obviously very important but hard to accurately predict. When I am running models and talking about a net asset valuation model, I generally value the company at $10 increments from $50 to $100 oil. That way an investor can see what the sensitivity to the oil price would be if oil prices fell below a certain level. My price deck is $80 oil and $5 gas. That's a perpetual $80 price; so, in the near term, oil prices might be weaker. But reserves are often estimated from recoveries from wells that may produce for 30 years or more. So a flat $80/Bbl oil price may look high in the near term, but seem conservative in the long term.
And proved reserves provide a good foundation for valuing companies. If I value the proved reserves and then compare that value to the stock price, the stock price could be trading below proved reserve value. If that's the case, it might look undervalued. If it's trading above proved reserve value, investors may be giving the company credit for some other asset, such as a large acreage position in a very prospective or "hot" acreage play.
TER: But how do you value reserves?
JM: I use the SEC reserve information that's provided in the company's filings, which is essentially a discounted cash flow model with a number of assumptions. Basically you're assuming that reserves get developed in the next few years, all of them get produced over time and each year that production generates some cash flow. Then you discount it back to today, and whatever that cash flow is worth in today's terms is the value of the asset.
TER: Let's talk management. Are you out talking to management? Are you visiting projects?
JM: Yes, I am constantly on the phone with managers, and any time I get the opportunity I will go out and visit a company's operation. You can learn a lot when you make these site visits. I think quality of management is important but it's kind of hard to quantify. You look for a company with a sound business plan and people who can execute. There are obviously some managers who are better at it than others. That could be the determining factor of whether value gets created or not, and a lot of times it is.
TER: Do you prefer companies that have a measure of cash flow?
JM: Cash flow is very important for an E&P company. Many large established E&Ps trade on a multiple of cash flow. For a smaller emerging E&P, cash flow is usually less important as a valuation metric, but it may be an important factor that dictates the firm's ability to move a project forward.
TER: It could cover their exploration expenses to some extent.
JM: Right. A lot of times startup companies don't have any proved reserves, and you need proved reserves to borrow money with a credit facility. These companies often need cash flow to finance exploration or development drilling.
TER: Do you have some thoughts on the E&P sector or on what's happening with the oil and gas prices?
JM: I'm bullish on oil prices. It's the transportation fuel; it's a worldwide commodity. I wouldn't say we're running out of oil, but there are fewer and fewer places to drill. And the places out there that public companies could drill are becoming more costly, so it's harder and more costly to get it out of the ground.
Then there are large regions where the national oil companies are buying assets to secure supplies. They're not trying to produce oil at the maximum rate or as a public company would. They have longer-term goals, so they're not opening up the spigots.
In terms of natural gas, we've seen the emergence of a lot of large shale gas plays where you can bring a lot of production on very quickly. Even if there were a shortage in natural gas, I think production could be brought on very quickly, so I wouldn't expect prices to remain elevated for long.
A lot of these gas producers have found themselves trying to maintain their leases, so a few of them are drilling wells that are not economical at today's prices. But they're drilling them anyway. That's holding prices down. Until that stops and they start basing their capital allocation decisions on well economics, I think gas prices will continue to be weak.
TER: Thanks, Joel. We appreciate your time.
Joel Musante has been a senior analyst at the Research Group for C. K. Cooper & Company, a full-service investment bank, since July 2007. He has worked as an analyst covering the exploration and production sector for nearly a decade.
Musante began his career in 1998 as an analyst with W.R. Huff Asset Management, performing due diligence on private equity deals and covering the high-yield E&P sector. In 2000, he joined the exploration and production team at Wasserstein Perella, Inc., which later became Dresdner Kleinwort Wasserstein Securities. Mr. Musante also held research analyst positions covering the E&P sector with Ferris, Baker Watts Inc., Zacks Investment Research and John S. Herold, Inc. Prior to working as an analyst, Mr. Musante was a geologist and project manager for seven years with several geological and environmental engineering and consulting firms.
He received an MBA degree with a concentration in finance from the University of Rochester and a BS degree in geology and geophysics from the University of Connecticut. He was awarded the CFA designation and is a member of both the CFA Institute and New York Society of Security Analysts.
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-- Posted Friday, 10 September 2010 | Digg This Article | Source: GoldSeek.com
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