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-- Posted Wednesday, 3 November 2010 | | Source: GoldSeek.com
Raymond James Oil and Gas Analyst Luc Mageau believes that with relative near-term stability in oil and gas prices, making money in the exploration and production (E&P) space is all about choosing wisely. Naturally, location is a big part of the equation. In this exclusive interview with The Energy Report, learn why Luc recommends investors invade Canada's Viking Formation.
The Energy Report: Luc, West Texas Intermediate (WTI) crude was trading at about $73 a barrel a year ago. It's now around $81. Should we expect similar gains this time next year?
Luc Mageau: If you look at the range that WTI traded around in 2009, it actually went from a low of $34 up to a high of $81. If you compare that to 2010, year to date it has traded from a low of $68 up to about $86. What's interesting is that the bottom of the range has come up, but the top really hasn't expanded very much. Over the short term, it really is anyone's guess what oil prices are going to do.
If oil prices, at least the top end of that range, are to move higher, some incremental demand needs to come from the United States. Given the economic situation there I don't know if that's necessarily going to be the case. For the next year, we're seeing oil trade in the $70–$90 barrel per day (bpd) range; at least until U.S. demand really starts to pick up.
TER: In the meantime, could China step into the breach in terms of demand?
LM: Absolutely. I mean that's always the wild card with oil. Chinese demand and even Indian demand for that matter can play a trump card when it comes to these prices and increase the demand outside of the U.S. quite substantially in relatively little time.
TER: What oil price are you using in your short- and long-term models?
LM: Next year we're assuming a price of $80, right in the middle of that range. Obviously, at some points throughout the year, there will be highs and lows around that range. Long term, we're at $95; and if you wanted to, you could easily paint a much more bullish scenario than that.
TER: What's your outlook on gas? It's probably not quite so bullish.
LM: Gas is an interesting story. If you look at Canada, gas production is at the lowest point it's been in the last five years; that's really a function of the drilling that's been going on. Producers here really aren't drilling, save for a couple of plays like the Montney Shale and others that have good natural gas liquids (NGL) components.
The situation in the States is much different. Gas production is way up; in fact, it's at the highest level it's been at in the last five years. Even with gas at $3.80, producers are still drilling because these shale gas plays and the horizontal drilling are making them economic with gas at $3.80. And the ownership structure of many of these plays is forcing a lot of producers to drill just to retain their leases. So, for the short term, we're definitely seeing that there's going to be a cap on the gas price. If the price exceeds that cap, producers will likely start drilling more wells or at least bring more wells on that have already been drilled, which should drop the price back down. We think gas prices are going to stay below $5 for the short to medium term.
TER: You cover mostly small-cap oil and gas (O&G) companies. Last week, the Canadian dollar briefly went above par with the U.S. dollar. How is a stronger Canadian dollar versus the greenback affecting Canadian oil and gas producers?
LM: Most Canadian producers still sell a lot of their production and realize revenues in U.S. dollars. So, when we see a rise in the Canadian dollar against the USD, it's actually a negative for a lot of the producers up here. What compounds that issue is the fact that all the operating costs are still in Canadian dollars, thus a rising Canadian dollar really puts pressure on a lot of these guys' netbacks and their bottom line.
Now the saving grace is that, over the last couple of years, a rise in crude prices typically has been followed by a rise in the Canadian dollar and vice versa. So, when crude prices increase, there has been an accompanying rise in the foreign exchange rate. This effect has dampened the impact somewhat, at least over the last couple of years.
TER: Does that mean these small O&G companies aren't quite the investments they used to be?
LM: I don't know about that. It's still a commodity-based environment where higher commodity prices are going to dominate the move in exchange rate, making for better economics.
TER: Judging by your analyst reports, you're still finding a lot of value among the small producers even with a stronger dollar. In one of those reports, you talked about the Williston Basin, which stretches across a large portion of central North America. The Bakken Shale is in that basin and most people know that name. But there are other formations in the basin that are starting to get some attention, one of which is the Viking Formation in southwestern Saskatchewan. Could you give us some background on the Williston Basin and some of its prospective non-Bakken formations?
LM: Sure. The Williston is a vastly prolific area—one of the most prolific concentrations of onshore oil discoveries in all of North America. It covers an area of about 600,000 square miles. When we looked at the Williston Basin, we realized we really had to study all the formations. In all, we looked at 11 different producing formations, including the Bakken, to see which ones were the best and to identify up-and-coming plays.
There's no disputing that the Bakken is still the king of the Williston formations. But we found several formations in the early stages of development that look like they could be the next big oil resource play. We identified a few, but the Viking is certainly one of the big ones. What makes the Viking so special is that it is truly a blanket formation. When it's drilled, there's not really much concern among the producers about whether or not a well is going to hit the formation. It's really just a matter of what kind of production it gets.
TER: In layman's terms, what's a blanket formation?
LM: It's essentially a broad-reaching formation. That means that over a large area of land, you can be reasonably assured that oil-bearing rock exists.
The reason the Bakken is so prolific is because it's the biggest blanket sand in the Williston. You can be reasonably assured that in any stretch one direction or the other around the field there will be Bakken oil.
Traditionally, producers would have to obtain a seismic survey and even do a test well before undertaking a full development. But now with a lot of these resource plays like the Bakken, and now the Viking, you don't actually need seismic. You can just drill the wells and be comfortable that the oil is going to be there.
TER: What kind of oil are they getting out of the Viking? Is that heavy crude?
LM: No. The Viking is all light oil. It's typically in the mid-30s for an API (American Petroleum Institute) range. It's sweet, so it doesn't have a lot of sulfur content. It doesn't have a lot of associated water production either. That usually translates to pretty good realized prices in and around WTI pricing. It also means that operating costs from the play are usually lower, typically around $11 a barrel. What all that comes down to is high netback. When a barrel of oil is sold for $80, essentially $40–$50 of that is translated to cash in the bank.
TER: What's the cost of drilling like? That can sometimes eat into your profits, as well.
LM: The good thing about the Viking is that it's a shallow play. It's about 700 meters or 2,100 feet deep. On top of that, producers are drilling shorter-length horizontals, usually about 800 meters in length or 2,400 feet. All in, that's about 5,000 feet total well length. That translates into cheap drilling costs. It's about just $1.2 million to drill and bring a well onstream. With sweet oil, a shallow formation and cheap drilling costs, the wells are paying out in slightly over a year. As a result, capital is recovered quite quickly. That means that after the first year, producers can just bank the cash or put it back into the ground for future growth.
TER: Are you noticing any trends right now among the small Canadian producers?
LM: There certainly is a movement toward oil production. Even the gas producers are trying to find oil plays on their existing land or trying to buy land that has exposure to oil. That's due to the disparity in economics between oil and gas. At $80 crude, producers have very good margins. At $4 gas, they're hardly making much at all in most plays. The oil producers are drilling a lot of wells and getting production up. All the gas producers are trying to find oil wells.
TER: Do you have some parting thoughts for us?
LM: Over the near term, I think it's going to be a stock-picking environment rather than a commodity-driven environment. I don't think you're going to see wide swings in valuations coming from commodity price movement. For the next while, it's mainly going to be about picking good companies that are going to increase production given the suite of assets that they have. I think that's going to be the environment here at least for the next year.
Luc Mageau joined Raymond James in March 2006. He was promoted to equity analyst in May 2009 and is responsible for covering junior and intermediate oil and gas producers. Prior to joining the firm, Luc was employed as a commercial lender at a major bank and as a research analyst at a U.S.-based equity research firm. Educationally, Luc has a bachelor of commerce degree from the University of Alberta (2001) and holds the Chartered Financial Analyst designation. Streetwise - The Energy Report is Copyright © 2010 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. The Energy Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report. From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise. Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported. Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734. Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.
-- Posted Wednesday, 3 November 2010 | Digg This Article | Source: GoldSeek.com
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