I wrote this weekend about how the investing public has yet to grasp the value that many companies have created for shareholders by accumulating large land positions in unconventional oil plays. It is hard to see the value. You can’t see it in the booked reserves of the company as drilling is just really getting started. You can’t see it in the financial statements either, as production is in the future, and all you can see is the cost of the land that has been gathered.
But that doesn’t mean the land isn’t extremely valuable.
Today there was further evidence from a transaction by Williams (WMB) who purchased 86,000 acres for $925 million. They aren’t purchasing production here, they are purchasing land.
Why ? Consider this from Williams:
"Development of the Bakken will be very similar to the low-risk, repeatable nature of the Barnett and Marcellus shales, as well as the tight sands in the Piceance Basin," Malcolm said. "Technological advancements in just the past few years have allowed the play to shift from exploration to resource development. “
The key sentence being the last one. Five years ago we all knew that there was oil trapped in these unconventional plays but we couldn’t get it out economically. Horizontal drilling has been a game changer. These large resource plays are like oil production assembly lines for producers. When the play is in resource development mode, companies like Williams can come in and pay $10,750 per acre and achieve excellent returns on capital. They know what production is going to be, so they know the economics involved.
Petrobakken as the name would imply is a big player in the Bakken in Canada. Shortly after coming public in late 2009 through a transaction with Tristar Oil and Gas Petrobakken was trading for as much as $35 per share. Last week the share price was as low as $20.
Petrobakken is the expert in horizontal drilling in Canada having drilled over 650 horizontal wells with multi-staged fracs. They were one of the first to “crack the code” in the Saskatchewan Bakken and quietly accumulated a massive land position. In 2010 they made the decision to also enter the Alberta Cardium in a big way as they went out and acquired almost $1 billion of acreage.
Why is the share price down from $35 to $20 ? Two reasons in my opinion.
1) The market thought Petrobakken was a “Bakken” only play and did not like this entry into the Cardium believing that the company has overpaid for the land it acquired.
2) The extremely wet weather in Western Canada that lasted until October have resulted in no production growth quarter over quarter. You can’t be a growth company like Petrobakken and not grow continuously, or people quickly lose interest.
I’m not bothered by the second concern. If you are any kind of value investor you will recognize that disappointing production because of a temporary weather delay does not change the value of Petrobakken’s assets in any way.
Whether or not Petrobakken overpaid for the Cardium land is something that will be determined by production over time. The initial drilling results have been encouraging with early production exceeding management’s expectations.
What might Petrobakken by worth per share ? The current stock price is $20
Most valuations I see on these producers assign a multiple to EBITA. That isn’t my favorite approach because the multiple picked is so arbitrary.
I look at Petrobakken this way.
Value of booked Reserves
At year end 2009 PBN had P2 reserves with a PV10 value of $3.6 billion. This relates to a part of the Bakken assets PBN has and its conventional Mississippian assets.
Value of Undeveloped Acreage
Bakken – 342 of 1,050 drilling locations are picked up in the PV10 reserve figure. These other locations have a similar value to the booked reserves as the geological risk is virtually nil in the play. But to be conservative and not recognize the PV10 value of the entire acreage I use an estimate of what the land could be sold for today. Petrobakken has 210,000 acres of undeveloped Bakken, so 140,000 of these have no reserves attributed (2/3 no booked reserves). As we have seen from Williams above Bakken transactions are happening at $10,750 per acre. That would value PBN’s undeveloped, unbooked acres at 140,000 x $10,750 = $1.5 billion
Cardium – As I mentioned PBN went into this play in a big way in 2010. They now have 240 net sections in the Cardium which is just over 150,000 acres. Very similar in size to the unbooked acreage in the Bakken and not surprisingly they have 650 identified drilling locations in the Cardium which is similar to their unbooked locations in the Bakken. So these land is likely worth another $1.5billion (similar in size and locations to their Bakken property). And this makes sense given that they paid just over $1 billion for it and have since added another 150 locations.
Northeastern BC Gas plays (Horn River, Monias) – Petrobakken has 400 plus potential locations in these two plays where they have large land holdings. They are putting these on the back burner until gas prices improve, so I’ll value them at zero and consider them a free option.
My total comes to $3.6bil (booked reserves) + $1.5bil (Bakken acreage) + $1.5bil (Cardium acreage) = $6.6bil
Per share that would be
$(1.4bil) Net Debt/Convertible Debentures
$4.0bil Value for shareholders
184 million shares outstanding
Value per share $28.26
Valuation work is not an exact science. What is really key for me here is what happens as this undeveloped acreage is developed. The $10,750 per acre figure is based on what a profit motivated buyer is willing to pay today. These people expect to earn a satisfactory return on those prices. As cash flow is realized from developing these acres the value to PBN shareholders is going to be far in excess of what I’ve valued them at.
The reserve figure is also based on year end 2009 oil prices were 10% lower than where they are today which would increase my valuation figure in this exercise.
And further consideration must be given to the fact that PBN’s horizontal wells are outperforming what was modeled by their reserve engineers at Dec 09. PBN has indicated that there will be upside reserve revisions to reflect this in 2010. See page 14 and 15 of the link below:
Early Days of Horizontal Drilling
I’m very comfortable with Petrobank at these prices. You lock in a dividend of almost 5% and get shares at a discount to what the assets are worth today. And worth today being a big part of this. These horizontal technologies are getting more oil out with each successive well as these companies are learning as they go. Petrobank, like Chesapeake which I follow closely have locked up the loads of land in these plays. You get to do that once. As we learn how to extract more and more oil the value to shareholders will continue to increase.
The big risk is the price of oil. Oil prices go down, the value of production go down. You can’t invest in oil and gas companies without having an opinion on the commodity.