I spend most of my time looking at Canadian light oil energy producers for investment ideas. And to be more specific, I look mainly at light oil producers that operate almost exclusively in new unconventional oil plays.
I call it my “unconventional plan” and there are seven reasons that I focus on these unconventional producers:
1) Little political or physical risk – I want oil exposure and I like to buy those assets at a discount, but I want to be able to sleep at night. Therefore I’m most interested in being invested in companies that operate in North America where for the most part government action or violence is not a large concern. There are plenty of unconventional oil resources inside of North America that are just starting to be developed.
2) Avoid the risks involved in deepwater exploration and production – While I don’t feel adventurous enough to invest in reserves in unstable countries, I also don’t feel particularly comfortable owning oil reserves and production that involve operating in miles of water with expensive infrastructure that is in the path of major hurricanes. Unconventional oil plays allow me to avoid being exposed to another Macondo style event.
3) No exploration risk – I love the idea of owning an oil company that hits on a giant oil discovery that immediately triples the value of the company. The reality is though that the wildcat oil exploration is high risk, and I have no ability to assess the likelihood of a successful outcome. These unconventional oil plays on the other hand are resource plays that have a broad areal extent and very little exploration risk. That is why you see companies like Lightstream Resources in Canada with a 99% success rate when drilling wells. They are basically repeatable manufacturing like operations.
4) Potential for large increases in the amount of oil recovered from enhanced oil recovery techniques – Profitable production from unconventional oil resources is relatively new. The Bakken in Canada, for example, did not produce economically until 2005 to 2006 when horizontal drilling with multi-stage fracturing “cracked the code” in this play allowing for sufficient rates of production to allow for an attractive return on investment. As these technologies and the plays themselves are young, every year sees improvements in technology and techniques that make these resources more valuable. Again using Lightstream as an example, the company currently has 5% of the oil in place on its Bakken land booked as recoverable reserves. Over time Lightstream believes that 25% to 30% of the oil in place will be recovered using primary and secondary recovery techniques. That means that reserves are going to quintuple from where they are today over time.
5) Undeveloped acreage tends to be undervalued by the stock market – Despite the positive things I have said already about these unconventional resource players, I would not be interested in them unless I thought they were undervalued by the stock market. What I am finding in many cases is that the stock market values these companies based on existing production and is slow to acknowledge cases where a company holds huge parcels of undeveloped land within established boundaries of a particular resource play. Every week I see transactions involving undeveloped land that proves it has considerable value, but until the stock market sees production coming out of the ground little value is often assigned. This means there is great opportunity to find a company that has a relatively small amount of current production but a long runway or production growth through a large undeveloped land base within an unconventional play.
6) Light oil production – Unconventional oil production results in a very high value light oil. Alternative means of gaining exposure to future new oil resources that I have looked at usually involves looking to heavier grades of oil. Heavier oil requires the cost of diluting to allow it to be transported through a pipeline and also is expensive to refine. Having a more valuable light oil puts these unconventional producers in much better shape to weather the cyclical nature of the oil business.
7) Consolidation of smaller players provides a likely avenue to realize value – Canada specifically has a number of emerging unconventional oil plays. These include the Viking, the Cardium and Swan Hills. In these plays are a number of very small publicly traded companies that have amassed enviable land positions. These companies are obvious acquisition targets and based on recent transaction multiples several of them have considerable upside. The only thing better than buying undervalued securities is buying them with a catalyst to realize that value sooner than later. I believe several of the above mentioned companies will be acquired in the coming two years.
On July 7, 2013, I submitted Novus Energy which was trading at $0.74 cents as a Value Investing Contest idea for GuruFocus. Novus is my largest holding and a perfect fit for my unconventional plan.
On Tuesday night of last week the Hong Kong Economic Times reported the following offer was pending for Novus Energy:
Yanchang Petroleum International Ltd. would fully acquire Novus Energy Inc., a Canada-based oil and gas company, for 500 million Canadian dollars ($475.94 million), according to market sources.
That is $500 million for the entire company, which is $2.08 per share, which is 2.8 times the $0.74 price that Novus traded at the time I submitted the company as a GuruFocus value investing contest idea.
However, all that we have seen so far is this news report of the offer from Yanchang Petroleum.
The following day both Yanchang and Novus had their stocks halted at the request of the companies. Here we are four days later, and the stocks are still halted.
My belief is that the news report of the offer was a leak of a legitimate pending deal, but that there was still considerable work to do before the deal could be finalized.
If the news report was not based on anything substantive both companies could simply have ignored the story or issued a press release saying that they do not comment on rumors.
So now we (Novus shareholders) sit and wait. The deal price is very high relative to where the Novus share price was trading, but it is not unreasonable based on comparable transactions.
A $500 million offer for Novus equates to roughly $120,000 per flowing barrel which is not out of whack with other light oil resource play transactions that have been completed in the past two years.
- On Nov. 2, 2012, Equal Energy disposed of 525 barrels per day (93% oil) of production for $62 million. That is $118,000 per flowing barrel.
- On June 1, 2012, Crescent Point closed on an acquisition of 2,500 barrels per day of oil production in the Shaunavon for $343 million. That is $137,200 per flowing barrel.
- On Nov. 1, 2012, Crescent Point Energy acquired 7,800 barrels per day (88% oil and liquids) of production for $861 million. That is $118,000 per flowing barrel.
- On Oct. 29, 2012, Renegade Petroleum acquired 3,600 barrels per day (94% oil) of production for $405 million. That is $112,500 per flowing barrel.
- On Dec. 10, 2012, Bonterra (BNEFF.PK) purchased Cardium focused Spartan Oil for $112,000 per flowing barrel.
I look forward to receiving proceeds from this Novus sale so that I can redeploy them into other opportunities that fit with my "Unconventional Plan."