As retail investors we are generally at a significant disadvantage to the pros. We don’t have research departments that can get us all kinds of useful information. We don’t have direct access to management to allow us to ask important questions. And most importantly we don’t have nearly as much time to dedicate to the process of turning over rocks looking for great ideas.
There is however one very significant advantage that a retail investor has. That advantage is size, or lack thereof.
A position size for a retail investor is a fraction of what a professional needs to invest. That means that a retail investor can invest enough money in a micro-cap to have a significant impact on overall portfolio returns.
That is a good thing, because the smaller the company, the more inefficient the stock market is. If most of the world doesn’t know a company exists there is a good chance that shares can be had for an attractive price.
The Energy Patch – Follow The Serial Entrepreneurs
It is no great revelation to suggest that the stock market pricing of micro caps is much less efficient than larger companies.
But if you aren’t a professional investor, who has the time to look at hundreds of micro-caps trying to find the ones that are inefficiently priced?
I’ve found a shortcut that helps me focus on only certain micro-cap opportunities.
In the energy sector, especially up here in Canada there exists a certain kind of management team. These are gentlemen that repeatedly start, build and then sell oil and gas companies.
And they make a lot of money doing it. Both for themselves and their shareholders.
These men are serial entrepreneurs and I love getting a chance to invest early in their latest ventures before the pros are able to get involved.
The latest instance of an established team starting up a new micro-cap that came to my attention involves a company called Outrider Energy (MCF:CNX).
The name attached to Outrider that got my attention was Brad Windt. Windt was the original and largest financier of Ultra Petroleum which went from $0.40 to almost $200 (pre-split) before the collapse in natural gas prices (it is still at $60 from $0.40 on a pre-split basis today).
Windt was also the original financier and founder of Pennaco Energy which was acquired by Marathon Oil for $445 million.
I'm looking for successful and wealthy individuals attached to new energy patch startups and Outrider fits the bill. Windt’s involvements and past successes have made shareholders significant returns on their investment.
For me that makes Outrider Energy worth a look.
How Do You Feel About Natural Gas?
I’ve spent more than half a decade getting as much exposure to barrels of oil as I can. I’m still bullish on oil but am also starting to feel a little more love for natural gas.
Outrider Energy is a pure play on dry natural gas. That is the company’s intentional strategy.
In no way do I think that natural gas prices are going to skyrocket, but I do think that we are likely entering an extended period where prices will at least be at a level where drilling new natural gas wells can make a decent return on investment.
Natural gas supply is leveling off, and demand is steadily increasing.
The supply side is being influenced by the huge drop in rigs drilling pure dry gas wells.
Supply hasn’t been impacted as severely as this graph might suggest as there are also other factors to consider (more efficient drilling, associated gas from drilling oil wells). But there is no doubt supply growth is slowing significantly and likely coming to a complete halt.
With oil at $100 per barrel those rigs aren’t coming back to natural gas drilling for a long time to come. Companies can make more money drilling for oil.
Meanwhile demand for natural gas has been increasing for a few reasons that seem set to continue.
Push For A Cleaner Fuel - The U.S. government is beginning to embrace and promote the benefits of natural gas as a clean energy choice for the country. According to the EPA and the U.S. Energy Information Administration, natural gas produces significantly lower levels of carbon dioxide, sulfur dioxide, nitrogen dioxide and mercury when compared to oil or coal.
Natural gas is the lesser of the hydrocarbon evils and is going to receive a push because of that.
Electrical Power Generation – Aging coal plants that are being retired are not going to be replaced with new coal plants. Natural gas is the preferred fuel to generate electricity and as coal plants are retired, natural gas is going to be the replacement.
In comparison to coal, natural gas emits up to 60% less CO2. Natural gas market share of electrical generation is projected to increase from 23% to 53% by 2038.
Industrial Demand- U.S. natural gas prices are driving a resurgence in U.S. industry. The global advantage of having cheap, reliable long term domestic natural gas supplies within a first world infrastructure and workforce is a catalyst for new industrial plant builds. Cheap gas benefits new steel mills, ammonia, plastics, fertilizer, munitions, etc. The resurgence of the U.S. chemical industry is directly attributable to natural gas.
The shale boom has made the U.S. the lowest-cost chemical producer outside the Middle East.
Cars/Fleets/Buses/LocomotiveConversions - The transportation and services sectors, in particular fleet operators, are realizing that natural gas is significantly cheaper than diesel fuel. Converting to compressed natural gas as fuel of choice may reduce fuel costs by 20% to 30% yielding a competitive advantage and operational efficiencies.
How fast vehicles will continue to convert to natural gas is unknown, but the potential savings from doing it is a powerful motivation. The Pickens plan shows that converting all of the countries long-haul trucks to natural gas could completely eliminate the need to import foreign oil from OPEC.
Outrider Energy – First Asset Identified
I’ve had Outrider on my watch list for several months dating back to last fall when I saw that Brad Windt had appeared again with a major financial interest (he owns 42% of the company) in a start-up.
There hadn’t been a lot of news out of the company over the past six months. The most significant announcement being that the company has arranged for an “advisory board”:
I would imagine the company spent these months looking at a variety of opportunities as there is currently no shortage of projects in need of capital in the energy patch.
The key is waiting for the right project.
At the end of March Outrider announced its first proposed transaction:
OUTRIDER ENERGY CORP. SIGNS LETTER OF INTENT FOR FARM-IN OF PINEDALE FIELD WELL LOCATIONS IN WYOMING
March 26, 2014
VANCOUVER, BRITISH COLUMBIA -- Outrider Energy Corp. (CSE:MCF) ("Outrider" or the "Company") is pleased to announce that it has entered into a non-binding letter of intent (the "LOI") with Pinedale Energy Inc. ("Pinedale"). Pursuant to the LOI, the Company proposes to farm-in to Pinedale's interest (18.75% - 21.25% working interest) in certain non-operated oil, gas and other mineral leases in Pinedale Field, Sublette County, Wyoming (the "Leases"). Under the terms of the LOI, the Company will farm-in to the Leases on a well-by-well basis, up to a maximum of 15 wells in exchange for the granting of certain overriding royalty interests to Pinedale and assuming Pinedale's working interest obligations in respect of the wells and Leases. Outrider will grant to Pinedale an overriding royalty interest pre-payout (1.875% - 2.125%) increasing to 9.375% - 10.625% after payout in consideration for the option to farming (no cash to be paid or shares to be issued). The royalty interest will be free of the costs of production.
"This LOI provides Outrider with an excellent opportunity to participate in a legacy gas field on a well by well basis," commented David Doherty, President and CEO, "We look forward to finalizing the definitive agreements and working to complete this transaction."
The farm-in is subject to, amongst other things, completing due diligence and entering into a definitive farmout or participation agreement. Pinedale is a related party as that term is defined in Multilateral Instrument 61-101. The completion of the transaction will be subject to compliance with that instrument and the policies and requirements of the Canadian Securities Exchange.
The deal is a bit complicated but breaks down as follows:
- Private company Pinedale Energy has a non-operated working interest in the Pinedale Field in Wyoming
- Outrider is going to farm-in on Pinedale’s interest on up to 15 wells on this property
- For this right Outrider will grant Pinedale an overriding interest of 1.875% to 2.125% prior to payout (capital invested recovered) and 9.375% to 10.625% after payout
Outrider is not out of pocket any cash for the rights to farm-in rights on 15 wells.
In case you hadn’t heard of it before the Pinedale Field is a big one.
The Pinedale Field produces 1.5 billion cubic feet per day. To put that in perspective Canada which is the fifth largest natural gas producer in the world produces 14 billion cubic feet per day.
This is an established, world class natural gas field.
What is very interesting is that the largest operator in the field and the operator of these 15 wells that Outrider can farm in on is Ultra Petroleum.
Ultra Petroleum being the company that Brad Windt was a founder of years ago. His connection to Ultra clearly has clearly been an advantage that most micro-caps would not have.
A few characteristics of the Pinedale farm-in that interested parties should be aware of would include:
- Production is 95% natural gas weighted
- This is an extremely low cost play with Outrider’s finding and development costs expected to be only $1.59
- At current natural gas prices the return on investment for Outrider participating in these wells is expected to be 25%
- All drilling in the area has had 100% rates of success
Outrider has basically secured for shareholders a free call on natural gas prices. What I mean is that Outrider doesn’t have to drill any wells. Outrider has the option on a well by well basis to participate in up to 15 wells.
At current natural gas prices that is reasonably appealing. At higher natural gas prices it is even more appealing. And if natural gas prices fall, Outrider can simply walk away and look for something else to do.
This isn’t a homerun transaction for Outrider by any means, but I think it is a very low risk opportunity.
You have a very low cost property with very predictable wells, run by a very experienced operator with which key Outrider people are very familiar and a deal that Outrider can walk away from if natural gas prices drop.
Outrider Energy – Let’s Be Clear About What We Have Here
We can now see what Outrider’s first deal is going to be. I expect it will be the first of many.
As an investor if you are buying shares of Outrider today you aren’t making a bet on the value of an asset or future cash flows, you are making a bet on management. This company does not yet have cash flow or booked reserves.
Outrider is going to use the connections that its management and advisory group have to find attractive deals and take advantage of the fact that they are an experienced group fishing in the inefficient micro-cap world.
This is an opportunity to get in on the ground floor with this team as they try and create a lot of wealth for themselves and shareholders.
I obviously like these types of opportunities but I think I need to stress that there is much more risk involved in buying a company like this than there is in buying a larger company with predictable cash flows.
The Outrider team has laid out for us the types of acquisitions that they are looking to do:
Considering that we are coming out of a multi-year depressed market for natural gas prices I think that hunting for opportunity amongst small dry natural gas properties is a very good idea.
There are all kinds of natural gas producers with strained balanced sheets that are desperate for capital. This is the kind of area where you want to be a buyer because there are loads of distressed sellers.
Outrider Energy – Directors
BOARD OF DIRECTORS
President & CEO
Mr. Doherty is founder and president of Inform Capital Corp., offering merchant banking and corporate advisory services to a number of companies across many sectors. Prior to joining, he was an investment adviser with Canaccord Capital, Canada's largest independent securities dealer covering the North American capital markets specializing in developing, restructuring and financing venture and natural resource companies. Mr. Doherty holds a Bachelor of Arts degree from Simon Fraser University, with a major in finance. Mr. Doherty is a director of Cuoro Resources and Saber Capital Corp. and was a founding member of Dagilev Capital (now Astur Gold).
Donald A. Sharpe
Geophysicist, Formerly Suncor 1981 - 1994
Velvet Exploration - Sold to El Paso for $430MM
UNX Energy - Sold to HRT Petroleum (Brazil) for $780MM
Mr. Sharpe is a Professional Geophysicist with 30 years' experience in the oil and gas business. During that time, Mr. Sharpe has gained wide experience in exploration, production, marketing, finance and the management of public companies. He has been a founder and director of a number of successful oil and gas companies in Canada, the United States and Africa.
Mr. Sharpe received a Bachelor of Science in Geophysics from the University of British Columbia in 1981, a Certificate in Business Management from the University of Calgary in 1989 and graduated from the Banff School of Advanced Management in 1991. Mr. Sharpe is member of the Association of Professional Engineers and Geoscientists of Alberta and the Canadian Society of Exploration Geophysicists.
Petroleum Engineer, A&D acquisition consultant
Michael Arguijo --- Mr. Arguijo is a Petroleum Engineer with over 23 years of experience in the oil and gas business. During his career Mr. Arguijo has served as an officer in a number of independent oil and gas companies with focuses on operations, A&D, and asset management. He also has significant background in reserves estimation and consulting. Currently Mr. Arguijo acts as a consultant and advisor for a number of clients involved in operations, asset development, and acquisitions/divestitures.
Mr. Arguijo received a Bachelor of Science Degree in Petroleum Engineering from Texas A&M University in 1990. He is a member of the Society of Petroleum Engineers.
John Proust, CDir
CEO of New Zealand Energy & Canada Energy Partners
John Proust is the founder and principal shareholder of numerous public and private companies. He has successfully managed, directed and advised public and private companies regarding debt and equity financing, mergers and acquisitions, and corporate restructuring since 1986. Highly regarded in the industry for his management skills and attention to detail, he has held senior positions and served on the boards of numerous private and TSX Venture Exchange listed companies. He is currently Chairman, CEO and a director of Southern Arc Minerals, CEO and a director of New Zealand Energy Corp., Chairman and a director of Canada Energy Partners, and Chairman, Interim CEO and a director of Eagle Hill Exploration Corporation. Mr. Proust received the designation of Chartered Director (CDir) from McMaster University, Directors College, Michael G. DeGroote School of Business.
Mr. Barry Loughlin served as a Divisional Operations Manager of Masonite International Corporation from November 2008 to September 2010 and served as its Group Controller from May 2005 to November 2008. Mr. Loughlin has been a Self-Employed Consultant Financial and Accounting Advisory Services since March, 2011.
Outrider Energy – Final Thoughts
I’m going to conclude with reference to some wise words from Warren Buffett (Trades, Portfolio)’s partner Charlie Munger (Trades, Portfolio) on the subject of incentives and the results they create. I’ve never forgotten this from a speech Munger did at Harvard University in 1995:
I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.
One of my favorite cases about the power of incentives is the Federal Express case. The heart and soul of the integrity of the system is that all the packages have to be shifted rapidly in one central location each night. And the system has no integrity if the whole shift can’t be done fast.
And Federal Express had one hell of a time getting the thing to work. And they tried moral suasion, they tried everything in the world, and finally somebody got the happy thought that they were paying the night shift by the hour, and that maybe if they paid them by the shift, the system would work better. And lo and behold, that solution worked.
Nothing drives performance like having people properly incentivize to produce those results. That is why I like investing alongside these successful energy patch entrepreneurs.
Outrider’s main backer owns 42% of the company. He is involved for one reason, to increase the share price over time. That doesn’t guarantee success, but I like being invested alongside management motivated to drive share prices higher instead of management that is motivated by the collection of big paycheques.