I spend a lot of time looking for value in energy companies. I certainly am more interest in oil weighted producers as I believe we are going to need every bit of oil we can find in the coming decade.
With respect to oil, the battle between supply and demand is one where both sides are pointing to tightness in the market in years ahead.
Our supply has peaked. Not the pure amount of oil, but rather the daily rate at which we can pull it out of the ground. Currently we rely on several enormous oil fields which flow at prodigious rates. Year after year the amount they produce declines. We just don’t find oil fields of that size these days, and therefore it is very tough to add production just to offset the declines, never mind grow production significantly.
And the demand equation is even more obvious. With 2.4 billion people in China and India where car sales are going up 30% to 50% year on year oil demand is leaping forward. China isn’t running around the world locking up oil supplies every month without good reason.
Sometimes in the search for value I’ll find opportunities where it is surprisingly easy to see assets priced at a large discount to their market value. Epsilon Energy seems like such an opportunity.
The company owns a variety of assets, but it is one property in the Marcellus Shale that we need to focus on.
In January 2010 Chesapeake Energy acquired 50% of Epsilon’s Marcellus shale holdings for $200 million. The payment is through Chesapeake carrying Epsilon’s share of the drilling program. So why is this interesting ?
Well, if Chesapeake paid $200 million for half of the acreage, that implies the acreage that Epsilon still holds is worth $200 million.
Value of Marcellus Holdings - $200 million
Epsilon Shares Outstanding – 50 million
Value per share - $4
Current Epsilon share price is $2.60
Pretty simple really isn’t it. There is 50% upside just from that one asset that we can verify through an arm’s length transaction from this year.
The rest of the value is as follows although the vast majority relates to the Chesapeake JV property:
Marcellus Shale New York (at $2,000 per acre) - $30mil = $0.60
Bakken Shale Saskatchewan (at $2,400 per acre) - $40mil = $0.80
Utica Shale Quebec (at $100 per acre) - $20mil = $0.40
Cash and other - $25mil = $0.50
Total Value = $315mil or $6.30 per share
As I wrote, I think the undervaluation is quite obvious. The important part for me being the Chesapeake transaction. Chesapeake has a lot of acreage in the Marcellus, so if they are adding something this small in 2010 it has to be in the sweet spot.
Important to note of course that the Marcellus is a natural gas property and not oil. But it is likely the most profitable shale play in the States.
I haven’t bought any shares in Epsilon at this point, but am watching and thinking about it.
