If I come across a speech given by or an interview with Seth Klarman I read it. If I don’t learn something new I am reminded of something that I should have at the front of my mind every day. One concept that I learned from him is that no matter how much work you do you will always be investing with imperfect information. You can’t ever be certain that you know more than the market because you “don’t know what you don’t know.”
And you have to keep that concept front and center and avoid getting overconfident. It helps you keep your position sizing sensible and your money better protected from a permanent loss.
Today I was reminded of the importance of this concept through some news related to an oil and gas exploration company called Toreador Resources. I first heard of Toreador last summer when they presented at an oil and gas conference. Toreador’s story was one with a very large potential upside.
Toreador is a very small company (market under $300 million). They have about 9 million barrels of conventional oil reserves, but more importantly they have a huge position in the Paris Basin in France. Why is that interesting? Because Toreador and other companies would have you believe that the Paris Basin is the next Bakken shale play. A shale resource that prior to the last few years would not be economical, but now is thanks to horizontal drilling and multi-stage fracturing. And there is a lot more than just hype and hope on this one. Consider the following:
- It is estimated that there are 65 billion barrels of oil in place in the Paris Basin.
- Roughly 40 billion barrels are on Toreador’s acreage.
- Data on the shale rock is available from the drilling of over 200 conventional wells from prior decades (companies had long been drilling through the shale on their way to deeper targets).
- Toreador uncovered the data on the shale from old drilling logs and took it to 40 larger oil companies looking for a partner to help fund a drilling program. None of those companies disagreed with the conclusions Toreador had reached about the potential for shale oil.
- Toreador received a number of bids from prospective partners and selected Hess who has loads of experience in the Bakken, which is analagous to the Paris Basin shale.
- The Hess deal basically funds the drilling cost for the smaller Toreador
To give you an idea of how valuable this property could be, consider that Bakken acreage goes for up to $10,000 an acre. According to their last presentation Hess has 340,000 acres awarded, 60,000 acres pending and another 400,000 in application. If you just assume the 340,000 acres turn out to be as valuable as the Bakken, the potential land value is $10,000 x 340,000 = $3.4 billion. Compare that to the $270 million market cap, and it is clearly interesting. It is very high level, but it puts the size of this in perspective against the size of the company.
When I first looked at Toreador, the stock price was $6.50. As the story started getting out and information from various sources (Vermillion Energy production in the play) helped give the play more credibility, the stock price took off, exceeding $15.
I never bought any shares in the company but know people who did. Their research gave them comfort that this promising big play was for real. I didn’t buy because I was concerned that if the play failed there was little downside support from other assets for Toreador’s share price. My point is that the risk we all focused on was the geology of the play. What we didn’t know or consider was that the bigger risk was political in nature.
On February 3, 2011, the French Government issued a moratorium on shale gas drilling to study the environmental impact of shale gas drilling. The share price suffered. Today it suffered more after this came out:
http://naturalgasforeurope.com/french-shales-starting-scratch.htm
“French Prime Minister Francois Fillon said that permits granted to explore potential shale gas fields in France must be canceled and that the whole issue must be reviewed from the start.
The government announced the cancellation of “permissions already given” in projects of exploration of gas shale with current technologies (i.e., 'hydraulic fracturing’) heavily criticized by environmentalists, without wanting to close the door to future exploitation of these deposits but with new techniques.
Speaking at the National Assembly today, Fillon said: “We need to start from zero, authorizations must be scraped."
Recognizing “legitimate concerns,” the French Prime Minister told the elected officials: “Permissions that were given were in terms that are not satisfactory. There has not been enough consultation … not enough information, I take responsibility as my chief of government.”
“We need everything again from scratch, so we must cancel the authorizations that have already been given,” added Fillon.
Exploration licenses were granted at the time of the former Minister of Ecology Jean-Louis Borloo for shale gas in southern France in the spring of 2010 and the oil shale in the Paris basin in 2008 and 2009.
Refuting the charges of trying to “sacrifice the environment,” the Prime Minister stressed that, “There is no question of closing the door to technological advances that allow future access to new energy resources.”
"A scientific research mission on the possibilities of exploiting these deposits with other technologies has been extended," he added.
The French parliament is due to debate motions on May 10, calling for permits to be revoked and all exploration to be banned in France.”
It is hard to imagine, as an investor I could last summer have had 100% knowledge and certainty that this shale play works, made a huge bet on the stock and now be left today with the possibility that all of this acreage could be virtually worthless. I never would have considered the potential at that time for a full stoppage of shale exploration. Keeping Klarman’s advice in mind would have kept my position size reasonable even though I would have thought I had perfect information.
Where does that leave Toreador as an investment opportunity today? I would be interested if the share price falls to the point where it basically only values the small conventional assets of the company and gives you a free option on the shale play. It isn’t quite there yet, and since I have no way to figure out how the government action will play out I’d prefer to just stay away.
