The Energy Report: With all the excitement over unconventional oil and gas resources these days, why are you focused on conventional exploration and production companies?
Randall Abramson: Being contrarian, when everybody's focused on one area, we tend to focus on the other. Our largest weighting at the moment in our All-Cap portfolios is Manitok Energy Inc. (MEI:TSX). I picked up the phone one day and somebody recommended that we look at it. The majors in Alberta were all leaving for unconventional plays, and they left behind a perfectly good conventional play for a junior to come in and pick up!
What happened was a bunch of Talisman Energy Inc. (TLM:TSX) employees had been drilling for deep gas wells in the Alberta foothills, and were bypassing perfectly good oil zones when they were looking for deep gas. That was what they were charged with in their Talisman days. Then, when gas prices declined materially in the debacle of '08–'09, and the majors left, suddenly land prices dropped back to 1998 levels. That created an opportunity for this team of former Talisman employees to swoop in, gather up a bunch of cheap land and go after the oil they knew was there, because they saw it when they were drilling for gas in the good old days. That's what created this conventional opportunity.
TER: How does a junior company like Manitok Energy compete in an industry dominated by oil and gas majors?
RA: Competition is somewhat irrelevant. Once you have land to exploit, it's under a lease for a certain amount of time, and as long as you're producing, that land is typically yours to keep until you sell it or move on. From that perspective, I'm not sure competition is relevant. In fact, big competition, as in the case of Talisman, was actually the source of Manitok's opportunity.
Manitok has a second big opportunity for growth in an area called Entice, with a lease it acquired from Encana Corp. (ECA:TSX; ECA:NYSE). Encana has been mostly a gas company since it spun off Cenovus Energy Inc. (CVE:TSX; CVE:NYSE). It isn't really interested in oil wells that can produce between 100 and 300 barrels a day (100–300 bbl/d). The Entice area was a case where the major had this asset for the longest time—since the 1800s—and wasn't interested in it because it was smaller. Encana did little drilling for oil in this vast area over the years, though the adjacent areas have produced more than 200 million (200M) cumulative barrels of oil. Again, the competition is creating an opportunity for Manitok.
On the other hand, another company that we own, Corridor Resources Inc. (CDH:TSX), needs majors to participate, because it's a junior that has stumbled into significant assets and it can't pull them off on its own. Sometimes you're at the whim of the majors, and sometimes you're lucky because you get the smaller items they overlook when they're out elephant hunting.
TER: Why is the market responding strangely to developments at Manitok?
RA: Oil and gas companies quite often are viewed as homogeneous. Investors think, "If I'm not investing in Manitok, I can invest in 'Shmanitok.'" I think today's analyst community is used to the unconventional play, and they like it because it's cookie-cutter. They can see the rate of return more easily; it's easier to quantify, to spreadsheet. Also, when something goes slightly awry or there's a bit of noise, that tends to depress some oil and gas companies, because investors, seeing them as homogeneous, think, "I may as well go play the next one."
Manitok had a few things go against them, which weakened sentiment toward the company. First, it had a pretty significant equity financing in the fall that satisfied a lot of demand for the shares. Then it had some disappointing well results in a noncore area. On top of that, the COO left the company and he was reasonably highly regarded as a geologist and driller. I think that created a lot of questions in people's minds about why he left. It also created a couple of camps, because some people were behind him as well. The new COO is an operator with much more experience in bringing production on stream, having grown his previous company from 3,000 bbl/d to 30,000 bbl/d. We believe management is much stronger now.
The acquisition of the Entice area from Encana also created some uncertainty about the direction of the company, because before that Manitok was focused solely on its Stolberg area. All of a sudden, this new area was introduced that people didn't know much about. There was also some downward guidance in Q3/13 because the company wasn't pulling fast enough on production. Even though Manitok announced it was back on track in Q3/13, sometimes the market shoots first and asks questions later, and selling begets further selling.
A number of things have temporarily kept a lid on the stock. As positive results keep coming out, both from Stolberg and the Entice area, Manitok should look very different as people get more comfortable. Recent positive indications from the initial five wells at Entice give us even more confidence in this area, where there's potential for more than 50 new pools of oil. Between Stolberg and Entice, the company should have a sizable drilling inventory for years to come.
TER: What is your recommendation and your target for Manitok?
RA: Our target today is $4.50. Our target valuation by year-end is $6. We would look for something closer to an $8 mark over the next three years. The stock is around the $2.20 mark today. The reserve-based NAV, including land, was around $3.80 at the end of March. That $3.80 would include zero value beyond land value for the new Entice area, and understates the value of Stolberg.
The going rate on the market today for Manitok's peers is about $68,000 per flowing barrel ($68,000/bbl), and somewhat higher if you look at what private market transactions have brought. You can use those metrics quite easily on the barrels Manitok is producing today. Manitok's exit guidance for 2014 is more than 7,000 bbl (7 Mbbl). You can easily see value of more than $6/share. Manitok, in our view, is a rare opportunity. The company has a rapid growth rate, industry-leading well results, high internal rates of return (IRRs), high netbacks, only a modicum of debt and plenty of room for further growth, yet it trades at a large discount to its fair value—in fact, bizarrely, it's the cheapest of its peers.
TER: Northern Tier Energy LP (NTI:NYSE) is an independent, downstream, energy master limited partnership (MLP) with refining, retail and pipeline operations that serve the Petroleum Administrative for Defense District (PADD) 2 region of the United States. What's your recommendation for Northern Tier?
RA: I think Northern Tier is getting closer to fair value. There is still probably 10% or 15% upside there, particularly if its large owner, Western Refining Inc. (WNR:NYSE), which owns close to 39% of the company, decides it wants to have the rest of the company for itself, to unlock significant value. This transaction could diversify Western Refining by geography, end-markets and feedstock, and allow a cash-flow boost in Western Refining's own MLP by adding Northern Tier's significant assets in retail, pipeline and storage facilities.
TER: How does the cyclical nature of the refining industry affect Northern Tier's earnings?
RA: I think Northern Tier is a bit of a standout. There is a shortage of refinery capacity within the U.S., which makes the refining industry less cyclical than it used to be. And Northern Tier should be even less cyclical than the group because there's a more pronounced supply/demand issue in its region. The company should also have better margins: It gets a Bakken feed of light oil, and at the same time there's a significant shortage in its Minnesota backyard, which allows it to get a better margin when it sells the refined product. Northern Tier also has some vertical integration because of its ownership of the retail downstream.
TER: Corridor Resources Inc.'s share price is up more than 300% over the last year. What's driving that?
RA: One of the key ingredients is that natural gas prices themselves have been rocketing up to where they sit today, just shy of the $5 per thousand cubic feet ($5/Mcf) range from as low as $2-and-change a year ago. That's attributable to storage inventory dropping as the number of gas rigs has plummeted, and to the fact that we had a disgusting winter. Demand has also been up because there has been switching from coal to gas for economic reasons, although, bizarrely, it's been going slightly back in the other direction recently because of the change in prices. But the carbon footprint issues have put upward pressure on the natural gas price.
At the same time, what's really helped Corridor, specifically on the gas price front, is the higher gas price in its specific market, which is the U.S. Northeast, as it sells into the New England area. There's been a tremendous shortage there. Gas refineries and natural gas plants were lying idle on the coldest days of the year simply because they couldn't get enough product.
There isn't enough pipeline capacity coming into New England right now. Corridor ships its gas through the Maritime Northeast Pipeline into New England. It has already locked in US$11/Mcf for a good part of next winter. That's been a huge change for Corridor, to be able to lock in those prices and to start capital spending again in a significant way both at its McCully Field, which is its main field, and its Frederick Brook shale field.
Corridor also took on partners for exploration and production on Anticosti Island in the Gulf of St. Lawrence: the Québec government and Maurel & Prom (MAU:EPA), out of France. Corridor has about 22% of the Anticosti play. The partners will put in the money to drill on that property over the next couple of years. We think anticipation of that event and the event itself have helped propel the share price. Anticosti Island is a shale oil project similar to what we've seen in the Utica Shale. It still requires some work to assess the viability of the project, but on the holes that the company has looked into thus far, the core samples look exactly the same as what we've seen in the Utica. Corridor should be drilling and doing more work through the rest of 2014 and 2015 to determine flow rates.
Corridor has two other properties, one called Old Harry, offshore Newfoundland and Québec, and Frederick Brook, the shale property. Those two fields need partners because they require tens, if not hundreds, of millions of spending to bring them to fruition. But they are massive projects.
What's amazing about Corridor is that it's still trading, in our opinion, below the breakup liquidation value of the company. If you took the land value, the value of existing production and the value of its compression gas plant, and sold those off, you'd probably get more than the share price today. Because that's not going to happen, we still believe that we're getting those megaprojects for free. The company has no debt and about $35 million ($35M) in cash on hand.
TER: Corridor has one producing property in New Brunswick. Is that shale gas or conventional gas?
RA: Most of it is conventional, but there is a little shale gas on the Hiram Brook zone, which is on the company's McCully property. Underneath the Hiram Brook zone, Corridor has discovered a zone called the Frederick Brook, and it's one of the most prolific shales in North America. It's more than 1,000 meters thick.
The problem for Corridor has been that it requires $100M–150M to begin developing it, and the company needs a partner to pull that off properly. Repsol-YPF S.A. (REPYY:OTCPK) has an LNG import facility nearby that it has been talking about converting into an import/export facility. That would create instant demand for Corridor and others' gas in the region, not just to sell into the Maritimes and into the Northeast of the U.S., but also to Europe and elsewhere. That can be done at a much lower cost than what we're seeing with export facilities in Louisiana or on the coast of British Columbia.
TER: Are the protests against fracking in New Brunswick threatening Corridor's operation?
RA: I don't think they've had an impact on Corridor because Corridor operates away from metropolitan areas. The protesting has led to more stringent regulations. That's a positive. To think that we're not going to have fracking at all is somewhat ridiculous because, again, circling back to conventional versus unconventional, this isn't the Beverly Hillbillies anymore, where the oil gurgles up to the surface. (Although, with Manitok, that's exactly what's been happening with its conventional rarity.) With Corridor, its rock has to get fracked. That's the case with most unconventional formations, which means most of the formations and reservoirs that exist today. Fracking is just reality.
TER: What's happening with Orca Exploration Group Inc. (ORC-A:TSX.V; ORC-B:TSX.V)?
RA: Orca is extremely neglected. I think there might be two analysts who follow the company. The company is domiciled in Tanzania. That puts it out of sight, out of mind. And the company has struggled with a number of issues.
Orca was supposed to have a pipeline built in the country to allow higher deliverability of its own gas, as its gas fires more than 50% of the power in the whole country of Tanzania. That pipeline was delayed and delayed, and finally broke ground in fall of last year. The pipeline is now more than 70% complete, and is scheduled to be commissioned this time next year. But the government of Tanzania has been in shambles. It has not been paying its own bills, which means TANESCO, which is the national utility of the country, has been behind in paying Orca and others who supply it. But Orca has received some money back.
The World Bank has now entered to help the country. Tanzania got a second tranche recently of about $100M, so Orca should see its share of that over the next month or so. There should be further dollars to come. As we see it, everything's actually improving now. The government has established a very capitalistic national energy policy. It's talking about having completely liberalized markets by the end of this year. There is an election at the end of next year. If this power situation isn't sorted out—because Tanzania has been dealing with significant brownouts for years now—I think the government is going to struggle to get reelected.
I think a lot of market participants want to see everything looking rosy before they participate. Meanwhile, the company has more than $1 per share of cash on hand at the moment and another $1 per share of working capital above that. You're essentially getting the rest of the business for free. The rest of the business has approximately $12 net present value using a 10% discount rate from the third-party engineer reserve value. There's arguably $14 of value and a $2.30 share price. There's no debt.
TER: What are some other companies you're excited about?
RA: We like Legacy Oil + Gas Inc. (LEG:TSX). It's a mid-cap company with just over a billion dollars ($1B) of market value in the Saskatchewan/Dakota area. It's an unconventional play and has essentially batted 1.000 on its drilling. I think last year it went 99% because it missed one, but in the most recent quarter it hit them all.
What we like about Legacy is its high netbacks. It's virtually all light oil, with a high IRR. It trades at about a 20% discount to its asset value. We see that changing over the next 6–12 months as the company makes accretive acquisitions or gets the balance sheet more in line with what the market would like to see. In the meantime, Legacy is growing its fair value. This is not a small company. This is a company that has forecast an exit rate of about 24 Mbbl/d production for this year.
TER: Any parting thoughts for the investor with money to spend?
RA: Oil prices obviously go up and down because oil is a commodity. But oil is not iron ore, it's not copper and it's not nickel. Those other commodities are much more cyclical in nature. Demand for oil rarely goes negative, like copper or nickel or iron ore would. I think that allows oil and gas companies to look more like any other company.
I think we're in a sweet spot right now. We've got ever-rising demand. If you look at the non-OECD nations, there's substantial growth in demand. And demand is greater than supply. Storage inventories are dropping way below the five-year average, which means that consumption is rising faster than production. That means the prices for products that the Orcas and the Corridors and the Manitoks of the world sell are likely going higher over time. If you've got a company with terrific production growth, a decent balance sheet and a high IRR—and the price of what it's selling is going up at the same time—that's a pretty good recipe for success, especially if it's already undervalued even at $85/bbl oil, like a Manitok and a Legacy.
TER: Thank you very much for your thoughts.
RA: My pleasure.
Randall Abramson, CFA, is CEO and Portfolio Manager of Trapeze Asset Management Inc., a firm he cofounded in 1999 shortly after founding its affiliate broker dealer, Trapeze Capital Corp. Abramson was named one of Canada's 'Stock Market Superstars' in Bob Thompson's Stock Market Superstars: Secrets of Canada's Top Stock Pickers (Insomniac Press, 2008). Trapeze's separately managed accounts are long/short or long only, and have either an all-cap orientation or large cap-only mandate via the company's Global Insight model. Abramson graduated with a bachelor's degree in commerce from the University of Toronto in 1989, and his career has spanned investment banking, investment analysis and portfolio management.
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1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Manitok Energy Inc., Orca Exploration Group Inc. Streetwise Reports does not accept stock in exchange for its services.
3) Randall Abramson: I own, or my family owns, shares of the following companies mentioned in this interview: Manitok Energy Inc., Corridor Resources Inc., Orca Exploration Group Inc., Northern Tier Energy Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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