How to pick stocks in Alberta’s junior oil and gas biz

Step one: avoid market "chameleons" and, on rare occasions only, trust your gut

November 04, 2011

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Horse Race
Illustration by Dushan Milic

Keith Schaefer knows how to raise money. Before founding Oil and Gas Investments Bulletin, a subscription-based newsletter about oil and gas juniors, Schaefer worked for 20 years in the mining sector, helping public companies raise exploration capital. Now, on the other side of the fence, he spends his days reading charts and analyst reports in order to decide which, among the hundreds of juniors, he’s willing to throw money at. Schaefer prides himself on his plain-language approach, characterizing the current investing climate as “a little crazy.” “There are so many juniors right now, so many management teams and so much money being poured into this sector.”

Indeed, it’s an optimistic time in the oil patch. While oil prices have dropped from their lofty peaks of last spring, they are much higher than they were during the economic dog days of 2008 and 2009. Horizontal drilling has been hailed as a revolution, and the resulting shale game has energized a junior sector still reeling from the credit crisis. Though the global economy remains wobbly, experts say exploration for and production of unconventional oil and gas will be a boon to juniors and, it follows, to brokers and any investors with an appetite for risk.

Even post-recession, Alberta’s junior sector is still one of the biggest and most vibrant in the world, thanks to an open investment climate and a long entrepreneurial tradition within the industry. Juniors, known to be scrappy and innovative, are often the ones taking risks and making technological leaps. According to the Small Explorers and Producers Association of Canada (SEPAC), there are roughly 1,500 junior companies in Alberta. Of those, 500 to 600 are active operators, ranging from smaller startups to publicly traded 40,000 barrel of oil equivalent (boe) per day producers.

In the wake of the market crash and the enduring slump in natural gas prices, many of the smaller shallow-gas juniors have been decimated. The surviving companies, ones that dealt in more cost-effective or more diversified deposits, are now targeting oil or natural gas liquids, which the market is favoring. According to Gary Leach, executive director of SEPAC, there are now fewer active junior operators. They have also become larger – increasingly consolidating with other companies to boost their clout and better withstand the capital risk of the new shale game. “A junior used to be able to start out with around $3-5 million,” Schaefer says. “Now they need $50 million to go after any of these shale plays, because it’s $4-6 million per well.”

With juniors hungry for capital and investors eager to buy – recent worries about the economy aside – the oil patch is abuzz. But with a multitude of companies and newly accessible plays out there, how can investors recognize a solid venture from a shaky one? Schaefer’s advice for those with a stomach for the high-risk – and potentially high-rewards – juniors’ game? Be fussy. “There are a lot of buses on the road, so if a company doesn’t look great, pass because there’s going to be another bus coming along.” But more importantly, he says, “wealth is vigilance,” so do your homework.

“The most important thing is the management team, pure and simple,” says Fabrice Taylor, an investing columnist at Alberta Venture, the Globe and Mail, and co-founder of its newly launched President’s Club Investment Newsletter. “Do they have a good reputation, have they made money for investors before, and do they have the right skill set?” In this business, a junior company can command a premium simply if it is steered by people who have previously built and sold a company.

Angle Energy Inc. – a profitable junior chasing light oil and liquids-rich natural gas plays and producing roughly 15,000 boe per day – launched seven years ago as a blind pool. Because president and COO Heather Christie-Burns and CEO Gregg Fischbuch came out of the successful Bear Creek Energy team, investors were confident enough to give them $15-million right off the bat. “We didn’t begin with any assets,” says Christie-Burns. “But we had a past record demonstrating success, and that was a big reason we got that initial support.”

When reading up on a company’s profile, Schaefer warns the inexperienced investor about reading too much into sometimes misleading management profiles. “Investment bankers and brokers are very good at dressing these things up,” he says. “They might take different snippets of management and say that they worked here and there, and that there were all these successful deals, when maybe they weren’t really part of the team. So you’ve got to know the right questions to ask.”

Another crucial indicator of a good management team is its ability to finance, which, says Taylor, means being a good promoter. “You can be a great petroleum engineer and yet be a crappy financer,” he says. “And if you can’t finance, you’re dead.” As someone who writes on good investments for a living, Taylor is called regularly by companies hoping to be profiled. But if they can’t make a case for themselves, Taylor asks, how can he possibly make a case for them? “You’ve got to be able to tell a story and get it out there. If the guy has no energy and sits there looking at his feet and twiddling his thumbs, he’s not going to get my attention,” he says. “But if he’s engaged, vivacious and his body language is good, he’s a seller.”

The best way to judge a company’s selling savvy is by checking out its financial backers – or “strong hands” as Taylor calls them. “Do they have big names that have capital and who understand the business?” A quick browse on a company’s website will often reveal other useful information, like how many analysts are covering the company. “Once you have success, analysts will follow you,” Schaefer says. “If they have a lot of coverage, that’s a good sign.”

But the true-blue indicator of a promising venture, according to Taylor, is how much a company believes in its own play. “I want to know how much a management team has invested in the game,” he says. “How much stock do they own – not options – but stock? You’ll never know more than the CEO or the insiders.” Taylor recommends picking up the phone and talking to CEOs and presidents, who are more accessible and enthusiastic than C-Suite executives working for the bigger players. “These smaller companies are somewhat happy to speak with investors because they’re always trying to raise money.”

 

Knowing how to raise capital is one thing, but a viable company must also know how to handle its money – how to stretch it in lean times and avoid excessive debt. “In the resource business, money tends to get borrowed when times are great, and then it tends to kill you when times are bad,” says Taylor, citing Compton Petroleum, a once-promising natural gas producer that recently fell into a sizeable debt hole after gas prices tanked. “When gas goes from $10 to $4 [per thousand cubic feet], and you’re paying eight per cent interest on a $100-million loan, suddenly you can’t make payments anymore,” Taylor says. “And the shareholders are the first to get wiped out.”

Staying clear of debt, though difficult in a turbulent market climate, is indicative of a company that spends money in the right places at the right time. In 2008, just before the markets crashed, Angle Energy applied to go public. “We were the last IPO (initial public offering) for a long time,” recalls Christie-Burns. “So during that time, we did a lot of planning and re-gearing and keeping our budgets intact.” But also, she adds, they kept an eye out for good buys. “Purchasing good assets in a weak environment is always good to do,” she says. “It’s difficult to convince yourself to do, but these investments will always pay out within a few years.”

It was the same for Bonterra Energy Corp, a dividend-paying natural gas and light oil-focused company producing around 6,000 boe per day. Also backed by a reputable management team, Bonterra is cashing in on a block of land it picked up 15 years ago in Alberta’s Cardium formation. “We took a chance on a lot of land at a low price,” says Bonterra CEO George Fink. “We knew that the field has been in existence since the 1950s, but only 17 per cent of the original oil had been recovered.” Now, with the perfecting and convergence of horizontal drilling and multi-stage fracturing, Bonterra is confident about its long-term growth prospects.

Heather Christie-Burns
Heather Christie-Burns, president and COO, Angle Energy Inc.
Photograph by John Gaucher

As much as a solid investment relies on solid management, it also depends heavily on the quality of a company’s discoveries and land positions. When considering his own investments, Keith Schaefer bears in mind a junior’s drilling ratio, preferring more oil to gas, wet gas to dry gas, and domestic plays over international. For Fabrice Taylor, overseas production is a red flag. “Anything foreign is very risky,” he says. “People have made a lot of money on companies exploring abroad, but they’ve also lost a lot of money. They often have better drill results, but the reason they’re better is because they haven’t been drilled very much, and the reason they haven’t been drilled much is because they don’t have stable governments.”

Taylor also cautions against chameleon-like firms that are constantly chasing the “flavor of the day,” moving from oil to gas, back to oil and then to natural gas liquids. “Because they’re following everyone all the time, they’re going to get there late, when everything’s been picked over,” he says. “This is what I call a lifestyle company – it exists to finance the lifestyle of the CEO.” Bonterra’s George Fink says a management team must be mindful of its behaviour and how it might appear to outside investors. “Fairness to shareholders is important,” he says. “If you’re not making any profit or you’ve lost a lot of money, you shouldn’t be paying out large bonuses. Shareholders don’t like that.”

As in real estate, the same “location, location, location” adage applies when scrutinizing junior plays. “You want to have a large land position around a discovery that can support many wells,” Schaefer says, adding that more is generally better, especially in any of the hopping shale formations like the Alberta Bakken, Montney and Cardium. Take, for example, Angle Energy, an industry darling that has secured long-term growth in the promising Viking, Cardium and Harmattan plays, the latter of which is known to hold valuable liquids-rich gas that provides an additional revenue stream for cash-strapped juniors. But as those attractive land packages quickly get snapped up, many juniors must take to the fringes, testing the boundaries of known plays, which can make for a riskier investment.

It’s why investors should also consider what’s around a company’s play, along with what lies beneath. “If you’re next door to somebody who just hit pay dirt, then the odds are better that you will, too,” Taylor says. (But again, he warns, overly promotional companies might overstate such claims.) Infrastructure is also an important consideration. “Is there power, are there pipelines to tie into, are there roads, is there gravel?” asks Taylor. If not, it’s likely better left to the bigger companies to develop.

 

An experienced investor will tell you there is no infallible system when it comes to sniffing out winning ventures. Markets crash, promising wells can disappoint, new technologies can fail, and there will always be bad luck. PetroBakken Energy and Resources Ltd., a major light-oil producer, is a case in point. It had all the makings of a solid investment: a good land position in the Cardium, strong production of up to 40,000 boe per day, and it was paying out dividends. But earlier this year its stock plunged. An unstable energy market combined with lousy fourth-quarter drilling results sent investors running scared. Despite the disappointing and, some say, over-promoted deposits, Schaefer is quick to defend the firm. “All these guys are well-meaning and they believe in their plays,” he says. “But this is high-risk money, and investors have to understand that.”

Taking risks, after all, is the name of the investor’s game. And seasoned ones, like Schaefer, sometimes go with their gut, perhaps weighing more heavily on a promising land position over, say, the track record of its management team. A year-and-a-half ago, that’s exactly what Schaefer did when he invested in Torquay Oil Corp. According to Schaefer, the team was unproven, but he had confidence in the company’s Bakken land package. “They have a big enough land position that if it works, I’m going to make a lot of money,” he says. “If it doesn’t, I’ll lose it all.” Results so far have been mixed, and the stock is trading at what he paid for it, even 18 months later. But he remains hopeful. “You’re taking a risk that the management team can grow into their job and the property will pay off.”

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