West Coast LNG will drive deals and asset swaps: Nuttall
Pressure pumpers, large landholders close to West Coast provide investment opportunity
Canadian West Coast liquefied natural gas (LNG) is set to revolutionize the Canadian domestic natural gas market, and will likely become one of the most significant energy investment themes in the coming years. However, investors at large are ignoring this opportunity because the commonly held view is that it will take at least another five years for LNG exports to have any impact on domestic natural gas pricing. Interestingly though, the most significant investment opportunities that arise from West Coast LNG are of a much shorter time frame − service sector tightness and reserve/resource acquisition potential.
But first, a bit of background on the Canadian West Coast LNG picture. Officially, there are three major consortiums who have expressed an interest in building 4.2 billion cubic feet per day (bcf/d) of liquefaction by 2017 on British Columbia’s West Coast – notably the port of Kitimat. They include: Apache Canada Ltd/EOG Resources Canada Inc./Encana Corp. (1.4 bcf/d), Shell/Kogas/CNPC/Mitsubishi (1.8 bcf/d initially), and Petronas/Progress Energy Resources Corp. (one bcf/d initially).
Given that Western Canada only produces 14.3 bcf/d of natural gas, this is not an insignificant number. However, the Bay Street chatter is that by 2020 there could be interest for as much as 7.5 bcf/d in liquefication capacity, which is truly staggering. But the catch in this LNG gold rush is that in order to qualify for project financing, companies must have approximately 20 years of dedicated proved and probable reserves booked ahead of the final investment decision, which occurs approximately three years before first gas.
Focusing on the 4.2 bcf/d of intended capacity, the three groups collectively would need to have 35.2 trillion cubic feet (tcf) of booked reserves by 2014 (Canada’s current reserves are around 61 tcf). Excluding what each company already has booked in the area, this means that approximately 470 wells in the Montney tight gas play or 156 wells in the Horn River basin would have to be drilled a year over a three-year period to accomplish this feat. (This assumes four offset wells in reserve bookings).
That’s quite a bit of drilling activity. And for the pressure pumpers used to fracture the reservoir in these plays, the above number of wells would require around 280,000 of annual horsepower to pull off. Compare this to a 2012 year-end estimate of 1.8 million horsepower and Montney/Horn River drilling alone could soak up almost 16 per cent of Canada’s entire hydraulic fracturing capacity by the end of 2012. Of course, this ignores the already very strong demand that is stemming from a high oil price and continued drilling in liquids-rich gas plays.
Given the terrible stock performance of Canadian pressure pumpers, the coming demand appears to be largely misunderstood by the market. This reality provides investors with an appealing opportunity. When fears of overbuilding of capacity diminish, the stocks should react accordingly.
When one reflects on the scale of the required drilling, it appears unlikely that the three groups will solely be able to drill their way to the 35.2 tcf of required reserves. This then leads to the second investment opportunity − firms that have already captured reserves/resource close to Kitimat and would provide both immediate reserve accretion and longer term resource feedstock for an acquirer.
That makes a take-out of at least one company in 2012 very likely, with names such as Progress Energy, Painted Pony Petroleum, Canadian Spirit Resources Inc., Canbriam Energy Inc., Advantage Oil & Gas, and Birchcliff Energy Ltd. all being reasonable targets. Asset swaps could also be likely, such as Crew Energy Inc. swapping its Kobes acreage in the Montney play to Shell for an oil-prone property. Recent acquisition metrics have been approximately $0.20 per thousand cubic feet (mcf) of resource potential, and this should lead to some very healthy takeout premiums.
Despite low natural gas prices for the next several years, the promise of $10-plus gas prices via LNG exports will encourage companies with future export capability on the West Coast to aggressively drill in both the Montney and the Horn River basin. This will lead to a much tighter drilling and well fracturing market than what is currently expected. And that should lead to an increase in acquisitions of companies that have captured large resource potential but do not have the internally generated cash flow to fund adequate drilling programs themselves relative to the size of their inventory.