Investors should target tight oil, water flooding in 2012

Liquids-weighted firms and LNG also present opportunities in new year

January 18, 2012

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For Canadian energy investors, 2011 was a year to forget. Industry faced a mountain of unique challenges: biblical levels of rainfall (I’m convinced Viewfield, Saskatchewan, became one of Canada’s largest offshore oilfields at one point), raging forest fires, upgrader fires, celebrity-studded environmental lobbying, record high WTI-to-Brent spreads, Greece-EU debt concerns, renewed fear of global financial contagion, significant oil price volatility, persistently low natural gas prices, and unpredictable access to equity and debt markets.

Looking to 2012, there are several reasons to be optimistic for a better investment and business climate, at least for producers that have large oil exposure. Despite all of the macroeconomic concerns last year, Brent, a proxy for global oil demand, remained over $100, signaling that global oil demand remains both resilient and robust. This underlying support, combined with a decrease in storage at Cushing, Oklahoma, should continue to lead to a decrease in the historically wide differential, meaning Canadian producers should realize a much stronger oil price this year than last.

Data continues to point to a high oil price for 2012: global inventories are at a multi-year low despite a production increase from Saudi Arabia and a strategic petroleum release; Organization of the Petroleum Exporting Countries spare capacity continues to decrease; Chinese net crude imports remain steady. Barring a global recession, which looks extremely unlikely, the outlook for crude oil appears to be very strong for 2012.

Several investment opportunities are glaring for the year ahead. The first is water flooding. Crescent Point Energy Corp. has been carrying the baton for industry with its Viewfield pilot, and continued success there bodes well for tight oil waterfloods elsewhere. Several junior and intermediates including Pinecrest Energy Inc., Wild Stream Exploration, Legacy Oil + Gas Inc. and Surge Energy Inc. will be testing pilots this year. The investment opportunity is significant because “The Street” is behind the curve in appreciating the low finding and developing reserve growth potential in many of these companies from water flooding recovery methods. Look for Bay Street to wake up to this in 2012, and to begin to place value on this largely hidden upside.

Tight oil exploration will also remain a key investment theme this year. Investors will specifically look to the Alberta Bakken, the Second White Specks and the Nordegg plays for further confirmation of commercial rates, all of which have had positive, albeit early, encouraging results.

The success of many companies in pursuing liquids-rich gas plays in 2011 was impressive. Their ability to grow liquids weighting (or at least demonstrate the potential for inventory) was key to attracting investors’ interest in 2011, and this will again prove to be imperative in 2012. This year industry will further test the commerciality of liquids-rich plays, with perhaps the most exciting – in Alberta – being the Duvernay.

The increase in gas-directed merger-and-acquisition (M&A) activity and joint venture interest is also encouraging for Canadian energy investors. Specifically, the entry of Petronas and Sasol into northeastern British Columbia’s Montney fairway demonstrates strong international interest in what is one of North America’s most economic natural gas plays.

West Coast liquefied natural gas (LNG) will continue to gain greater traction with investors this year. Plans for up to five billion cubic feet per day of liquefaction by 2018 are rumored to be in the works, which suggests a coming uptick in M&A activity as companies seek to book substantial proven and probable reserves ahead of financial information data. Look for at least one high profile (i.e., high premium) takeover in 2012 that relates to West Coast LNG.

Finally, a theme that will be new to the patch is investor activism. There are too many oil and gas companies that are trading at substantial discounts to net asset value where Bay Street perceives the only obstacle to unlocking shareholder value is an entrenched management team with a limited ownership stake. There has been recent evidence of international institutional investors sniffing around the patch (and looking for support from Canadian investors) and my expectation is that we’ll see the results of this new interest materialize in 2012 in a few cases.

Eric Nuttall is a portfolio manager with Sprott Asset Management LP based in Toronto and a frequent contributor to the Business News Network.

The opinions, estimates and projections (“information”) contained within this report are solely those of Sprott Asset Management LP (“SAM LP”) and are subject to change without notice.  SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information.  SAM LP is not under any obligation to update or keep current the information contained herein.  The information should not be regarded by recipients as a substitute for the exercise of their own judgment.  Please contact your own personal advisor on your particular circumstances.

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One Response to “Investors should target tight oil, water flooding in 2012”

  1. Powerwave fits nicely into the water flood theme.

    Why would you want to use Powerwave injection on a water flood?

    High production upside (25-200%), significant reserves growth (35-50%), rapid payback (2-10 month payout), and high ROI (>100%).