67 WALL STREET, New York–February 14, 2005–The Wall Street Transcript has just published its Exploration and Production Issue, a report offering a timely review of the sector to serious investors and industry executives in the Energy Industry. This 84-page feature contains a roundtable forum, commentary from 2 research analysts and top management of 13 firms. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.
The oil and gas E&P group enjoyed another record year in 2004 with nearly every company outperforming. The sector has invited a lot more funds and a lot more momentum money, and it has increased the volatility as a whole of the group, which has affected how it has traded. Commodity prices have also been volatile. For 2005, the panelists are more cautious, focusing on those companies that have the underlying assets that can generate meaningful growth. Topics include: Commodity price outlook, Stock price volatility, Project optionality, Industry consolidation, Costs of Sarbanes-Oxley, Barriers to entry, Lack of mid-cap names, Increased rig costs, Drilling activity outlook, Exploration access issues, Administration energy policies, Free cash flow and share buybacks, Bolt-on and asset acquisitions, Changes in S&P 500 industry weighting, Hedge funds and beta names, Stock recommendations, Small-cap company picks.
Companies include: Anadarko Petroleum (APC); Apache (APA); ATP Oil & Gas (ATPG); Burlington Resources (BR); Carrizo Oil & Gas (CRZO); Chesapeake Energy (CHK); ChevronTexaco (CVX); Cimarex (XEC); ConocoPhillips (COP); Delta Petroleum (DPTR); Devon Energy (DVN). Double Eagle Petroleum (DBLE); Dune Energy, Inc. (DENG); EnCana (ECA); Energy Partners, Ltd. (EPL); Exxon Mobil (XOM); Falkland Oil and Gas Limited (FKL.L); FieldPoint Petroleum Corporation (FPPC); Forest Oil (FST); Gentry Resources Ltd. (GNY:TSX); Kerr-McGee (KMG); NAV Energy Trust (NVG_UN:TSX); Newfield Exploration (NFX); Noble Energy (NBL); Occidental Petroleum (OXY); Patina Oil & Gas (POG); Petrohawk Energy Corporation (HAWK); Pioneer Natural Resources (PXD); Plains Exploration & Production (PXP); Royale Energy, Inc. (ROYL); Southwestern Energy (SWN); Sterling Planet; Ultra Petroleum (UPL); Unocal (UCL); U.S Energy Corp. (USEG); Vintage Petroleum, Inc. (VPI); Whiting (WLL); Whittier Energy Corporation (WHIT). Analysts include: Michael D. Bodino of Sterne, Agee & Leach, Inc.; John P. Herrlin Jr. of Merrill Lynch Global Securities; David Tameron of First Albany Capital, Duane Grubert of Fulcrum Global Partners and Bruce Lanni of A.G Edwards & Sons.
In the following short excerpt, David Tameron and Michael Bodino explain why consolidation is inevitable for the small sap E&Ps.
TWST: David, what do you see as the key theme for 2005?
Mr. Tameron: Near term we continue to be cautious about commodity prices, particularly on the natural gas front given the warm start to winter. January comprises roughly 25% of the heating degree days for the entire winter season, and thus far, including November and December, it has been about 10% warmer than normal. That has obviously resulted in less demand. Combining the warm weather with weaker demand per degree day, which has been running slightly below the historical averages, we could get some additional pressure on natural gas prices. In addition, historically January has been an underperforming month for the stocks. Combined, these factors could put some pressure on the share prices near term.
Longer term, I still believe the fundamentals haven’t changed and we’re in the same old boat. The natural gas storage situation will reset itself come April and May, and it will be back to lack of supply because of the same factors we’ve heard time and again, like lack of prospects. We think consolidation will continue to be the theme in 2005. So while some of the mid-cap players have disappeared – Tom Brown, Westport, Patina (POG), etc. – I still think, particularly in the smaller cap names, that this could be a theme that overrides the sector in 2005.
TWST: Michael, what’s your view on this consolidation theme that has permeated the industry?
Mr. Bodino: From a public company standpoint, we believe that most of the companies that were to be consolidated last year were consolidated. We think there will be some limited consolidation and mergers as some companies may find economies. The biggest problem with some of the up and coming mid-cap and small cap names is that they continue to outspend their cash flows. The larger companies are throwing excess free cash flow off, and they can certainly accelerate projects in some areas with the critical path not being money for the larger cap names but people and services. So to the extent that a bigger company can find those opportunities where they can attract the right people and the right projects and some of the services, it may make some sense to have further consolidation.
We think the biggest change we’ve seen over the last couple of years in this business has been that, with Sarbanes-Oxley and other issues, a lot of those that have sold out have re-entered the business using private capital. There have been record levels of private equity raised for energy over the last couple of years. The funds tapped from private equity markets have limited life to them, so those companies will either have to IPO or be sold. The vast majority of those in that situation will choose at the end of the day to monetize the company. So most of the consolidation we’ll see will be small and mid-cap and even large cap buying private companies. I’m surprised how bimodal the group has become. It happened in the service industry in the mid-1990s where all the mid-cap service companies got gobbled up, and now we’re stuck with some very large service companies and a few very small service companies.
Historically, we used to argue that in the E&P business, there were no barriers to entry. Anybody who could buy a shell and put a project in it could be a public E&P company. For the first time, given commodity prices and the competitive nature, the barriers to entry have become significant from a legal, accounting, SEC and expertise standpoint, and it is more difficult to be a fully reporting public company. I do expect a lot of this to continue going forward such that the larger companies will continue to pick off some of these up and comers. If they can put good projects together in the right basins and be a few years ahead of the larger companies, those are going to continue to be acquisition candidates, provided they can come to terms with some of these managements.
TWST: David, how about your views about what’s going to go on in this consolidation phase?
Mr. Tameron: I’m on the same page as John and Mike. Adding some data to the argument, the top 50 publicly traded companies in Canada account for roughly 85% of production. If you compare that to the US, you have the top 100 that account for only about 70% of domestic production. I think the US will move more toward the way of Canada in terms of the larger firms continuing to dominate the landscape.
I would like to comment more on the public vs. private debate. Being in Denver, we speak to numerous company executives who have been bought out. To a person, they talk about the difficulties of trying to run a public company in today’s environment with Sarbanes-Oxley, about the absolute cost as far as dollars and the simple drain on manpower to integrate such procedures. This is particularly true with the smaller and mid-cap companies. One executive whose company was recently acquired said he would get back in the game, but definitely on the private, not the public side. That feeling is commonplace across the industry. I think we’ll go the way Michael referred to. Small caps will build themselves up and then become an IPO or a private transaction. Jim Lightner, Floyd Wilson – you can go up and down the chain. People are using that model today, and I think you’ll see that continue.
TWST: David, what are your top two or three names that you’re using at this point?
Mr. Tameron: First I’ll focus on a few smaller names, which perhaps some investors aren’t familiar with. Carrizo Oil & Gas (CRZO), which has been historically a Gulf Coast play, has acquired close to 35,000 acres in the Barnett Shale. For a company of its size ($300 million market cap), this is a significant position. In recent months, there have been Barnett Shale property transactions from EnCana (ECA), Chesapeake Energy (CHK) and recently, XTO Energy (XTO). All three of those companies have paid anywhere from $11,000 to $17,000 per acre. In addition, the Barnett Shale should help lengthen Carrizo’s reserve life and smooth its production profile.
The other name I’d like to mention is Double Eagle Petroleum (DBLE), which is another small cap name that’s underfollowed. Double Eagle is a Washakie Basin coal bed methane play. It is still early in the development cycle, but the company has a significant acreage position that is now just being exploited. The company also has some overlapping interest with Anadarko, which is starting to step up development activity in the Atlantic Rim area. Being a coal bed methane play, Double Eagle’s breakeven is around $2.00/Mcfe, which provides significant price risk protection if gas prices pull back. The company also has a small working interest position with Questar (STR) in the Pinedale Anticline. We believe it’s a name that will continue to get more visibility. There’s some pretty good upside in this name.
In the mid-cap space, we like Forest Oil (FST). Forest is a turnaround story that’s probably in the second half of the turnaround. Craig Clark took over as CEO in August 2003 and has dramatically changed the company culture. He has revamped the management team, including hiring 10 new Vice Presidents. They’re much more focused on exploitation and cost discipline than they have been in the past. He has changed the asset base. Approximately 35% of the reserves are new to Forest, which has been accomplished through a variety of asset transactions.
Craig Clark was in charge of North American operations at Apache and he kind of brought the Apache model to Forest. In this environment – a mature environment without a lot of prospects -there’s value that can be added by someone who can execute a horse-trading strategy, acquiring undeveloped properties and exploiting them. Craig Clark is as well positioned as anybody to do that, given his background at Apache.
In addition to these three names, we also have Buy ratings on Apache, Gasco Energy (GSX), Spinnaker Exploration (SKE), and Western Gas Resources (WGR).
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