Every year, the global demand for energy grows. This is the primary reason that energy companies make such attractive investments.
But most of the big names in the energy sector - Exxon-Mobil (NYSE:XOM), BP (NYSE:BP), and Chevron (NYSE:CVX) to name a few - have already experienced the big growth spurts of their childhood and adolescence. They'll still grow along with the sector, but they're also unlikely make any explosive breakouts.
However, if you're not afraid to roll the proverbial dice on an energy company that's still in its infancy, consider Dejour Energy (DEJ).
In the past year, Dejour Energy has begun the transition from oil and natural gas exploration to production. The company should begin production at its most promising project within the current fiscal quarter. In addition to this project - which by itself contains assets worth 3 - 10 times the company's current market capitalization - Dejour has a portfolio of other properties with the potential to sustain its growth for years to come.
But if the company's situation were that simple, I wouldn't be writing about it as a speculative stock.
Dejour Energy's Move Out Of The Cradle
Dejour Energy is very much in the early stages of its life as an energy company. It's a Canadian-based oil and natural gas exploration and extraction operation with properties under development in both Canada and the United States. But what sets it apart from its peers on the endless list of exploration-stage companies is that Dejour has recently begun to make the shift towards production and profit.
On September 25th, 2012, the company successfully drilled the first well at its Kokopelli Project in the Piceance Basin in Colorado. The company has a 72% ownership stake in the well, and expects production to begin in Q4 2012 - the quarter we're currently in. According to the company, it has a claim on proven oil and natural gas reserves of $94 million at Kokopelli, and probable reserves of up to $202 million at the net present value.
In addition, the company claims that it can access newly discovered shale oil reserves via horizontal drilling at its currently producing Woodrush property. It has drilled a discovery well at its South Rangely property, and although it has found gas in the area, the company is currently evaluating the size and value of the reserves. It also owns over 135,000 acres of property that are currently under exploration. Within these acres lies the North Rangely area, which has the potential to contain up to 1 billion barrels of oil, although even the company's investor presentation admits that that particular estimate is a long shot, and refers to North Rangely as a "high risk exploration area."
While the amount of gas and oil at Kokopelli would barely be a drop in the bucket for a larger, more established energy producer, as of the time of this article's writing Dejour Energy trades at $0.182 per share with a market capitalization of only $27.12 million. If the Kokopelli project starts producing on the scale that Dejour says it will - and some of their other exploration projects pan out - the company, along with its shares of common stock, will suddenly be worth quite a lot more.
Unfortuntely, that's where the good news ends.
Surviving The Playground
The problem with Dejour is that Kokopelli isn't their first foray into production. Although it's certainly their largest and most promising operation, they've been producing at Woodrush since October of 2011 and they still haven't been able to turn a profit
They claim that the project will enter peak production of its $19 - 40 million worth of oil in Q4 2012 and Q1 2013, but the operation has encountered setbacks. The most recent of which was stated in their Q3 2012 financial reports as, "[a] temporary curtailment of production on one of the oil producing wells after workover fluids used during the installation of artificial lift equipment."
Admittedly, I'm a writer, not an engineer. But Dejour's explanation for the production slowdown doesn't make much sense to me and isn't even phrased in a complete sentence. Perhaps this kind of thing happens all the time at oil wells. But my gut tells me that it's a deliberately complicated way of saying either, "we screwed something up," or, "something broke." Neither one casts the fledgling company in a particularly positive light.
But regardless of the truth behind their problem at Woodrush, it's excusable as the kind of growing pain that a developing company is going to experience. The company's management has a good record and a long history in the industry, including experience in the engineering, business, and equity domains. These are people who know what they're doing, and I'm sure they'll quickly and competently handle whatever's going on at Woodrush.
The biggest problem Dejour faces is something completely out of their control, and it's the thing that takes Dejour - with their strong management and proven reserves - out of the growth category, and places it in the questionable company of other speculative stocks.
Dejour Is Part Of Its Own Problem
Demand for energy will always grow in the long run. But so will the stock market, and just as the S&P 500 likes to take a dip every now and then, so too does the global demand for energy. Cars are now more fuel efficient, and Europe appears to be on the verge of turning back towards recession. Both of these factors - combined with the overall global slowdown of the past few years - have decreased demand for oil and natural gas.
However, what could ultimately prove to be the nail in the coffin for Dejour isn't the decrease in demand. It's the increase in supply. The North American energy boom in oil and gas that has created Dejour - and countless other companies like it - has drastically increased the supply of these commodities on the market. Since the resources are no longer as scarce as they once were, prices have plummeted. The chart below shows natural gas spot prices for the past 5 years.
After peaking in 2008, they've more than halved. The glut of supply that's caused this drop is great for energy consumers. And since the vast majority of the gas has been found in America, it brings us one step closer to achieving energy independence. But it's terrible news for Dejour Energy, as it directly depresses their revenues.
Oil prices have followed a more volatile path, but they've also dropped from their highs for largely the same reasons.
If Dejour were currently operating at 2007's prices, they'd already be a profitable venture, and the decision of whether to invest in them or not would be much easier to make. But they're not, and that leaves the company in a bad situation.
There's no question that the depressed prices of oil and natural gas are directly responsible for both Dejour's operating and net losses. Their most recent financial statement, released on November 7th of this year, directly states, "The Company's loss for the current quarter was $1,365,000 or $0.009 per share, compared to a loss of $346,000 or $0.003 per share for the same quarter in 2011. The increase in loss was primarily due to the reduction in oil production revenues..."
Regarding their exploration projects, the statement also remarks that, "potential developments will be deferred to at least 2013 as the low natural gas price experienced earlier this year have caused Dejour to delay the start of investments on its leases in Colorado."
Thus, Dejour continues to lose money because oil and natural gas currently don't sell at high enough prices for them to turn a profit. In an effort to cut costs and save their bottom line, this stark reality has forced them to halt the exploration and evaluation of their promising properties in Colorado.
Perhaps this reduction in expenses - combined with the increase in production at Woodrush - will finally enable them to post positive earnings in Q4 2012. It certainly appears that that's what management wants to do. But it would only place a band-aid on the problem, and they'd swing back to operating at a loss as soon as they start spending money on exploration again.
And these projects are necessary for the company to continue to grow. The Woodrush wells are moving towards the end of their production lives, and in the simplest terms, Dejour will not be worth more than its current valuation if natural gas and oil prices do not rise - and soon.
How To Play Dejour Energy
Dejour's stock is currently bouncing between support of $0.15 and resistance of $0.25
Historically speaking, this range is right around the stock's all-time lows. In fact, it's done almost nothing but lose value since it first became publicly listed in 2006.
News of yet another quarterly loss combined with a general market sell-off couldn't take it below $0.15, but it definitely won't break much higher unless something pushes it past it's current ceiling. All in all, I'd say that if you're willing to roll the dice on Dejour, now is the time to initiate your position. It seems to have found support - however low it may be - and it's unlikely to run away while you're not looking. Choose your limit, and place your order. But once you do that, you need to keep one eye on the prices of oil and natural gas.
Natural gas is facing resistance at the $4.00 point. If it can sustain trade above that point by the end of the current quarter, then it may have bottomed and Dejour may just get the spark it needs to finally come alive. If prices continue to rise, so will their revenues, earnings, and stock price. But before you pop the champagne, remember that natural gas can always go back down, dragging Dejour Energy along with it.
Oil is a bit more complicated, as it has repeatedly tasted the air above $100, and found that it couldn't remain at that height. It's also the less likely of the two to stage a sustained rally.
Current EPA restrictions on coal have made it more expensive than natural gas, causing many power plants nation-wide to switch to the more cost-effective choice. This is natural gas's main advantage over oil, and the main reason I think it's the more likely of the two to be the catalyst that brings Dejour out of its current slump. Regardless, if oil does sustain trade above $100, that too could provide the financial push that the company needs.
However, if neither of the two commodities can sustain prices significantly higher than their current points, Dejour simply doesn't have the cash to hang on much longer. The company has about $3 million in cash, and $1.3 million left in a $7 million line of credit. Barring any new loans or a substantial new investment in the company, that leaves it in a $4.3 million life boat to wait out the current flood of supply that's lowered energy prices. They've already lost about $2.3 million in the first three quarters of this fiscal year. If they continue to operate at a loss, they can only stay afloat for about two more years.
Energy prices will certainly rise in the future. Oil and natural gas are, after all, limited resources, and the demand will only increase. But the question is when that rise will occur. BP, Chevron, and Exxon-Mobil can afford to wait out this price drop for as long as they need to. Dejour Energy cannot.
Though the stock is currently priced at an attractive level compared to its growth potential, that potential cannot be unlocked by anything the company itself can do. Buying into Dejour Energy is also a bet that oil and natural gas prices will rise in the near future. If they do not, there will be little - if any - force to push the stock higher than it's current lows.
Like all speculative stocks, Dejour Energy has the potential for extraordinary growth, beginning as soon as next quarter. However, this stock carries with it a level of risk that many investors will find unacceptable.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DEJ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I sold my original position in DEJ in October of this year to free up capital for another trade. However, my speculative outlook on the company has not changed, and I plan to re-initiate my long position in the near future.