Galleon Energy (GO.TO (Toronto) C$6.50,OTC:GLNYF $6.06) is a small cap Canadian natural gas exploration and production company with extensive land assets and two interesting development fields. With 750,000 acres in the Peace River Arch field in western Alberta, GLNYF has the ability to expand its resource base through an aggressive drilling program focused on either natural gas or oil. Galleon, due to its size and capital base, carries a higher financial and execution risk, but could reward investor handsomely. The ability to switch drilling programs from natural gas to oil based on market conditions gives Galleon somewhat unique flexibility for its size.
In my opinion, cash flow, production, and proven reserves are the best matrix to analyze small cap energy companies. The main questions that need to be answered are: Does operating cash flow cover the necessary capital expenditures to continue expanding production and add to reserves? If not, how is the shortfall to be funded – additional debt or secondary offerings of equity that will dilute current shareholders? At what point will cap ex become internally funded? These answers will provide some insight into the potential future of a shareholder’s investment.
Galleon is close to having cap ex funded by operating cash flow, and has the resource base to grow production needed to bridge this gap. Somewhat stronger oil and natural gas price should put the company over the top, along with continued success in Galleon's drilling program.
Assets with potential
There are two specific fields of interest within GLNYF’s land holding, the Montney gas field and the newly explored Doig light oil field. The Montney is a long established gas field with proven production opportunities, while the Doig is just getting started.
Production has been stuck at 16 to 17 mboe/d for the past year or so, with 4th quarter 2009 production a disappointing 14.8. The company drilled 16 wells in the 4th qtr with 94% success. This year's cap ex anticipates drilling about 70 wells - 30 in the Montney and 25 in the Doig fields, with the balance in other assets. It seems that projected cash flow will almost cover this drilling program with a $20 million deficit, which will be funded through slightly higher debt. It is anticipated that there may be a similar shortfall in 2011.
Galleon currently has C$235 million long-term debt, 91 mil shares outstanding (diluted), and a market cap of C$550 million. Making up a $20 mil shortfall in cap ex should not become a big financial issue in 2010.
The Montney field is Galleon’s bread and butter. The Eastern Montney wells produced 21 mmcf/d in 2008, versus current production of 45 mmcf/d. It is anticipated that once production reaches 60 mmcf/d, it can be sustained with as little as 10 new wells annually. It is estimated that the field becomes economically self-sustaining with a low number of new wells and natural gas pricing of around C$5.50. The goal is to drill an additional 130 wells by 2013, and hopefully reach this production target. There have been over 400 additional well sites identified within the Montney field.
The inventory of future well sites makes this asset long lived and a steady cash flow producer. The Montney wells appear to be shallower and less expensive to drill, with a breakeven at natural gas price of around C$3. Offsetting this is the concern that total company gas production seems to have plateaued at 60 mmcf/d, implying the added production from East Montney has only offset production declines in other areas.
The Doig light oil field is being compared to the Bakken field in production quality, although it seems is a bit more expensive to drill due to higher number of fractures. Galleon has drilled 6 wells in the field since 2008, and anticipates a substantial drilling program going forward. The company has identified 150 to 200 potential well sites. While still in the early stages of development, it seems the Doig field prospects look bright.
From natural gas to unconventional oil
Cash flow per share in 2009 was C$1.34, down from a record C$3.38 in 2008. Estimates for 2010 are in the C$1.50 - C$1.75 range, and 2011 is estimated to be C$2.00 - C$2.25, with a price deck of $80-85 for oil and $6 for natural gas. The company is transitioning from a natural gas focus to unconventional oil with multiple fractures to maximize production. Production increases to 18 mboe/d will depend on successful development of its oil assets. With a higher exposure to oil, Galleon will also achieve a better positioning of its resources.
Current asset value could be calculated as follows: PV-10 of its reserves is estimated at C$6.30 per share, with potential reserve additions of C$2.00 based on further development of Montney and C$1.00 for Doig. This would bring near-term value at C$9.00. If Galleon were to generate $2.00 in cash flow, a reasonable 4x to 4.5x valuation would equate to about the same value.
The west coast of Canada is becoming more adapted to exporting oil and gas. There is a huge LNG facility being built that is lining up 20-yr supply contracts. Oil exports to Asia are of growing interest from this region as well. Galleon’s assets in western Alberta appear geographically well positioned for this expansion.
High Risk, High Reward
For investors seeking a higher risk, potential higher reward oil and gas exploration & development company, Galleon would be worth your time to investigate. The key going forward is management’s ability to fund cap ex through operating cash flow and to increase production to at least 17mboe/d with a rising production trend. My personal 12 to 24 month price target is C$8.50 or higher (USD$8.00). What keeps my interest is Galleon's extensive land holdings, and the assets they contain.
It is not out of the realm of possibility that a larger company with the financial resources to develop the property faster could be interested in acquiring Galleon for its cash flow potential. There has been greater interest in the stock recently and the share price has been strong. A slightly lower entry price would be preferable, but current share price should still provide ample capital gains potential.
Disclosure: Long GLNYF and have been a shareholder since 2009