Since early 2011, I have really been focusing on small- to mid-sized Canadian oil companies that are focused on emerging unconventional resource plays. I have taken a beating on those that I held (Petrobank (OTCPK:PBEGF) going into 2011, but have fortunately been able to invest a good amount of cash into a group of these companies recently at what I think are bargain prices.
Here is the group that I have been buying. Note their current stock prices vs. their February 28 stock prices.
Feb. 28, 2011 - $24.99
Current - $13.70
Down – 45%
Skywest Energy (SKWEF.PK)
Feb. 28, 2011 - $0.77
Current - $0.48
Down – 37%
Novus Energy (OTC:NOVUF)
Feb. 28, 2011 - $1.23
Current - $0.88
Down – 28%
Westfire Energy (OTCPK:WFREF)
Feb. 28, 2011 - $9.25
Current - $7.50
Down – 17%
Arcan Resources (OTCPK:ARNBF)
Feb. 28, 2011 - $5.10
Current - $6.20
Up – 21%
Some conclusions: The group has been hammered in the past few months despite oil still being near $100; the actual underlying businesses haven’t changed much (they still all own the same assets and have the same levels of production), so if you liked these companies on Feb. 28 you must really like them now (and I do); one of these is not like the others, and that is Arcan Resources -- which has actually gone up considerably despite swimming against a nasty equity market.
Arcan is typical of the type of company I have been focusing on over the past half year. It is a relatively small company that has established a large land position in an emerging oil resource play in Canada. In the case of Arcan, that resource play is the Swan Hills Reef complex, which produces from the Beaverhill Lake formation.
And while the industry knows that horizontal drilling and multi-stage fracturing have turned acreage in Swan Hills (and other emerging plays) into a very valuable asset, the stock market is less convinced.
Here is a rough idea of what Arcan could be worth:
Arcan land position – 150 net sections
Estimated oil in place – 600 million barrels
Expected oil to be recovered – 250 million barrels
Current booked reserves – 20 million barrels
The key thing to note is that out of 250 million barrels of oil that Arcan expects to recover only 20 million are currently booked, as reserves as the company is limited to how many drilling locations can be booked on undeveloped land (despite limited geological risk).
Now with the 20 million barrels of reserves that are booked, Arcan has an estimated Net Asset Value per share of $5.51; see page 5 in this presentation.
The current share price of Arcan is $6.20. If less than 10% of its recoverable oil reserves are worth $5.51 per share, then investors clearly aren’t paying much for the other 90%. I’m not saying Arcan is going to reach $50 per share, but I am suggesting that it seems very likely that Arcan is worth considerably more than $5 or $6.
Acquisition of Arcan Looming?
I feel pretty good about the undervaluation of the shares of Arcan, and the following items make me think that Arcan may be taken over in the fairly near term.
- Recent strength in share price. While every single Canadian producer has had a falling stock price over the past several months (including the other smaller producer focused on Swan Hills), Arcan has performed strongly. I think that may be because a potential acquirer has been buying shares in the equity market.
- Insider activity. In April and May of this year, several top insiders sold convertible debentures that they held and used proceeds from those sales to buy Arcan shares in the open market.
- Penn West comments. I’ve listened to several Penn West presentations where the company has discussed how aggressively it is moving into the Swan Hills play and how the junior oil companies in the play will be taken out. It isn’t a secret Arcan is in play.
- Surrounded by big fish. There are two small publicly traded companies focused on Swan Hills. Arcan and Second Wave Petroleum. Those two small players are surrounded by Penn West (NYSE:PWE), Pengrowth (NYSE:PGH), EOG (NYSE:EOG), Apache (NYSE:APA) and Devon Energy (NYSE:DVN). This play is being quickly de-risked and the bigger fish will want to eat the smaller guys now rather than pay more later (as production increases so does the asking price.
I feel confident Arcan will be acquired. Whether I’m right about that acquisition happening soon, I’m less certain. I feel that the current share price is attractive either way.