Why Sonde Resources Is Undervalued

| About: Sonde Resources (SOQ)

Sonde Resources (NYSEMKT:SOQ) is an interesting, diversified oil and gas (liquids) play with a good balance sheet, some production, and a number of promising exploration areas with considerable upside.

Some data

  • Market cap $140 M, 2.25 per share.
  • 62.3M outstanding shares (69.9M) fully diluted shares
  • Cash $30M, zero debt with $60M in debt capacity
  • Capex Expected to be $35M in 2011, mainly on Drumheller and Kaybob
  • Market cap around $3 per recoverable barrel
  • All revenue and cash-flow are obtained from its Canadian properties containing 329,000 net acres
  • The offshare Trinidad and Tobago operations have been sold [to Niko Resources (OTCPK:NKRSF) for $97M]
  • The interest in Liberty Natural Gas has been sold as well (for $1M in cash now and $12.5M in deferred payments on first gas delivery)
  • Old management from the Canadian Superior days are long gone and have no connections to Sonde


  • Production was 3090BOE/d in August and projected to reach 3300 BOE/d by year-end [Oct presentation]
  • 74% of production is from the greater Drumheller area in Alberta
  • The rest comes from the Kaybob/Windfall and Boundary Lake/Eaglesham areas
  • 67% of preduction is gas (August 2011), down from 79% at end of Q2 last year
  • Income from oil and gas sales was 16.5M in the first six months of 2011 (up 1% from 2010)
  • Operating cost are $11.79 per BOE [Oct presentation]
  • 12Bcf/d gas sales (down 11% in volume, with prices falling 18%), 205 bbl/d liquids (up 39% in volume, prices up by 17%) and 466 bbl/d oil (up 2% in volume, prices up by 23%)
Their properties Most of the properties are in Alberta (Eaglesham, Kaybob and Drumheller) accounting for 10.2MMBOE of 2P reserves [Oct presentation] but the company also has a large area (768,000 acres) off the cost of Libya and Tunisia.
Duvernay The source rock for the prolific Leduc and Beaverhill Lake oil/gas field. It's where Sonde has 65,000 net acres with a 100% working interest. There are 388 horizontal locations. This is what Macquarie had to say about Duvernay (pdf):

Over the next decade, we believe the Devonian-aged Duvernay shales will emerge as one of the most promising oil/gas resource plays in Canada. In fact, we see these shales as having the potential to be Canada’s answer to the prolific Eagle Ford shales in south Texas.

This is an area rich in infrastructure and Macquarie's assessment is vindicated on very promising well data from Trilogy/Celtic, which suggest estimated ultimate recovery (EUR) of 1MMBOE+ per well, especially because of the high liquids content. Land has been selling like hotcakes.

In a land sale that set a provincial record for the average amount paid per hectare, companies poured out $451-million to buy oil and gas rights on prospective land. Fully three-quarters of it was aimed at the Duvernay. And prices are rising fast: Discovery (geoscience company Canadian Discovery Ltd.) calculated that Duvernay lands averaged $3,984 per hectare in December; on Wednesday they went for $6,184, a 55-per-cent leap.[Globeandmail Aug 2010]

Assuming an average of $5,000 per hectare (2.47 acres per hectare), then SOQ’s 60,000 acres are worth $121 M, a little less than the current market cap. You'll get the other properties for free. And they join a fine list of players, apart from Trilogy (partnering with Celtic)

What’s clear, experts say, is that this level of spending comes from major companies. On the list of possible buyers, according to industry players: Talisman Energy Inc., Husky Energy Inc., Royal Dutch Shell PLC, Encana Corp., Canadian Natural Resources Ltd. and Apache Corp. [Globeandmail Aug 2010]

Kaybob/Windfall The Company's Kaybob/Windfall area assets contain a series of vertically stacked Cretaceous and Jurassic tight gas sand development opportunities, of principal importance being the Windfall Gething pool. The Company had good success proving the economic viability and a geographic limit of this liquids-rich gas play with two vertical re-entries in 2010, and is preparing to develop the pool using horizontal wells and multi-stage fracturing.
The Company has identified 14 horizontal development locations on its acreage base and plans proof-of-concept drilling at two of these locations in 2011. In addition, the Company holds a number of attractive re-entry candidates targeting Jurassic Nordegg and Cretaceous Viking tight gas sands, and plans a modest re-development program targeting these wells in 2011.[Q10p23 - pdf] The first horizontal well in Kaybob Gething should be drilled this year. Drumheller There are six properties there, for a total of 101,000 net acres with Sonde having an 82% average working interest. There are five oil pools, which are literally perforated with hundreds of vertical wells that show target zones for the horizontal infill drilling. The company has identified 67 future horizontal infill locations [Oct presentation - pdf] and 132 net for all Drumheller pools. The biggest and immediate prospect is the Manville I pool.
Manville I-pool
Sonde bought the remaining 1/3 (10,367 net acres) it didn't already own for CAN $6.3M. This includes production of 110 barrels of oil equivalent a day. There was a fine line between negotiating a price and moving drilling full force and showcasing results. It's where efforts are concentrated at the moment, as it's relatively low hanging fruit.
Before year-end, a total of 9 horizontal wells will be drilled. These wells are mostly infill wells between vertical wells that have already been drilled, so they are cheaper (about $3M per well) and lower risk.
In late June, the Sonde 3-4 well was completed using 12 stages of gelled propane. The company has drilled and fracked three horizontal wells with results of the first one above expectations:

The well came online flowing at an initial 7-day average rate of 414 bbl oil/day and 0.6 MMcf gas/day (514 Boe/day) and it continued to flow unassisted for the next 30 days at rates averaging 192 Boe/d. A significant portion of the decline is due to the need to install artificial lift on the well. [Q2 results]

Using p50 drilling estimates of NPV10 equal to $3.8 M per well based on $85 oil, $3 M drilling costs per well, then the planned 67 horizontals in the Manville I pool is estimated to be worth $196 M (this assumes the 67 wells come on over 5 years, discounted to present at 10% per year).
Of course, since the initial production rates exceeded expectations, it is likely that this value is conservative. Further, note that there are also plans for an additional 66 HZ infills for the other Drumheller oils pools (Aerial, Craigmyle, Michichi, and Wildunn). If results are consistent with pre-drill estimates then these additional infills could add approximately another $200 M in firm value.
Libya/Tunisia offshore
The company has a 100% interest in 768,000 acres located in Tunisia and Libya. The appraisal well obligation was satisfied by drilling the Zarat North-1, which was temporarily abandoned on January 11, 2011, while the Company evaluates the recoverable reserve scenarios, development options and cost estimates for the field’s development.
The well was the third drilled on the large Zarat anticlinal feature, following two wells drilled by Marathon in 1992 and 1994, respectively. It encountered 240 net feet of gas/condensate and oil pay in the Eocene El Gueria limestone, with oil/water and gas/oil contacts at the same structural elevation found in the Marathon wells.
Tested in three separate intervals, the Zarat North-1 flowed at sustained rates averaging eight MMcf/d of natural gas plus 750 bbl/d of condensate. [Q10 report - pdf]
This month, a Ryder Scott Contingent Resource update is expected to be released. If we conservatively estimate this at 60mmbbs recoverable at $2 per barrel we arrive at $120M for this property alone. So we get: Cash: $30M + Drumheller $196M + Duvernay $120M + Tunisia $121M = $467M, which is several times the present market cap of $140M. One has to realize that Sonde is already producing 3090BOE a day (67% gas), and to make these properties producing will significantly enhance their value. We haven't even included all of them. Also, this doesn’t consider future tax savings of the $240M in accumulated deficit.
Insiders have been buying. The following two-year agreement that restricts certain interested parties from purchasing more than 20% of the company ends Dec. 17, 2011.

The Subscription Agreement also provided that subject to completion of the Placement, neither Treherne, Riddell, nor any affiliates thereof, will make, or will act jointly or in concert with any person who makes, any proposal or offer to acquire Common Shares or other securities of the Issuer which (giving effect to any exercise, exchange or conversion rights attached to such securities) when added to the Common Shares then held by Treherne, its affiliates and person with whom it acts jointly or in concert would total in excess of 20% of the outstanding Common Shares of the Issuer for a period of two years from December 17, 2009, without the prior written consent of the Issuer. [Edgar]

So to summarize, Sonde is trading 1/3rd of its conservative estimated value, insiders are buying, and an agreement to restrict certain interested parties from taking more than 20% of a position in Sonde ends in December. We think the risk/reward for Sonde's shares is particularly interesting.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SOQ over the next 72 hours.