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  • With Expertise And A Little Luck, East West Petroleum Reels In Profits Despite Oil Price Plunge

    Many oil companies have been devastated by the oil price debacle. East West Petroleum, on the other hand, is making money, pumping more oil and strengthening its cash balance. CEO David Sidoo tells The Energy Report how shrewd joint ventures and a firm commitment to low costs have led to highly profitable wells in New Zealand and significant upside in Romania.

    The Energy Report: When was East West Petroleum Corp. (OTCPK:EWPMF) [EW:TSX.V] founded, and where do you operate?

    David Sidoo: East West was formed in 2010 on the back of the award of four exploration blocks in Romania's prolific Pannonian Basin. Following the award, we raised $30 million [$30M] to fund a work program and future business development. We then entered into joint ventures on these blocks with NIS (Naftna Industrija Srbije), the Serbian subsidiary of Gazprom. NIS is committed to funding Phase 1 exploration of €60 million (€60M) in exchange for 85%; we retain an interest of 15% carried through to commerciality.

    In 2012, East West entered New Zealand's Taranaki Basin with the award of three blocks held jointly with TAG Oil Ltd. Ten wells were drilled initially, and production and cash flow from New Zealand began in 2013.

    TER: What was your experience before you started East West?

    DS: I studied at the University of British Columbia [UBC] in Vancouver and played on its Thunderbirds football team. In 1982 we took home, for the first time, the Vanier Cup, the Canadian interuniversity championship. I then played professionally for six years in the Canadian Football League. After retiring from football in 1988, I entered the brokerage business and worked at Canaccord and Yorkton Securities for 11 years.

    TER: What did you learn from football that is applicable to business?

    DS: I learned that you can't build companies and achieve success on your own. You've got to have a good team around you. That's what we've assembled at East West. Most important, members of the team have to have strong technical knowledge. Next comes a good management squad that knows how to run a company, and has the expertise and connections to raise capital.

    TER: What was your experience in oil before East West?

    DS: More than a decade ago, I became involved in a company in the Pannonian Basin called Gasco Energy Inc. We secured acreage and raised over $150M. Gasco has some very good reserves and is doing well.

    We then formed a company called American Oil & Gas Inc. in 2013. We worked in the prolific Bakken fields in North and South Dakota, and sold the company to Hess Corp. for $630 million ($630M) in 2010.

    TER: What is your philosophy of building an oil company?

    DS: Our model has been to enter highly prospective areas early to build a material position, and then find companies with operational capabilities that complement our technical expertise. Our goal is to complete successful partnerships and maximize value to shareholders.

    As far as exploration goes, we're not interested in moose pasture. We want decent acreage in proven areas with infrastructure.

    TER: How does your management team give East West a competitive advantage?

    DS: We have the experience and the technical expertise. Aside from my own track record, Dr. Marc Bustin, a director who's our technical advisor, is a professor of petroleum and coal geology at UBC. He was awarded the Canadian Society of Petroleum Geologists' Stanley Slipper Gold Medal in 2013. He is world-renowned and has examined source rocks all over the world. He can quickly evaluate assets when we look for new opportunities. We're agile and nimble, and we can pull the trigger quickly.

    TER: What are the advantages of working in Romania and New Zealand?

    DS: Both have proven histories of oil production, which significantly derisks exploration. And both offer stable political environments with attractive fiscal terms. The netbacks in Romania and New Zealand are quite high, unlike many other places in the world. Working in these countries is quite similar to working in the United States or Canada.

    TER: What are the advantages of the joint venture [JV] model?

    DS: It allows explorers and producers like East West to diversify and hold a larger portfolio. JVs make our money go further. By partnering with professionals in the areas we operate, we benefit from their local expertise, while they gain access to our technical team's track record and history of reviewing many different projects around the world. You can never get enough trained eyes to evaluate projects.

    We have a substantial and successful history with this model. American Oil & Gas worked with Halliburton Co. This allowed us to monetize assets that were sold for $45M, which gave us the capital to develop our Bakken play.

    TER: What do your partners in Romania and New Zealand bring to the table?

    DS: In Romania, our partner NIS has extensive success operating in the Pannonian Basin. The company has been the leading oil producer for many decades in Serbia, which is just across the border from our southern two blocks.

    In New Zealand, TAG Oil is one of the leading operators and most active drillers in the Taranaki Basin. The company has a well-earned reputation in New Zealand for great community relations. We had long-term relationships with senior members of their team, which greatly facilitated our deal there.

    TER: How soon after you began exploration in New Zealand did you begin production?

    DS: We were awarded three concessions in New Zealand in December 2012, and began drilling our first well, E1, in August 2013, nine months later. We achieved our first production by year-end 2013. This was our first JV well, and it is still flowing naturally today, with little decline to date. I'll tell you something my wife always says I shouldn't say-you need to be a bit lucky. Some guys have a lot of luck and do well in business, and some don't.

    We're now producing about 330 barrels of oil equivalent per day [330 boe/d] at a cost of about $22 per boe, and that includes all royalties. With the Brent price at about $56 per barrel [$56/bbl], that makes our operations profitable, and allows us to fund the rest of this year's capital expenditure [capex)] from cash flow without using any of our $8.1M cash balance. Our rapid progress in New Zealand is a testament to TAG and to the country, which is very supportive of oil and gas development.

    TER: How much of your production is oil, and how much is gas?

    DS: Oil is 73%; 27% is gas. Right now we're only selling the oil; we're flaring the gas. But in about three months, a gas pipeline will be completed. That should reduce our cost per barrel to about $18.

    TER: What do you anticipate East West's year-end daily production to be?

    DS: We have one commitment well to drill later in 2015. Production should remain fairly steady, but we hope to raise it to perhaps 400 boe/d.

    TER: You announced the successful recompletion of your Cheal-E2 well in mid-March. How significant is that?

    DS: When E2 was drilled initially, in 2013, it did not produce. So its recompletion demonstrates the technical abilities of both TAG and East West. It provides the JV with an additional 100 boe/d for relatively low cost, and greatly improves our bottom line.

    TER: What's the status of your Romanian operation?

    DS: We are fully approved by the National Agency of Mineral Resources. Our JV has four blocks in Romania, and NIS has done seismic work to identify two drill locations on block number 7. NIS is permitting for one location as we speak, and we're hoping to drill by the end of the year.

    TER: You mentioned that East West is profitable, even with Brent at $56/bbl. How low would Brent have to fall before that profitability is threatened?

    DS: Breakeven for our operations is $35/bbl. That includes opex, salaries and all expenses. Today, many petroleum companies are shutting in oil wells or not completing them. They're waiting until oil rises to over $60/bbl, which is their breakeven cost. We're safe and sound now, selling at a Brent crude price even as we benefit from the weakness of the New Zealand and Canadian dollars. But when the price does rise above $60/bbl, we can start taking risks again.

    We've had people approach us for financing, but this would create dilution, so we're not interested. We're making money in New Zealand and we're carried in Romania, but the market isn't giving us any credit for the latter. We are discussing some other locations at the E site in New Zealand, but right now we're determined to focus on our bottom line and keep our general and administrative expenses low. When the market turns around-and this tends to happen fast in our space-we are poised to respond quickly.

    TER: As you said, your cash balance is $8.1M. How much of a cash cushion would you like to maintain?

    DS: I think a double-digit cushion never hurts. When you've got $0.10/share in cash in the bank, and you're building reserves, you start to look quite attractive to the market.

    TER: Despite your rapid advance to production and high margins, East West trades at only $0.15/share. What are you doing to persuade the market of the value of East West?

    DS: We are continuing to spread the word that we're a well-capitalized company, with profitable operations at current prices and meeting our financial obligations. It is our strong belief that when you build a good company, the stock price will follow.

    We were at $0.50/share with no production; now we're at $0.15/share with stable production. We'll be doing $3-4M this year at current oil prices, and we'll start selling our gas shortly. We have a strong shareholder base, and 15% of East West is owned by management. We are all shareholders here. I think there has never been a better time to buy this stock. We're derisked in New Zealand, and our cards are on the table.

    TER: Where do you see your company in three years' time?

    DS: We believe oil prices will likely stabilize in the next few years at $70-75/bbl. In three years, we would like to see production rise above 1,000 boe/d with no further dilution. We'd like to have $15-20M in the bank. We are already looking at increasing our acreage in New Zealand. Our operations in Romania should be well advanced by then. And then we'll look at acquiring a couple of other companies, bringing in partners and getting carried.

    Our shareholders have been really patient in Romania, which is great because we see real upside potential there. This is where we expect to get a big win in terms of developing toward that 1,000 boe/d.

    TER: David, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Energy Report and can be read in its entirety here.

    David Sidoo is president, CEO and a director of East West Petroleum Corp. Mr. Sidoo is a successful businessman based in Vancouver, where he oversees a successful private investment banking and financial management firm. Upon graduating from the University of British Columbia in 1982, where he held a four-year football scholarship with the UBC Thunderbirds, he was drafted to play professional football with the Canadian Football League. Mr. Sidoo retired from football in 1988 and was introduced to the brokerage business. From there he became a broker with Yorkton Securities, where he quickly became one of the company's top revenue generators. He went on to become partner and advisory board member at Yorkton Securities, consistently generating commissions that ranked in the top five nationally. In 1999, he left Yorkton to pursue private investment banking. He was founding shareholder of American Oil & Gas Inc. (AEZ), which was sold to Hess Corporation in 2010 for over US$630M in an all-stock transaction. In 2008, The Vancouver Sun voted Mr. Sidoo one of the top 100 South Asians making a difference in British Columbia. In 2014, Mr. Sidoo was appointed by the British Columbia government to the board of governors for the University of British Columbia.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    DISCLOSURE:
    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) East West Petroleum Corp. paid Streetwise Reports to conduct, produce and distribute the interview.
    3) David Sidoo had final approval of the content and is wholly responsible for the validity of the statements. Opinions expressed are the opinions of David Sidoo and not of Streetwise Reports or its officers.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Tags: EWPMF
    Mar 26 7:50 PM | Link | Comment!
  • How Healthier Food Boosts Margins For Ag Companies And Investors: AltaCorp's John Chu

    More people are eating better, and demanding food with no gluten, more fiber, less fat and more protein. According to John Chu of AltaCorp Capital Inc., this trend equals tremendous growth potential for companies specializing in high-margin foodstuffs. In this interview with The Energy Report, Chu highlights one such specialty food stock, examines the effects of low oil and natural gas prices on the fertilizer space, and explains why he prefers the prospects of nitrogen-based fertilizers over potash.

    The Energy Report: How have the collapses in the prices of oil and natural gas affected the fertilizer sector?

    John Chu: Natural gas is an important feedstock for nitrogen-based fertilizers-up to 50% of the production cost. This means higher margins. Fuel and lubrication-related costs account for 10-12% of farmers' operating expenses. Lower fuel prices result in cost savings, which might be spent instead on fertilizers and other inputs. Lower gas prices should result in higher gasoline consumption, which in turn should result in greater ethanol demand and an increase in demand for the corn used to make ethanol.

    TER: There were recent reports that Russia was planning export duties as high as 35% on fertilizers. What effect would this have on the industry?

    JC: The rumors were unfounded. The Russian industry minister said that an export tax has no support and is not being discussed. In any event, we don't think an export tariff would have much of an impact. We would expect to see the Russian players continue to export most of their fertilizers to international markets-90% of potash, in particular. The Russian government has, in the past, floated the idea of an export tariff as a means to get domestic fertilizer suppliers to offer a meaningful discount to local farmers. And that is exactly what has happened; Russian fertilizer producers have agreed to a 33% discount for Russian farmers.

    TER: Have sanctions affected the Russian fertilizer space?

    JC: No. And we don't see them having an effect, especially on potash, because world supply is limited in terms of the different regions that can supply it.

    TER: When we spoke last summer, you mentioned the possibility of Russian producer Uralkali reforming its marketing alliance with Belaruskali, its Belarus equivalent. Did this happen?

    JC: No. It seems they're growing further apart, with Uralkali accusing Belaruskali of disrupting the market with higher volumes and price discounts.

    TER: We're hearing more about ever-closer political and economic bonds between Russia and China. Has this been reflected in the fertilizer market?

    JC: Uralkali held a conference call Mar. 5, and revealed that 2015 potash production will be reduced about 15% due to a flood at one of its mines. The company doesn't expect to lose market share in the U.S., Brazil or Europe, but we could see it lose market share in China and Southeast Asia. Uralkali will allocate volume based on netbacks and higher margin customers. We understand that Belaruskali and some other suppliers have been funneling a lot more volume into China relative to what Uralkali had in the past.

    TER: What is your 2015 projection for corn prices?

    JC: We expect that lower acreage will be planted in the U.S. and other key regions, and that yield will decline from the record achieved in the U.S. last year. We expect overall demand to remain pretty firm, based on feed demand, ethanol demand and increased demand from China. As a result, we expect higher prices: about $4-4.25 per bushel.

    TER: And your 2015 projection for fertilizers?

    JC: We haven't put out a hard forecast, but I can give you a sense of direction. We expect a $15 or so per tonne rise for potash. We think China will have to pay that much more, and that will greatly influence the cost to the other major customers. On the nitrogen side, we expect an equivalent $15 per tonne increase, driven by some supply disruptions and solid demand. We expect a more modest increase in phosphates, about $5-10 per tonne.

    TER: Why do you believe that, as you have said, fertilizers will "continue to act as a safe haven for resources funds"?

    JC: Portfolio managers in the materials, mining and energy sectors tell us that corn and fertilizers are more stable and involve lower risk, with higher prices expected.

    Fertilizer equities offer very solid dividend yields, anywhere from 2-4%. The capital expenditure [capex] programs for most of the senior fertilizer players in North America will fall starting in 2015, which suggests we'll see higher dividends and/or an increase in stock buybacks going forward.

    TER: How have shares of the nitrogen companies performed compared to the potash companies?

    JC: Agrium Inc. (NYSE:AGU) is up about 18% year-to-date. PotashCorp (NYSE:POT) is down about 6%. CF Industries Holdings Inc. (NYSE:CF) is up over 14%. The Mosaic Co. (NYSE:MOS) is essentially flat. Agrium and CF are the main nitrogen players. PotashCorp is obviously a potash player, while Mosaic is more of a phosphate player.

    TER: Agrium is your top pick of the majors. Could you expand on that?

    JC: We like its exposure to nitrogen, which is by far the most stable and predictable of all the fertilizer nutrients. Nitrogen has had a long upward trend of demand growth over a 40-year-plus period. The same can't be said for potash or phosphate. As I mentioned earlier, lower natural gas prices should help the cost side for many nitrogen producers, and we believe that nitrogen prices have bottomed. And nitrogen has a better outlook in terms of supply. Nitrogen has seen several global supply outages, with 4-5% of capacity coming offline due to gas disruptions or gas availability, mechanical problems, or political problems such as the Ukrainian upheaval. Many of those issues are expected to continue into 2015.

    Agrium also has a retail division, which offers good stability relative to the wholesale fertilizer business. It's been hitting record levels of sales the last couple of years. We're definitely impressed with that. We're also seeing increased disclosure and transparency from this company. It gave full-year guidance for 2015, for the first time ever. Agrium could be in line for a valuation rerating.

    TER: Agrium declared a $0.78 dividend last month. Can we expect higher dividends in the future?

    JC: The company's original dividend formula was 25-35% of free cash flow. It recently increased that to 40-50%. We expect that as its capex program declines free cash flow will increase, resulting in a higher dividend. From the perspective of a base-case scenario of projected free cash flow from 2016 through 2021, we could see a $4-5 dividend per share. Based on the company's upside-case scenario, we could see a $5.90-7.40 per share dividend.

    TER: Agrium announced an aggregate $1 billion [$1B] debt issue of 10-and 20-year debentures on Feb. 25. Is this troubling?

    JC: No, it's just standard debt management.

    TER: Among the companies you cover, how do you rate Agrium's peers?

    JC: We cover PotashCorp. We're concerned about the potash side because of the possibility of oversupply. We had inventory restocking in 2014 and, as I've already noted, Belaruskali is flooding the market and offering price discounts. This is not good for the potash price outlook.

    TER: PotashCorp just bought 9.5% of the Brazilian company Fertilizantes Heringer S.A. [FHER3.SA:Sao Paolo] for $55.7 million [$55.7M]. Is this significant?

    JC: It's certainly very interesting. It's a good move for the company because Brazil is one of the top three fertilizer consumption markets in the world, and we believe there's substantially more upside as to how much fertilizer the country can import and consume.

    The Moroccan state fertilizer company OCP (Office Chérifien des Phosphates) bought a 10% stake in Heringer in January. This led to a long-term supply agreement whereby OCP will provide Heringer with phosphate-based products. I think PotashCorp is hoping they can do something similar with Heringer: a long-term supply agreement with a large fertilizer producer and distributor in one of the world's fastest-growing fertilizer markets.

    TER: Your January industry update highlighted the emerging importance of the "higher-margin food ingredient sector." Could you explain what that is?

    JC: It relates to the desire of health-conscience consumers for non-GMO, gluten-free, low-fat, high protein and high fiber diets. Food companies are responding to this and also moving toward higher efficiency, sustainability and having smaller carbon footprints.

    To give an example, AGT Food and Ingredients Inc. (OTCPK:AGXXF) [AGT:TSX] had traditionally processed crops by sorting, dehulling and cleaning. The problem with that approach was that it resulted in lower margins, in the high single-digits. The company is now taking a different approach. Instead of merely cleaning and sorting a crop, it is processing it even further, into pulses-food ingredients that food companies can then use. This approach results in much higher margins, double and perhaps even greater.

    TER: Pulses are lentils, peas, beans and chickpeas? Is that correct?

    JC: Foods like that, yes. These pulses are now being incorporated into healthier breads, chips, soups, peanut butter and even beverages. This is a huge opportunity for the food industry, the potential of which is still in the early stages.

    TER: How do consumers know that food products contain higher value food materials?

    JC: Through advertising. The healthier ingredients will be reflected in labeling, which will note lower saturated fat contents, higher fiber and protein contents, that the food is non-GMO, etc. Higher-value foods are getting a big push from big industry players. General Mills has introduced it into Cheerios. Whole Foods and Walmart are moving in this direction.

    TER: AGT announced an $80M bought-deal financing in October. What does the company intend to do with that money?

    JC: Some of it will pay down debt. Some of it will go toward fine-tuning its plant in Minot, North Dakota. The rest will be spent to convert existing excess capacity at its legacy facilities in Canada, the U.S. and Turkey to produce pulse ingredients, and add an additional pasta line in Turkey.

    AGT stock was up 67% in 2014 on the basis of its food ingredient initiative and its joint venture with Ingredion Inc. (NYSE:INGR), a company with a $5.7B market cap.

    TER: AGT stock rose to almost $30/share in February but has since fallen to about $27/share. Have we seen the end of its run?

    JC: I don't think so. The company will report results in the next couple of weeks, and update the investment community on its progress in converting excess plant capacity to pulse ingredients. This conversion will essentially raise utilization rates and improve margins. We'll probably also hear final plans regarding the addition of a new pasta line. These data points down the road will provide much more clarity regarding AGT's expansion, and should help fuel continued momentum for the stock.

    TER: Your industry update also highlighted the emerging importance of what you call "non-traditional agriculture."

    JC: There's one particular company in this sphere we like: Input Capital Corp. (OTC:INPCF) [INP:TSX.V], which streams canola.

    TER: Input recently announced its intention to consider streaming soybeans as well. What do you think of that?

    JC: It's definitely a smaller market opportunity, but interesting nonetheless. There are about 50,000 canola farmers in Canada, but only about 6,500 soybean farmers. Most canola farmers are on the prairies, whereas 85% of soybean farmers are in Ontario. When Input presented farmers with the opportunity to stream canola, what the company heard from some farmers was that there was less of an interest in canola, and more in soybeans.

    TER: Considering that soybeans are considered health food, and given the increasing popularity of Asian food, could the soybean market earn a significantly larger share of Canadian agriculture?

    JC: I would expect both soybeans and corn to generate potentially larger market shares. And both deliver substantially better margins than wheat.

    TER: How diversified could Input become?

    JC: The company is somewhat limited by the nature of the market. Input's concept is built around futures contracts, which enable pricing visibility going forward. Soybeans are in the oil-seed complex with canola, and the prices are fairly well correlated with each other. Crops without futures contracts would be much harder to stream. For example, I don't think Input would look at wheat. Actually, I don't think the company is in a position to look beyond soybeans now, because there's so much untapped opportunity on the canola side.

    TER: How do you rate Input in terms of the number of contracts it has signed, and in terms of its balance sheet?

    JC: The company announced it had deployed $16.9M as of the quarter ending December. That was a very nice surprise, considering it is a seasonally weak period. The company signed 26 contracts, of which 24 were new. That demonstrates a growing confidence in streaming within the farming community. The January-to-May period is the time when Input will be busiest.

    Input has got about $50M cash. No complaints there.

    TER: Let's talk about companies in the ancillary ag space.

    JC: I'll mention three we like. The first is Ag Growth International Inc. (OTCPK:AGGZF) [AFN:TSX], which is in the handling and storage business. AG was one of our top picks in 2014, and was up about 26% that year. The company announced a $90M public offering on Dec. 1, to partially fund its acquisition of Westeel from Vicwest Inc. (OTC:VICUF) [VIC:TSX]. Westeel is involved in green storage and has a dominant market share in western Canada. This complements Ag Growth's core business, as grain handling and storage work hand-in-hand, and should help drive earnings in 2015.

    Ag Growth has also demonstrated good growth in international markets-specifically in Ukraine, despite that country's difficulties. The company is looking at expanding its Brazilian operations. It is beginning with a small greenfield expansion, with the hope that it can become more substantial. We're pretty excited to consider what this company can do in Brazil, given its upside in storage and grain handling. We like this name for 2015 and beyond.

    TER: And the other two companies are?

    JC: The other two are in transportation. The first is Cervus Equipment Corp. (OTC:CSQPF) [CVL:TSX], a well-diversified company and a potential sleeper for 2015. It is the largest John Deere dealer in Canada, and has some exposure in Australia and New Zealand. It has also has an industrial transportation component, which is about a third of its business.

    Cervus made several acquisitions in the second half of 2014, and these should help drive 2015 earnings growth. This might actually surprise some people, because the 2015 ag equipment environment will generally be troublesome. Fortunately, the company has good exposure to the used vehicles, parts and service sectors. If farmers aren't buying new equipment, they are likely to buy used equipment instead, which would help offset new equipment sales weakness. In addition, Cervus will further offset losses with its high-margin (higher than equipment sales) equipment servicing side.

    Rocky Mountain Dealerships Inc. (OTCQX:RCKXF) [RME:TSX] has a very strong brand name. Rocky is more Canada-based than Cervus-not as geographically diversified. But like Cervus, they also have exposure to used equipment and the higher-margin sales and service business.

    We believe there's an opportunity for this company to become involved in the ongoing consolidation of the equipment industry and to expand into the U.S. with acquisitions there. We hope to see that happen. Once again, this is a challenging environment, but the Canada-based equipment players should do better because Canadian farming is expected to be down only 7% year-to-year in 2015, as compared to American farming, which is expected to be down 22%.

    TER: To sum up, what are the best choices for investors in agricultural products?

    JC: We like the nitrogen players rather than potash, and Agrium is our best bet for that sector. The market for healthier foods is expected to show a substantial increase, and therefore companies with a growing stake in that market will demonstrate higher margins, which in turn will lead to better visibility, more stability and, in time, higher valuations.

    TER: John, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Energy Report and can be read in its entirety here.

    John Chu, CFA, is managing director of agri-industry institutional equity research at AltaCorp Capital Inc. He was previously senior vice president in agriculture and industrials research at Mackie Research Capital, and also worked for Scotia Capital and HSBC Securities. He holds a bachelor's degree with honors in economics from Queens University, and a master's degree in business administration from the University of Western Ontario.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    DISCLOSURE:
    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Input Capital Corp. Streetwise Reports does not accept stock in exchange for its services.
    3) John Chu: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. AltaCorp Capital is a market maker for the following companies mentioned in this interview: Agrium Inc. AltaCorp Capital was involved in an equity financing for Input Capital Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Tags: energy
    Mar 19 5:53 PM | Link | Comment!
  • Michael Waring Has Seen The Energy Downturn Movie Before, And He's Not Worried

    With oil and gas prices down, it's time to cull the herd, sell marginal producers and double down on the strong ones in your portfolio, says Michael Waring, founder of Galileo Global Equity Advisors Inc. In this interview with The Energy Report, Waring explains that this kind of correction happens every 10 years in this space. It presents opportunities for companies to improve and investors to profit-and he names four companies he considers most likely to succeed.

    The Energy Report: Michael, you said in November that the Organization of the Petroleum Exporting Countries (OPEC) expected the U.S. to share in reducing production growth to help stabilize the oil market. Have events justified that expectation?

    Michael Waring: Events have not. But I think we need to address that statement. I don't believe that the Saudis are out to hurt Iran, to punish the Russians or to take down shale oil production in the U.S. I don't think this is some Machiavellian scheme. I think it is simply a question of market share. The Saudis are saying they have the lowest operating costs in the world, so why should they be the first guys to cut? It makes more sense that the more expensive guys cut production first. When you say it that way, you can actually understand the point the Saudis are trying to make here. It wouldn't be logical to assume that Russia or the U.S. would voluntarily take production down, but it's going to be forced on them by lower prices.

    And the Saudis have really talked the price down. When you look at the rhetoric of the last two months, they've gone out of their way to drive it down. I think the basic attitude has been that if the high-cost guys don't want to voluntarily reduce production, we'll make them reduce it by lowering the price to the point where it hurts.

    TER: Will those low prices do permanent damage to the North American industry?

    MW: I wouldn't use the word permanent, but damage is being done that will take probably more than a couple of years to recover from.

    I think that the smaller oil and gas companies on the shale oil and gas treadmill-and I refer to it as a treadmill because they have to keep drilling aggressively if they want to keep their production flat or growing-have a real problem now because the banks won't lend to them, the bond markets are closed to them and they can't issue equity because the stocks have collapsed. You'll see consolidation. And it's going to shake a lot of the marginal guys out of the business.

    "Investors want to use this as an opportunity to clean house and go high grade into the companies that will give good torque on the way up."

    This happens every 10 years in the oil and gas industry. It is a commodity business after all, and what's happened to the price isn't way out of line with what's happened in the past. This is actually a good thing about the industry: It tends to be self-correcting and cleansing. What happens at a moment like this is that the good guys, with really good plays, are solid and secure. It's the marginal guys that get squeezed out, and the marginal guys tend to drive the cost up over time because everybody is outbidding for services. If you clean all those guys out, then you have a reset back to a lower cost base, and a focus on oil and gas plays that make sense and generate a good economic return through full-cycle pricing.

    TER: What should investors do in this market?

    MW: In our own portfolio, if we have two or three names in the energy sector that we were interested in, or that we owned but didn't have a high degree of conviction in, we would use this as an opportunity to sell those names and double down on the two or three stocks that we have a high degree of conviction in-that we know will dramatically outperform coming out the other side. That's a key. Investors probably want to use this as an opportunity to clean house on the energy portion of their portfolios and go high grade into the companies that will give good torque on the way up.

    TER: Is there a silver lining for oil and gas investors in this dark cloud of falling prices?

    MW: In every previous cycle, prices 6-12 months after the bottom are up quite sharply. I don't know the exact timing this time around, but I do know that the harder and faster prices come down, the harder and faster they're going to go up. That's typically been the case, unless you want to utter those very dangerous words: "This time is different."

    The point I would make is that we have an opportunity to buy shares in companies where the stock price is down 50-60%, but the business models are not impaired and the companies have a solid asset base. We are actually being given a gift. If you can look out one year, it will be a gift to own these stocks at fabulous, attractive valuations.

    TER: The Energy Information Administration (NYSEMKT:EIA) is forecasting Brent crude averaging $58/barrel ($58/bbl) in 2015 and $75/bbl in 2016. What's your forecast?

    MW: We wouldn't be too far off that. I just had to send an estimate out to a client, and we're thinking $70-75/bbl oil in 2016, and we're depending on natural gas at $2.75-3.25 per thousand cubic feet ($2.75-3.25.Mcf).

    TER: Is that oil price Brent or West Texas Intermediate (NYSE:WTI)?

    MW: That's WTI. I wouldn't say they're trading at parity, but the gap between Brent and WTI has narrowed dramatically.

    TER: Do you expect that to remain the case? They've been running $3-4/bbl apart.

    MW: On a go-forward basis, I'm expecting it to remain narrower than it's been historically, or for the last two years, let's say.

    TER: The EIA's forecast seems to point to an extended period for lower prices. What oil and gas investments are safe in such a market?

    MW: We have to remain focused on the fundamentals behind the business. It's a moment where psychology has taken hold, and people have forgotten, overlooked or can't be bothered with the fundamentals. The fundamentals of each company on its own will tell us what we need to know. If you look at the supermajors and large-cap oil companies, from Suncor Energy Inc. (NYSE:SU) to Canadian Natural Resources Ltd. (NYSE:CNQ)-we don't own those names and those aren't part of our universe-any company of that stature is going to be just fine. Likewise, a company like PrairieSky Royalty Ltd. (OTC:PREKF) [PSK:TSX] on the royalty side is going to be fine. It's debt free with a lot of cash. There are ways to play this sector at the moment, looking at companies with very attractive valuations, solid balance sheets, and secure assets and cash flow going forward. Something like PrairieSky, in my mind, would certainly fit the bill.

    TER: Are you expecting mergers and acquisitions (M&A)?

    MW: I think there will be consolidation in the business. I think that's inevitable. Having weak players without a lot of choices in terms of flexibility going forward will lead to mergers and consolidations. But good companies with good asset bases won't have to be in the M&A game. All they need to do is focus on those assets.

    TER: You have a diverse portfolio of companies. Are the companies you're referring to in that portfolio?

    MW: Yes, they are. We have a concentrated list of holdings in oil and gas. Oil and gas currently makes up about 20% of our mutual fund holdings. We have a fairly concentrated list of four or five names that we like a lot.

    TER: Can you talk a little about some of those?

    MW: Sure. The first one would be Paramount Resources Ltd. (OTCPK:PRMRF) [POU:TSX]. I think at one point late last summer, this was a $65/share stock. It cut down to $22/share. It's currently $29/share. This is a natural gas and liquids producer. It has exposure to a play in Western Canada, along with a company called Seven Generations Energy Ltd. (OTC:SVRGF) [VII:TSX]. These two companies together probably have the most attractive rock in the Western Canadian sedimentary basin. The returns from this play are the highest we can identify out there, because of the high level of liquids and condensate produced alongside the natural gas.

    "What happens at a moment like this is that the good guys, with really good plays, are solid and secure."

    Paramount has decided to build its own infrastructure and its own gas processing plant, as opposed to using a midstream company like a Keyera Corp. (OTC:KEYUF) [KEY:TSX] or Pembina Pipeline Corp. (NYSE:PBA). What that means is that on a go-forward basis, Paramount will capture more margin and have lower operating costs and greater control over its operations than a company using a third-party midstreamer.

    We're very excited about this company. It is currently producing 37,000 barrels a day (37 Mbbl/d) from a gas plant that it brought on last June. It is adding a piece of equipment in the plant that will allow it to deal with all the condensate and liquids coming out of these wells. When that is complete in March, corporate production will increase to 70-75 Mbbl/d in 2015. The company will have a dramatic increase in production and a dramatic increase in cash flow.

    The knock against the company is that it borrowed a lot of money to build up this plant. It was a $250 million ($250M) capital expenditure, so the debt numbers look high. But we would argue that once it is up and running at 75 Mbbl/d, on an annualized basis, the cash flow is going to be $700M at $65/bbl oil. We think the debt/cash flow numbers are going to dramatically improve. In this environment, how many companies can double production in the next four to six months? Understand, the money is all spent. The company has 45 wells standing behind pipe to support this plant once the stabilizer comes onstream. There's nothing that Paramount has to do at the margins. It's a slam dunk.

    The risk is that we want to see this stabilizer come onstream smoothly. It's going to have a startup period, but the main plant itself was started up last spring, and Paramount has been able to bring that on pretty steadily, without any problems or interruptions. This is a name we like a lot. We think when prices finally bottom, this stock will recover very quickly.

    TER: What other companies do you like?

    MW: One is Secure Energy Services Inc. (OTC:SECYF) [SES:TSX]. This company deals in oil field waste and water disposal. This is a razor blade-type story, because Secure Energy provides a service to the industry, and whether prices are up or down, the industry needs to deal with waste and water. As wells mature in Western Canada, they tend to have higher water production over time, so the older a well gets, the more water it produces. This is probably the most solid of all the service businesses that we know of.

    Management at Secure Energy is great. I've known the guys for 15 years, maybe longer, and they've done an excellent job to date, since the company has come public. Secure has been beaten up along with other oil service names, but it stands apart. This company will stay busy-maybe not at the same level, but it's going to stay busy.

    "The Saudi attitude has been that if the high-cost guys don't voluntarily reduce production, we'll make them reduce it by lowering the price until it hurts."

    Then I'd mention Canadian Energy Services and Technology Corp. (OTCQX:CESDF) [CEU:TSX]. It provides drilling fluids to the oil and gas industry. Part of the business is tied to oil well drilling, because the company makes specialized fluids needed to drill complex horizontal wells. But it also produces chemicals used by the industry to stimulate production from existing wells. This is a consumable-chemistry company, not a true oil and gas service company. Again, it doesn't have to go out and invest in all kinds of steel and iron. What it invests in is research and development in a chemistry laboratory.

    We like this company. It has tremendous free cash flow because it doesn't have to buy and sit on equipment. We think, again, this is a name that will come rocketing back when the time is right. EOG Resources Inc. (NYSE:EOG), in the States, is the biggest operator in the Eagle Ford Basin-one of the best at what it does. It uses Canadian Energy Services for all of its drilling fluids, so that should tell you something about the quality of the product.

    The last company-a straight oil company-is Whitecap Resources Inc. (OTC:SPGYF) [WCP:TSX.V]. It has top management and light oil. It has a dividend yield of something like 7.25%. The all-in payout ratio is about 100% at current prices, but that compares very favorably to most other dividend-paying companies in the space. Whitecap has maintained a very steady payout ratio. It is very good on the operating cost side. Again, this one will come bouncing back when the psychology finally turns in the oil market.

    TER: A lot of energy service companies are suffering because of lower demand from their customers. Are Canadian Energy Services and Secure Energy Services having that problem?

    MW: To date, no, they are not. It's not to say that at some point. . .Come spring breakup, will activity fall off? Yes, it probably will. These companies will not be completely immune to a slowdown in the industry, but they'll be a whole lot more immune than, let's say, contract drillers and other service companies. And they'll provide really good torque on the upside. Again, when the psychology turns and people decide it's not the end of the world for the energy industry, names like this will be the first out of the box to bounce back.

    TER: What is going to give them a leg up?

    MW: I think it's the high-quality nature of what they do. Both companies provide something very specialized, as opposed to a fleet of generic drilling rigs. They are not commodity-type businesses. In the case of Canadian Energy Services, when it gets involved with a company like EOG Resources, it tailors its drilling fluids to suit the needs of EOG in that particular field. Once it gets engaged with a customer, it's very hard for that customer to go somewhere else just because somebody can shave 10% off the price. This is very specialized stuff. Once you get that relationship going, you have to really screw up to lose that relationship.

    TER: What are Paramount Resources and Whitecap Resources doing to ensure they can survive in this low-price market?

    MW: Both are watching their capex very carefully. Paramount does not pay a dividend; Whitecap does. It has a history of raising that dividend, and has done so every couple of quarters consecutively since it became public. Just before Christmas, Whitecap said it was expecting to raise the dividend in January this year, but it has decided to defer that increase until it sees how things shake out.

    "The harder and faster prices come down, the harder and faster they're going to go up."

    In both cases, it's a function of how quickly these companies want to grow, or whether they want to slow down the growth rate. They have the luxury of deciding their fates, of determining how quickly the business grows or whether they're going to throttle back on capital expenditures and slow it down.

    TER: What qualities in a company catch your attention and keep you interested?

    MW: I think in oil and gas, first and foremost, it has to be the management team. I don't know any other business where companies end up reinvesting so much capital in the business. If you're not good at what you do-if you're not good on the cost side-you can blow your brains out and destroy capital very quickly. Investors should get a read on management-look at the track record, the pedigree, etc. Operating costs and netbacks tell you a lot about the caliber and diligence of management. Those are very important metrics to look at.

    Second, investors need to assess the geology of the company's holdings. Asset quality can vary greatly between companies. To use Paramount as an example, you can't own better rock in Western Canada. Maybe somebody will find something else in the future, but at the moment, this company has some of the best acreage in the business. Understanding something about the geology is helpful.

    It's never easy going through the down times. I've been to this movie before, and quite frankly I'm tired of seeing it. Each movie plays out a little differently, but it always ends up the same. At the moment it feels like it's the end of the world, it will never come back, etc., etc. But it always feels this way. Every cycle, it always feels this way.

    TER: Thank you for your insights.

    This interview was conducted by Tom Armistead of The Energy Report and can be read in its entirety here.

    Before forming Galileo Global Equity Advisors Inc. in 2000, Michael Waring served from 1985 to 1999 as a vice president, director and portfolio manager at KBSH Capital Management Inc., a private investment management firm with over $10B under management. Waring obtained his master's degree in business administration from the University of Western Ontario, is a CFA charter holder and a member of the Toronto CFA Society.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Tom Armistead conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Michael Waring: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Paramount Resources Ltd., PrairieSky Royalty Ltd., Secure Energy Services Inc., Keyera Corp., Canadian Energy Services and Technology Corp., Whitecap Resources Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.
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    Streetwise - The Energy Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

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