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  • Oil And Gas Investor Editor Leslie Haines: We Will Never Stop Importing Oil, But We May Start Exporting

    Horizontal drilling and fracking have opened new opportunities for investing in domestic energy, whether for pure-play explorers in developing shales, producers in mature areas, or service companies opening up the monster wells. Oil and Gas Investor Editor-in-Chief Leslie Haines has been following the revolution for nine years, and agreed to share with readers of The Energy Report the names of some beneficiaries of new technology's multiplier effect.

    The Energy Report: As editor-in-chief of Oil and Gas Investor, based in Houston, you follow the development of U.S. shale closely. Is the U.S. really on track to energy independence, or will depletion rates cut this boom short? What are the production numbers telling you?

    Leslie Haines: I have been covering shale development since 2005, and it looks like we are on track for energy independence by 2020 or so. However, we're never going to stop importing oil because supply diversity is prudent.

    Depletion rates are significant in every shale play. Some of the depletion rates are quite steep in the early years of a play, but wells tend to produce for 20 years or so at a lower rate, so overall production rates are still growing.

    The monthly U.S. Energy Information Administration [EIA] reports show that in H1/14, U.S. gas natural production alone increased by more than 4 billion cubic feet a day [4 Bcf/d]. The bulk is coming from the Northeast, from the Marcellus and Utica plays in Pennsylvania, Ohio and West Virginia. Also, a lot of new natural gas is coming on, in association with oil production in West Texas, in the Permian Basin, and in south Texas, in the Eagle Ford play. While some gas areas might be declining, we're getting enough new natural gas to offset that decline. In fact, both oil and natural gas production in this country are the highest they've been in about 35 years.

    Natural gas in storage was down last year, and now we're refilling. Every summer and fall, you refill storage to prepare for winter. It looks like we're going to have a lot of gas in storage. We've had a fairly mild summer and haven't had a huge call for natural gas for air conditioning, compared to what it could have been. Between the production and the weather factors, it looks like we'll have plenty of gas in storage for the fall.

    TER: How will the development of monster wells, as they're being called, impact that balance?

    LH: When we say monster well, we are referring to an above-average initial flow. We're seeing this happen in the Utica play in West Virginia and southern Ohio. Some very large dry-gas wells are being reported with initial flows of 20-25 million cubic feet of gas a day [20-25 MMcf/d]. That's a huge gas well by anybody's measure. It is just one more example of U.S. production surging due to horizontal drilling and fracking. Those two techniques combined have revolutionized everything in this country and allowed us to recover a lot more of the underground reservoir.

    TER: The techniques continue to develop as more environmentally friendly and efficient methods are discovered. What are some new techniques you are seeing?

    LH: The size of the average frack is getting quite a bit bigger. It used to be that the horizontal leg might only go out 1,000-2,000 feet [1,000-2,000 ft]. Now, it's going out as far as 5,000-7,000 ft horizontally, so the well bore is exposed to more of the reservoir. The size of the fracks has also gotten bigger, with 20 or 30 frack stages along a lateral. That has increased production.

    In one basin, you may find the number of formations that can be tapped is quite numerous. In the Permian Basin of West Texas, for example, more than 5,000 vertical feet of pay can be tapped. If you sink three horizontal legs into that well, three different horizons can be fracked and produce from one well. It triples the effect of that well and acreage.

    TER: What's an example of a company taking advantage of that multiplier effect?

    LH: Two good examples are Pioneer Natural Resources Co. (NYSE:PXD) and Concho Resources Inc. (NYSE:CXO) in the Permian Basin. Production is soaring. In fact, Pioneer is one of the companies that recently received special permission from the government to export a little bit of condensate as a test case. Pioneer is a very active proponent of exporting crude.

    TER: Is the company testing price impact, or market demand, or something else?

    LH: All of the above. The company is trying to prove to the government that we need to be able to export crude oil in addition to refined products like gasoline. It is very controversial.

    TER: In the absence of exporting, are we producing too much? The EIA's Weekly Natural Gas Storage Report showed 2,801 Bcf at the beginning of September. Is oversupply keeping the price of natural gas down?

    LH: A lot of Wall Street analysts have reduced their outlooks for oil and gas pricing-and company earnings projections-through the rest of this year and into next year. For example, Bernstein Research just came out with a report in which it is bringing down its natural gas price estimate for 2015 from $4.50/thousand cubic feet [$4.50/Mcf] to $4/Mcf. It plans to leave the price there through 2016.

    We are seeing such an incredible surge in supply of both oil and gas that producers, analysts and investors are starting to get a little bit worried. We had very high natural gas prices a few years ago, and then the surge of new production, combined with a mild winter, made the price of natural gas go right back down. At one point, natural gas was below $4/Mcf. It's come back a little this year, but there is still quite a bit of concern.

    TER: Are today's prices less than what it costs to pull the oil out of the ground?

    LH: Producers are still making money, but the prices for drilling and fracking are inching up because there's so much demand for wells to be drilled and fracked.

    TER: You sat on a panel at the Stansberry Society conference in Dallas with S&A Resource Report newsletter writer Matt Badiali earlier this year to talk about the future of shale. He divides the shales into mature [the Bakken and the Eagle Ford], and developing [the Tuscaloosa, Utica and Cline areas]. Are investors rewarding companies with shale play diversity, or is it considered smarter to master one shale type?

    LH: The stock market used to reward companies for diversity. Investors wanted to see a balance between oil and gas, and two, three or four different project areas. However, that has changed. Now investors favor pure-play companies. A company like Oasis Petroleum Inc. (NYSE:OAS), which is in just one play, the Bakken, has done very well in the last year.

    Sanchez Energy Corp. (NYSE:SN), which is in the Eagle Ford and Tuscaloosa Marine Shale, is not being rewarded for the Mississippi project yet. The Tuscaloosa play is still developing, and hasn't proven to be economic yet. The company has some expensive wells with downhole technical challenges. The players in that area are still working on solving the geology. In the Eagle Ford, however, Sanchez is very experienced and successful. That part of its business is well recognized.

    But, in general, I would say that diversity is not being rewarded in the market at this time. It's better for companies to focus on two or three plays at the most, and in well-established areas like the Bakken, the Eagle Ford and the Marcellus.

    TER: Are there still upside opportunities in the established shales?

    LH: The Marcellus Formation is considered the second largest gas field in the world. Production keeps growing every quarter. It's difficult for a company to get in there now. Most of the lease positions are already carved out. Companies have gone beyond finding the sweet spots, and are focusing on two things. One is how to drill a more efficient well faster, while reducing costs. The other is infrastructure. The Marcellus and Utica plays are constrained because there is not enough pipeline to get all the gas to market. A ton of midstream projects have been proposed and are underway. Billions of dollars are being spent to build pipeline infrastructure to move the gas not only to the population centers in the northeast, but also to eastern Canada. Some of the gas is going to be piped down to the petrochemical plants on the Gulf Coast. Some of the gas is even being piped to the West, to Chicago and beyond.

    TER: This sounds like more of a manufacturing operation, now that companies don't seem to be drilling dry holes anymore. Who are the main players?

    LH: Companies like Cabot Oil & Gas Corp. (NYSE:COG), Range Resources Corp. (NYSE:RRC), Chesapeake Energy Corp. (NYSE:CHK) and EQT Corp. (EQT:NYSE) are doing quite well in the Marcellus. The same thing is true in the Bakken, the Eagle Ford and the Permian Basin. Some 20 companies may drill a play, but a handful do most of the work. And they are the bigger companies.

    TER: Do you envision mergers and acquisitions in that space, as some of these companies mature?

    LH: It's really about the play maturing. We see a similar pattern in every shale play. Companies decide that a play is relatively mature, and that they can make a higher return somewhere else. They put their assets on the market, sell to somebody else in that play or to a master limited partnership [MLP], and then redeploy their money into another play that might have a faster growth trajectory.

    TER: What is a recent example of that?

    LH: Marathon Oil Corp. (NYSE:MRO) sold its North Sea assets to redeploy more capital to the Eagle Ford, which has much higher returns.

    TER: You wrote a September cover story on service and supply companies, which is one way investors are leveraging the oil and gas industry. Are margins increasing in that business?

    LH: It looks like they're about to, yes. Almost 1,900 rigs are drilling in this country at any given time. I'd say 90% of those wells will need to be fracked. That is an enormous demand for rig crews, frack crews and all the associated equipment and materials. Last year, about 17 million hydraulic horsepower was installed. The amount of horsepower available for fracking has probably doubled in the last five years. Everything is bigger, longer, higher pressure-more, more, more. Service companies have pricing power because there is such a frenzy of activity right now.

    TER: There are many types of service companies. Is there one part of that industry that's growing faster than the others?

    LH: One bright spot is in companies that provide sand for fracking. They've been doing extremely well in the marketplace. Their stocks are way up, and they keep adding new capacity, to deliver yet more sand to the marketplace for fracking. The oil field service index, PHLX Oil Service Sector (OSX:NASDAQ), has risen steadily since January, and the hottest subsector seems to be the frack sand providers. Some of them have tripled in the past 12 months.

    TER: What are some examples of solid frack sand providers?

    LH: US Silica Holdings (NYSE:SLCA), Hi-Crush Partners LP (NYSE:HCLP) and Emerge Energy Services LP (NYSE:EMES) are three. Their revenues mirror the increase in drilling activity, which could be 14% in the next year. That is why analysts are telling us that it looks like profit margins have come off their lows, and service prices are starting to rise again.

    TER: Thank you for taking the time to talk to us.

    LH: Thank you.

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

    Leslie Haines is editor-in-chief of Oil and Gas Investor magazine. She began her journalism career in 1980 in Williston, North Dakota, at the Williston Daily Herald. She was the energy and business reporter for the Midland Reporter-Telegram in Midland, Texas, in 1982 and 1983. She joined Hart Energy Publishing in Denver in late 1983 as a copy editor. Soon thereafter she began writing for Western Oil and Gas World. In 1985, she joined the staff of Oil and Gas Investor magazine. She was named managing editor two years later, and became editor in January 1992. In November 1992, the Independent Petroleum Association of America awarded Haines with the 2nd Annual Lloyd Unsell Award for Excellence in Petroleum Journalism. She is a former president of the Houston Producers' Forum, and is on the board of the Houston Energy Finance Discussion Group.

    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) JT Long 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. She owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) Leslie Haines: 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. 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 what 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.
    3) 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.
    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.

    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.

    Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

    Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

    Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.

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    Oct 02 2:54 PM | Link | Comment!
  • Kal Kotecha: Going Against The Grain In The Junior Resource Market

    Economics professor and newsletter writer Kal Kotecha says to obtain superior results, you cannot do what everyone else is doing. He maintains that much of the risk associated with junior resource equities has been beaten out by the herd mentality and that selectively buying what's left presents mindboggling opportunity. In this interview with The Mining Report, Kotecha shares some insights in the current junior resource market to help investors.

    The Mining Report: You're the editor of Junior Gold Report, but you also follow similar-sized companies in the energy sector. Please give our readers an overview of the energy space.

    Kal Kotecha: I've been involved in the space since 2002 and I've never witnessed anything like what is currently happening. In the energy sector, I see the price of uranium increasing, but to see price appreciation across energy stocks, the price of oil must remain near $100 per barrel [$100/bbl]. That $100/bbl benchmark could prove challenging, given the growing supply of shale oil in the U.S. Texas produces as much oil as Iraq or about 3 million barrels of oil per day [3 MMbbl/d]. Most of it comes from two sources: the Eagle Ford Shale in southwest Texas and the Permian Basin in west Texas. Chris Guith, senior vice-president of policy for the U.S. Chamber of Commerce's Institute for 21st Century Energy, estimates that recoverable resources amount to 120 years of natural gas, 205 years of oil and 464 years of coal at current demand levels.

    Fracking has lowered the price of natural gas by about 70% over the previous seven years or so. The price of oil, especially in the U.S, should decrease to $60-70/bbl on average because of shale oil. U.S. dependency on imported oil should lessen, too.

    TMR: You said that the ready availability of shale oil could eventually push crude prices to $60-70/bbl. Is that a near- or medium-term forecast?

    KK: That's a medium- to longer-term forecast. I don't believe in peak oil theory. The U.S.' savior in the oil industry is going to be shale oil, and there is a lot of it. Ultimately, that's going enhance the U.S. economy. Basically everything runs on oil. The U.S. won't have to import as much oil from Saudi Arabia or even Canada.

    TMR: What's your price forecast for natural gas?

    KK: Natural should stay between $4-6/thousand cubic feet [$4-6/Mcf]. It's more expensive in Europe, but in North America the floor should remain around $4/Mcf. I don't think it's going to go back up to $12 or down to $3.

    TMR: You mentioned earlier that you expect uranium prices to rise.

    KK: Uranium is an interesting space. As oil prices slowly decrease, the demand for uranium seems to increase. Geopolitical tensions, especially in Russia and Ukraine, could lead to much higher prices. Russia is a large uranium producer and Western nations might stop importing uranium from Russia if political fires burn much hotter.

    As of last month, China had 21 nuclear power reactors operating on 8 sites and another 20 under construction. China's National Development and Reform Commission intends to raise the percentage of electricity produced by nuclear power to 6% by 2020 from the current 2% as part of an effort to reduce air pollution from coal-fired plants. Ultimately, uranium demand will triple inside six years.

    In India, the government is expected to spend nearly $150B to develop nuclear power over the next 10-15 years. India now has nuclear energy agreements with about a dozen countries and imports primarily from France, Russia and Kazakhstan.

    TMR: In a recent note on Junior Gold Report you wrote, "I smell smoke, but where's the fire?" in relation to the current sentiment in the junior precious metals market. What's your conclusion?

    KK: The current pessimism surrounding the junior precious metal space has largely contributed to the fall in price of the commodities, but the beautiful thing about pessimism and hate towards a market sector is that there is plenty of room for error. Fantastic opportunities arise when great companies have been undervalued due to negative news that does not have a long-term impact on the company. So how do you determine which stocks, in a beaten up resource market, are great buys?

    TMR: Do you have an answer?

    KK: One must understand the essential principles of intrinsic value and the margin of safety. The principle of intrinsic value determines the worth of a stock through a combination of the price and the condition of the company. So no matter how great a company is, it may not always be a good investment. As Howard Marks wrote in The Most Important Thing: Uncommon Sense for the Thoughtful Investor, investment success doesn't come from buying good things, but rather from buying things well.

    The principle of the margin of safety involves minimizing risk and then, therefore, minimizing the potential loss of one's money. Dealing with risk is a necessary part of investing, as stock price fluctuations occur and are often unpredictable. If the risk perceived by the herd-general investors who follow the majority-is less than the actual risk, then the returns will outweigh the risks. So when consensus thinks something is risky, the general unwillingness to buy it pushes the price down to where it is no longer risky at all, given it still has intrinsic value, because all optimism has been driven out of the price.

    TMR: What are some metrics to help investors?

    KK: A junior mining company's ability to produce resources at a cost below its market price is essential for its sustainability. Junior mining companies should be judged by their ownership of mines, the quality of these mines and how management has executed similar projects in the past. Determining whether this data has been incorporated into the stock price is essential when seeking undervalued companies. I think this is where a lot of resource investors get duped.

    Do you smell the smoke? I suggest investigating the source. I'd say that the herd is done shouting fire, and smart investors are filling up their baskets with goodies. But don't forget to do your research, check the facts and invest in a contrarian fashion. To obtain superior results, you cannot do what everyone else is doing.

    TMR: Many investors have heard the adage "buy when there's blood in the streets." When should investors reasonably expect to start making money again, given the current market conditions?

    KK: That's a billion-dollar question. A lot of colleagues have predicted prices that have not come true yet. The big upswing in gold in the late 1970s was followed by a collapse and we had to wait 20 years for another upswing. It's already been three years. I don't think we have to wait another 5 or 10 years, but there is going to be a time very soon where investors will be rewarded. I think when the upswing happens it's going to be very parabolic. I think it's going to take wings on its own. Patience will be rewarded.

    TMR: What gold price are you using in your analysis?

    KK: $1,200 an ounce [$1,200/oz]. Many factors go into determining the price of commodities, especially gold and silver. Some of these factors include price manipulation, which cannot be foreseen; geopolitical strife; and import quotas, which are happening in India. However, I remain very bullish on precious metals in the long-term.

    The best buy right now is silver. Silver is a screaming steal at $18/oz. I first started buying silver at around $7/oz in 2003 and I sold quite a bit in the $48 range a few years ago. I'm starting to accumulate silver quite heavily again. The ratio of gold to silver prices is currently around 68:1. I see that going to 50:1. If there's another precious metals mania, perhaps 25:1. Silver demand is also very high. A record 6,000 tons silver was imported into India last year-roughly 20% of global production.

    TMR: What's your advice for investors in the current junior resource market?

    KK: I think a combination of five or six stocks in a portfolio with a mix of junior energy and mining equities is probably a good start. That's what I do. It's difficult for the average investor to follow more than five companies.

    TMR: Thank you for your insights, Kal.

    This interview was conducted by Brian Sylvester of The Gold Report and can be read in its entirety here.

    Kal Kotecha is the editor and founder of the Junior Gold Report, a publication about small-cap mining stocks. He was the editor and creator of The Moly/Gold Report, which focuses on critical analyses and open journalism of companies profiting from the precious and base metals sector. The scope of his current activities include worldwide onsite analyses and reporting of developing companies. Kotecha has previously held leadership positions with many junior mining companies. Kotecha completed his Master of Business Administration in finance in 2007 and is working on his Ph.D. in business marketing. He also teaches economics at the University of Waterloo.

    Want read more Mining 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) Brian Sylvester 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.
    2) Streetwise Reports does not accept stock in exchange for its services.
    3) Kal Kotecha: 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.

    Streetwise - The Mining 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.

    Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

    Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

    Participating companies provide the logos used in The Mining Report. These logos are trademarks and are the property of the individual companies.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8999
    Fax: (707) 981-8998
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    Sep 30 2:12 PM | Link | Comment!
  • Keep Truckin': Russell Stanley On How To Snap Up Growing Energy Services Companies

    The oil and gas fields in western Canada are sucking up rental equipment, trucking services and well site accommodation services like the proverbial black hole. Russell Stanley of Jennings Capital, an expert on mergers and acquisitions, knows how to find the margin in the increasingly profitable energy service industry, and explains the rules of this investment game to The Energy Report.

    The Energy Report: Are oil and gas field services in Canada a high growth sector?

    Russell Stanley: Energy prices drive oil and gas field construction and infrastructure development in western Canada. Other drivers include the need to build out liquefied natural gas [LNG] facilities and rail facilities.

    Jennings Capital targets service companies with market caps in the $50 to $200 million [$50-200M] range. These names tend to have fewer analysts following than do the larger names. We like companies that rent out niche-type equipment at high margins. These firms are typically low headcount businesses with a lot of operating leverage. Oil and gas field demand is so strong that these companies must source equipment externally to extend their fleets and meet commitments.

    TER: What defines a service company in this context?

    RS: The definition is fairly broad. We cover companies that operate oil and gas field rental equipment, and a broad group of what we call services to the services. These companies may be employed by an exploration and production [E&P] company directly, or by one of the companies that services the E&P.

    The service equipment supports oil and gas field infrastructure and construction, which is seasonal. But it can also be used for projects managed by utilities or governments that aren't seasonally dependent. Extending the customer base enhances revenue stability, mitigating the impact of the spring breakup. The challenge right now is that traditional oil field demand is so strong that service companies' fleets are stressed. We call that a Hollywood problem, though.

    TER: What happens during spring breakup?

    RS: During spring breakup, the ground thaws in the northern parts of Alberta and Saskatchewan. The resulting moisture prompts a lot of road bans. The E&P and service firms are not allowed to move heavy equipment because of road instability. As a consequence, drilling activity slows down, as does demand for related services. The spring quarter of the year is generally the weakest quarter for companies in the energy service space.

    TER: Is spring breakup the time when the E&P companies are offline? What about during really cold winter weather?

    RS: The E&P companies in the northern parts of the provinces like the colder weather. Ground conditions are ideal in the winter. This past winter was longer and colder than normal, and more conducive to rig activity. Drilling in western Canada was at relatively high levels, which supported the service companies.

    TER: Do you advise investing in small, growing energy service firms, or in buying shares in companies in the business of acquiring the small firms?

    RS: Investing in smaller companies can offer short-term advantages to investors. The speed of execution of a business plan is a simple metric to understand. And investing in a quality startup that is following its business plan is always a good bet. Of course, many of these firms are privately held.

    But on a mid- to long-term basis, we are seeing more and more merger-and-acquisition [M&A] activity for a combination of reasons. The larger, more liquid companies have easier access to capital. Smaller companies can run into challenges raising the money they need to pursue immediate growth opportunities. That provides an opportunity for a larger player to acquire the small firm. We are also seeing an increased level of centralized procurement by the end customer. The E&P companies prefer to make one phone call to a service provider. From the customer's perspective, it is more efficient to deal with a large service company that can offer a fuller suite of products and services.

    TER: Are acquirers proving to be good managers after the acquisitions close?

    RS: The challenge on a post-acquisition basis is preserving the customer base of the company acquired. Small, private companies have often been in operation for 20-30 years. They often have excellent brand value on a local basis. They have longstanding customer relationships. The acquirer does not want to erode that goodwill. The challenge is to optimize the synergies while maximizing overhead savings and cross-selling opportunities.

    The companies we cover do a good job in that arena, and it is a skill we applaud. A key factor in maintaining a smooth transition in M&A is that all the involved parties understand that the buyer's intent is to continue with current management. We like to see the former owner/operators of acquired private companies incentivized to stay on board with earn-out provisions and blocks of stock in the business.

    TER: How can a service company best increase its margin?

    RS: We like private companies that are running flat out. Their fleets are extended. They are renting third-party equipment to support customer demand. They have great customer relationships. When they have trouble renting to meet increasing demand for services, they inject capital to expand the fleet. It is better to buy the equipment necessary to meet demand; renting equipment from a third-party reduces margin.

    A good example of a company using these tactics is Enterprise Group Inc. (OTC:ETOLF) [E:TSX.V]. Enterprise is involved in oil field construction and equipment rentals, as well as in serving the local utilities and transportation markets in western Canada. It is currently injecting capital to displace the use of third-party equipment to drive margin improvement.

    TER: The charts show that Enterprise enjoyed a four-fold increase in share value during the past year. What do you attribute that to?

    RS: We attribute Enterprise's performance to its strong M&A strategy. Enterprise recently announced an LNG acquisition in the Fort St. John area of British Columbia. Its last significant acquisition was Hart Oilfield Rentals in early 2014. It acquired a couple of companies in 2013. The companies Enterprise acquired sold at very attractive prices, usually 3x trailing EBITDA. Most are operating in niche markets, offering a service or a line of equipment that is in high demand. Because Enterprise is a public company, it has excellent access to the capital markets. It can support the growth of the acquired companies on a post-strength action basis.

    TER: What financial metrics do you look at in an M&A candidate?

    RS: The most popular target from an acquirer's standpoint is a private company that has grown organically and needs capital support to make it to the next level. Trailing EBITDA is the metric that acquiring companies look at in determining the worth of an acquisition target. Most transactions are getting done between 3x and 4x trailing EBITDA on a normalized basis, excluding exceptions consistent with the operation of a private company. Usually the buyers want a mix of cash and stock, and a provision that ensures the continuity of management.

    TER: What other names are you following in this M&A and execution space?

    RS: We have just launched coverage of CERF Inc. [CFL:TSX.V]. CERF recently completed a combination with Winalta Inc. We have a $5/share target and CERF's stock's is currently trading at about $3.50/share. CERF provides equipment rentals to both the oil field and construction markets in western Canada. The Winalta transaction was a $70M equity and debt deal, which added exposure to the well site accommodation space, which means providing shacks that allow staff to live and work in close proximity to rigs operating in extreme weather conditions. Well site accommodation is a high margin business. CERF's existing rental business was doing gross margins in the neighborhood of 35-40%. The well site accommodation business has gross margins of over 60%. On top of that, CERF is paying a dividend yield of 6.7%. It is a relatively high yielding stock with a very attractive earnings growth profile.

    TER: Are private equity investors interested in the energy services M&A game in western Canada?

    RS: We are seeing more interest from private equity. Private equity firms are starting to participate in managing public entities acquiring the oil and gas field service companies, but that game is still in the fourth inning.

    TER: Thanks for the insights, Russell.

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

    Russell Stanley has recently returned to Jennings Capital, having first joined the Toronto office in August 2007. He has worked in the brokerage industry since 1997, with the last 10 years in equity research. He has previous experience covering companies in industrial, consumer and health products, technology, alternative energy, bulk commodities and mining services. Stanley looks for underfollowed micro- and small-cap companies with strong earnings growth potential and solid management teams. He holds a master's degree in business administration from the Schulich School of Business [York University], and is a CFA charterholder.

    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.

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    1) Peter Byrne 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.
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    Tags: ETOLF, Energy, Oil Gas, M A
    Sep 25 1:18 PM | Link | Comment!
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