If you want the most bang for your buck, quality E&P micro caps are the way to go. At least that's the opinion of Analyst Phil Juskowicz of Casimir Capital, an early follower of a company that ended up discovering the Barnett Shale. In this interview with The Energy Report, Juskowicz explains his investment rationale and talks about micro caps, including one that went shopping at an asset bankruptcy sale and absolutely cleaned up.
The Energy Report: With oil prices firming up over the past couple of months and the spread between West Texas Intermediate (WTI) and Brent Crude narrowing, what are your price expectations for the remainder of 2013 and into next year?
Phil Juskowicz: While I don't spend a lot of time predicting commodity prices, I personally see relatively stable short-term oil prices. Intermediate or long-term prices may weaken, assuming no supply disruptions arise from political upheavals, while gas prices may strengthen based on supply/demand fundamentals. We've seen continued oil supply growth and the short term market seems to be pretty range bound, having developed a good base around the $100 per barrel ($100/bbl) level.
TER: Where do you see some of the best investment opportunities in the oil and gas business?
PJ: Micro-cap exploration and production (E&P) stocks have severely underperformed the S&P Small Cap E&P Index since the second half of 2011 (H2/11). However, the definition of "small cap" depends on who you're talking to. The Small Cap E&P Index consists of companies around the billion-dollar range like Approach Resources Inc. (NASDAQ:AREX) and Northern Oil & Gas Inc. (NYSEMKT:NOG). Casimir has a micro-cap E&P index, which is comprised of companies with market caps up to $500 million ($500M) with some names under $100M. That index level started to diverge in H2/11. Both of these groups consist of relatively equal gas/oil weightings, so the performance should not, in our opinion, be attributed to the relative strength of oil prices over gas that commenced around that time. As a result, we believe that there are attractive investment opportunities in the micro-cap E&P universe.
Casimir Micro-Cap E&P Index (White) vs. S&P Small-Cap E&P Index (Yellow)
Casimir Micro-Cap E&P Index composed of: AMZG, ANFC, CAK, CPE, CXPO, EGY, EEG, ENRJ, ENSV, FEEC, FXEN, GMET, GNE, HDY, HNR, IFNY, IVAN, LEI, MCEP, MILL, MPET, MPO, OEDV, PHX, PNRG, PSTR, RDMP, SARA, SSN, STTX, TAT, TENG, TGC, TPLM, USEG, WRES, ZAZA
Source: Bloomberg; Casimir Capital
TER: How do you choose the companies in your coverage list?
PJ: We look for small companies that have largely flown "under the radar screen" and are underfollowed. The companies we cover have strong management teams and operate in premier areas with good assets that have substantial cash flow potential.
TER: What E&P names on your coverage list look interesting?
PJ: We like Miller Energy Resources (NYSE:MILL), which, in late 2009, captured former Pacific Energy Resources Ltd. assets out of bankruptcy that were valued at $500M for an outstanding $4.5M. Miller's entire enterprise value, meanwhile, is just $240M. Moreover, its infrastructure assets were valued by third parties on behalf of its lender at $190M. What makes these assets most attractive is the fact that recent well results indicate that original estimates by Forest Oil (which sold the properties to Pacific in 2007) may in fact be correct, which would mean that these Alaskan assets could contain 100-200 million barrels (MMbbl) of recoverable oil reserves. Proved oil reserves presently stand at 8.61 MMbbl.
TER: How was Miller able to buy $500M worth of assets for less than 1% of their value? Even in bankruptcy, you'd think that there'd be buyers willing to pay more than that.
PJ: David Hall, a Miller Energy executive who had worked on the assets even before Pacific bought them from Forest Oil in 2007, was following the Alaskan bankruptcy proceedings. He got in touch with the CEO of Miller, Scott Boruff, and told him about these assets that were becoming available.
TER: Why does Miller believe that the original estimates of recoverable oil reserves may, in fact, be correct?
PJ: The thesis is that Forest Oil used the wrong completion techniques, which is why well performances had dropped off. The completion techniques Forest Oil used were in fact different from techniques used for other assets on the McArthur Trend. David Hall believed that workovers on existing wells, for example, replacing some electric submersible pumps and making changes to completion techniques on new wells could improve production. Low and behold, that's exactly what's happened.
In addition, Miller just started doing sidetracks of some of these old wells. It posted a 21-day production test of its RU-2A well several weeks ago at 1,314 barrels per day, which would indicate that the oil's there and it's recoverable. Management has been doing a good job of utilizing preferred equity to have substantial capital expenditure programs without diluting the common shareholders. To top it off, it has about 600,000 undeveloped acres that it's just starting exploration on as well.
TER: What sort of strategy would you suggest our readers consider?
PJ: I think the micro-cap space, in general, is less correlated to the market's vagaries. Perceived changes in foreign interest rates, for example, have a larger effect on large-cap names. Micro-cap pricing is determined more by company-specific dynamics, such as anticipated future cash flows. Plus, a lot of micro-cap names and E&Ps in general seem to be more active on hedging, and therefore should be less susceptible to changes in commodity prices. As a result, investors who exercise due diligence should be rewarded for accurate cash flow predictions. If you want to find companies where your hard work can actually pay off, then the micro-cap space is a good place to look.
Micro caps seem to be getting more active in reaching new investors, and some of the management teams have regrouped from previous lives and are starting up very successful new companies. I think Bonanza Creek Energy Inc. (NYSE:BCEI) is a great example of management hailing from one company and getting back together and starting all over again.
TER: Thanks for talking with us today and giving us some interesting input, Phil.
PJ: I appreciate the opportunity.
This interview was conducted by Zig Lambo of The Energy Report.
Philip Juskowicz, CFA is a managing director in the research department at Casimir Capital, a boutique investment bank specializing in the Natural Resource industry. Juskowicz began his career at Standard & Poor's in 1998, where he was one of the first analysts to recommend Mitchell Energy, credited with discovering the Barnett Shale. From 2001-2005, He worked with a former geologist in equity research at both First Albany Corp. and Buckingham Research. At Buckingham, Juskowicz was promoted to a senior oilfield service analyst position, leveraging his extensive knowledge of the E&P space. From 2006-2010, he was an insider to the oil and gas industry, serving as a credit analyst at WestLB, a German investment bank. In this capacity, Juskowicz was responsible for $500M of loans to energy companies and projects. He earned a Master of Science in finance from the University of Baltimore.
1) Zig Lambo conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family owns shares of the following companies mentioned in this interview: None.
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3) Philip Juskowicz: I own or my family owns shares of the following companies mentioned in this interview: Bonanza Creek Energy Inc. 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: None. 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.
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