The price for oil briefly surpassed $110 per barrel recently, on the back of increased geopolitical risk, with the potential U.S. intervention in Syria following on to risk of supply and transportation disruption in Egypt. Small cap oil and gas stocks have generally lagged the market this year, despite oil prices rising considerably. At some point, at a sufficiently high oil price, these stocks could "catch up", as they did in early 2008 after lagging the rise in the price of oil for over a year.
The most interesting way to get exposure to that possibility is through small companies that trade at a large discount to their NAV and to comparable companies, and that have had positive developments that could re-set their market values closer to those NAV and comparable values.
In particular, two companies that meet that criteria are Gastar Exploration (NYSEMKT:GST) and Lucas Energy (LEI). Gastar trades at less than half its CEO's recent estimate of the value of just one of its assets, and has done a number of asset deals and financings to help unlock that value. And Lucas trades at ~1/3 of its proved reserve value despite having changed its management, settled a major lawsuit, and having been recently backed in a financing by Ironman, a renowned, high performing energy hedge fund.
Gastar also trades at a large discount to Goodrich Petroleum (OTC:GDP) and Rex Energy (NASDAQ:REXX), which are the two closest comparable companies to Gastar, from the perspective of production growth, asset bases, balance sheets, and recent developments. Rex's core asset is in the Marcellus, like Gastar's, and Goodrich's core asset is a combination of the Eagle Ford and Haynesville, which combined has a similar profile to Gastar's liquids rich Marcellus.
And both Rex and Goodrich have exposure emerging resource plays with limited well results and lots of potential - Gastar has exposure to a similar play, the Hunton, with similar potential except that there are significantly more well results with more consistently positive outcomes. REXX and GDP trade at ~10x EV/2013 EBITDA, which implies a ~$9 per share value for GST, in line with the $7 per share estimate for the value of Gastar's Marcellus by Gastar's CEO plus $2 per share for the Hunton (which likely trends higher over time as more wells come online), and nearly 3x Gastar's current share price.
Lucas is in a similar situation, with properties adjacent to highly successful Eagle Ford wells drilled by EOG (NYSE:EOG), Marathon (NYSE:MRO) and Sanchez (NYSE:SN), albeit without recent operated well results.
However, Eagle Ford pure-plays like Sanchez and stars like EOG trade at well over their proved reserve value, despite a high proved undeveloped component, while Lucas trades at ~1/3 of its proved reserve value. And with sufficient capital to begin translating proved undeveloped reserves into production and cash flow, Lucas may be on the cusp of re-valuing closer to its proved reserve value. Lucas's CEO, Tony Schnur, has successfully turned around oil and gas companies before, and so far he is on track to turn around Lucas too.
The longer the price of oil rises or continues to stay well over $100 per barrel, the more likely it is for smaller cap oil and gas stocks to trade higher. And companies like Gastar and Lucas seem like among the most likely to trade up the most if that happens, with significant "catching up" to do on valuation versus their peers.
Disclosure: I am long LEI, GST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Lucas is a small company, and investing in the stocks of small companies incurs additional risks. I was on the board of Lucas and left the board in March 2012 to pursue other endeavors. I have no ongoing business relationship with Lucas or any other company mentioned in this article.