(Editor's Note: Investors should be mindful of the risks of transacting in securities with limited liquidity, such as CNKEF. Chinook Energy's listing in Toronto, CKE.TO, offers stronger liquidity.)
My Seeking Alpha followers know very well that I love shining light on "off the beaten path" opportunities and/or going against the grain. And this is why I have helped them generate triple-digit returns multiple times thus far.
Specifically, they have been handsomely rewarded thanks to my bearish calls on firms such as Quicksilver Resources (OTCPK:KWKAQ), Restoration Hardware Holdings (NYSE:RH), Sears Holdings (NASDAQ:SHLD), Penn Virginia Corporation (OTCPK:PVAHQ), Halcon Resources (NYSE:HK), Key Energy Services (NYSE:KEG), Cheniere Energy (NYSEMKT:LNG), SandRidge Energy (OTCPK:SDOC), Midstates Petroleum (OTCPK:MPOY) or American Eagle Energy (OTCPK:AMZGQ), and my bullish calls on Yoho Resources (OTCPK:YOHOF), Petrodorado Energy (OTC:PTRDF) and Newport Exploration (OTC:NWXPF) to name a few.
History repeats itself. Currently, Chinook Energy (OTC:CNKEF) is incredibly mispriced. Actually, I believe it should trade between C$1.40 and C$1.87 per share (Toronto), based on conservative key metrics resulting from the peers' valuation and the recent energy deals in Canada. No, that's not a misprint, as presented in detail in the next paragraphs.
Chinook Energy trades on the Toronto board under the ticker CKE and currently stands at about C$0.52 per share (Toronto).
The Hybrid Business Model In 2014 And The 500% Return
To-date, I have written two articles about Chinook Energy. But unfortunately, I'm the only SA author who has written articles about this debt-free company, and therefore, it has very low awareness among investors. However, those few who followed my recommendations have done well. For reference, my articles are here and here.
Specifically, in my first article in December 2013, I recommended investors buy Chinook Energy at C$0.82 (Toronto) explaining why they could make at least a 200% return.
In that article, I pointed out that the key reason for the irrational undervaluation was the hybrid nature of the asset base. Chinook had Canadian and Tunisian operations back then, and investors were unable to correctly assess its value. As forecasted, Chinook sold its Tunisian assets, focused on its Canadian operations and the stock reached C$2.55 (Toronto) in June 2014. Clearly, the return surpassed 200% in six months or 400% annualized.
In my second article in July 2014, when the stock was at C$2.60, I noted that the low hanging fruit wasn't there anymore and Chinook Energy had limited upside potential from that C$2.60 level. As such, I recommended that investors should sell it if they wanted to maximize their returns. Declining oil prices in the second half of 2014 made things worse for the energy stocks and the downward trend began, as illustrated below:
The Hybrid Business Model In 2016 Pro-Forma The Tournament Deal
And history repeats itself. In June 2016, the company announced a transformative deal. It completed the divestiture of the majority of its Alberta oil and natural gas assets, excluding its Montney assets with an effective date of May 1, 2016, to Tournament Exploration Ltd., a private oil and natural gas company, for common shares in Tournament representing approximately 70% of the issued and outstanding share capital of Tournament upon closing of the transaction.
Management determined that:
"The disposition of the subject assets will allow Chinook to focus on its emerging Montney assets at Birley/Umbach, British Columbia and at Gold Creek, Alberta. Through the proposed share distribution and retained ownership of Chinook, Chinook shareholders are expected to benefit both from the ownership of Tournament shares and the continued participation in the growth and future value creation of Chinook".
It must also be noted that pro-forma this transaction, Alberta Investment Management Corporation (AIMCo), one of Canada's largest and most diversified institutional investment managers with more than $90 billion of assets under management, owns approximately 10% of the issued and outstanding share capital of Tournament Exploration.
That said, and pro-forma this deal, Chinook Energy currently includes two parts:
1) The non-Tournament part: This part consists of all the Montney assets in British Columbia (Birley/Umbach) and Alberta (Gold Creek and Knopcik) totaling 122 net sections, along with other producing assets primarily located in British Columbia.
2) The Tournament part: This part consists of 70% of the issued and outstanding share capital of privately-held Tournament Exploration. Tournament's assets are primarily located in the Willesden Green and Ferrier areas of Alberta, with other minor interests in Wilson Creek, Lochend and Pembina areas of Alberta.
"All of the common shares of Tournament we received are expected to be distributed to our shareholders and we anticipate holding a shareholder meeting before the end of 2016, to approve the proposed share distribution. The date for determining the shareholders of record who will be entitled to the distribution will be confirmed at a later date. The share distribution will be subject to, among other things, shareholder approval at the meeting. Until the share distribution is approved and completed, our consolidated financial statements will include the accounts of Tournament since June 10, 2016."
The non-Tournament Part
I'm not going to deepen into the Montney formation. Market participants know well that the land rush at Montney quietly began in the mid-to-late 2000s, and the Montney play has rapidly evolved into one of the hottest plays in the world, attracting billions of dollars in investment thanks to its key characteristics such as massive thickness, superior lithology and "fracability", high permeability, over-pressured and repeatable performance. On top of that, the Montney play isn't too shallow and isn't too deep. The Montney play is just right and this is why, it has become the rock star of the Canadian oilpatch making for some really very economic wells in today's challenging commodity environment.
As with any unconventional resource play, the financial success of a producer is directly linked to its acreage being located in the core of the play. The sweet spot and the acreage close to it are the places where all of the economic wells are located. And I will show in this paragraph why Chinook Energy is an exceptionally well-positioned Montney producer, while its drilling results (in the next paragraphs) prove that its Montney wells are equal or better than those from the offset operators.
That said, pro-forma the Tournament deal, the non-Tournament part owns 18.29 MMboe of 2P Reserves (24% oil/liquids) with NPV10 of C$74 million. However, Chinook announced in August that it signed a new gas handling agreement in NEBC impacting the majority of its British Columbia natural gas production that reduces the operating cost while increasing netback by C$2.70/boe. As a result, Chinook Energy estimates that this new gas handling agreement effective Sept. 1, 2016, increases reserve values (2P NPV10) by approximately C$30 million, as illustrated below:
In other words, the 2P NPV10 for the non-Tournament part currently is approximately C$100 million. And again, this figure refers to the non-Tournament part alone.
Additionally, the non-Tournament part consists of the following three subparts:
1) Operated Montney acreage in British Columbia (Birley/Umbach): Chinook currently produces 1,690 boepd (14% oil and liquids) from this acreage that covers ~44,700 net acres, as illustrated below:
And the first map above from Black Swan Energy's presentation speaks volumes. As clearly illustrated in that map, Chinook's entire acreage in Birley/Umbach in British Columbia is located in the over-pressured, liquids-rich fairway which has delivered thus far the best wells in the area, as expected of course. Chinook's acreage in Birley/Umbach is NOT crossing into the oil window (green area) where well performance is reduced, according to Black Swan Energy.
For instance, Leucrotta Exploration's (OTC:LCRTF) acreage is located in the oil window. And Leucrotta's drilling results to-date clearly confirm that well performance in the oil window is reduced. I will detail on Leucrotta's results in the next paragraph.
As also shown above, M&A activity in the North Montney has been evident since 2013 with significant transactions totaling just over $4 billion, including Enerplus' (NYSE:ERF) asset sale to Petronas, Talisman's (NYSE:TLM) asset sale to Petronas, Yoho's asset sale to Storm Resources (OTC:SRMLF), Paramount's (OTCPK:PRMRF) asset sale to Todd, Artek Exploration's (OTCPK:ARKXF) sale to Kelt Exploration (OTC:KELTF), Carmel Bay's sale to Black Swan Energy and Shell (NYSE:RDS.A) (NYSE:RDS.B) to ARC Resources (OTCPK:AETUF).
And I will present in detail the key metrics for these North Montney deals in my next article, proving Chinook Energy's irrational undervaluation from an acquisition standpoint.
2) Operated Montney acreage in Alberta (Gold Creek and Knopcik): Chinook currently produces 75 boepd (42% oil and liquids) from this acreage that covers ~22,000 net acres, as illustrated below:
Chinook owns 35 net sections in this area next to privately-held CIOC, Canadian Natural Resources Limited (NYSE:CNQ), Apache (NYSE:APA), ConocoPhillips (NYSE:COP), Encana (NYSE:ECA), Shell, Birchcliff Energy (OTCPK:BIREF), Husky Energy (OTCPK:HUSKF), Blackbird Energy (OTC:BKBEF) and privately-held Inception Exploration.
3) Operated acreage in the Peace River Arch District (~98,000 net acres): Chinook Energy has retained producing assets that are located in the Peace River Arch District on the BC/Alberta border, as illustrated below:
Specifically, these assets are mainly lands north of Birley at Martin/Black/Conroy and Boundary Lake that are currently producing 1,657 boepd (18% oil and liquids), based on re-starting previously shut-in volumes impacted by Station 2 pricing, as illustrated below:
Production in the Boundary Lake area is primarily from Mississippian, Jurassic and Cretaceous aged formations, while the assets in the Martin Creek and Black-Conroy areas primarily produce from Baldonnel, Halfway and Gething formations.
Other producers in the area are Centrica PLC (OTCPK:CPYYY), Enercapita Energy Trust, Whitecap Resources, Qatar Petroleum International, Canadian Natural Resources Limited, etc.
The Tournament Part
As mentioned above, pro-forma the Tournament deal, Chinook currently owns 70% of Tournament's common shares that will be distributed to Chinook's shareholders by year-end. Alberta Investment Management Corporation (AIMCo), one of Canada's largest and most diversified institutional investment managers with more than $90 billion of assets under management, owns approximately 10% of the issued and outstanding share capital of Tournament.
As also linked above, pro-forma the deal with Chinook, Tournament Exploration produces 5,041 boepd (34% oil/liquids) and owns 21.26 MMboe of 2P Reserves (~35% oil/liquids) with NPV10 of C$192.2 million.
Tournament Exploration's core acreage is located in the Willesden Green and Ferrier areas of Alberta, with other minor interests in Wilson Creek, Lochend and Pembina areas of Alberta.
Specifically, Tournament's assets are close to the properties of Whitecap Resources (OTC:SPGYF), Bonterra Energy (OTC:BNEFF), Tamarack Valley Energy (OTC:TNEYF) and Penn West Petroleum (NYSE:PWE). But, Tournament's new website isn't ready yet. As such, you can get an idea about the location of Tournament's properties on the map below:
And I put this map because I want to underline the fact that Tournament doesn't drill uncharted land. In contrast, Tournament's acreage has been de-risked thanks to thousands of producing wells in the area to-date.
On that front, it must be noted that Penn West's wells in Willesden Green have exceeded internal production expectations and this area has become its core producing asset, while Pembina is the largest conventional oilfield in Canada with large oil in place, low recovery factors, long-term stable production, high quality oil and high netbacks.
Drilling Results From Chinook Energy's Montney Acreage
Thanks to the excellent location of its Montney assets, Chinook has experienced very good drilling results thus far, which are often superior to its Montney peers. Specifically:
1) In Birley/Umbach (British Columbia): As shown above, Chinook currently produces 1,690 boepd (14% oil and liquids) while having built a huge drilling inventory in the heart of the Montney play with 236 net drilling locations (6 wells/DSU) in the Upper Montney and additional Middle and Lower Montney potential over a 240 meters thick Montney interval.
And given that a picture is worth a thousand words, Chinook's top quartile well performance and drilling results in Birley/Umbach are illustrated below:
According to the presentation (2016 AGM), test rates for the company's Montney wells in this area are between 4.8 MMcf/d (or 800 boepd) and 7.7 MMcf/d (or 1,300 boepd) with free condensate rates of 24 - 45 bbl/MMcf.
2) In Gold Creek and Knopcik (Alberta): Chinook currently produces 75 boepd (42% oil and liquids) from this acreage because it has retained ownership of the two (1.13 net) horizontal Montney wells it drilled in 2014. Also, it has identified numerous multi-stacked targets (Middle, Lower, Upper Montney) in Gold Creek and Knopcik areas that represent significant oil growth opportunities.
Specifically, Chinook's drilling results in the Gold Creek and Knopcik areas are illustrated below:
Chinook's two Montney wells in this area are 100/16-30-067-03W6 and 100/14-12-069-06W6 with their IP-10 being 1,500 boepd (30% oil) and 900 boepd (40% oil and 107 Bbls/MMcf condensate, as shown here), respectively.
Drilling Results From Chinook Energy's Montney Neighbors And Peers
No, this isn't rocket science. Since you know now Chinook Energy's drilling results from its Montney acreage, you will quickly realize that they are not just equal but sometimes better than the peers' ones. Specifically:
1) Storm Resources: Storm is drilling next to Chinook, as shown in the map above. According to the annual report, Storm's drilling results in Birley/Umbach from 2011 until the end of 2015 are below:
|Year of Completion||Avg |
|Actual Drill & |
90 Cal Day
180 Cal Day
365 Cal Day
|2010 - 12 |
|11||1.9 Mmcf/d |
(340 boepd sales)
|1.4 Mmcf/d |
|1.3 Mmcf/d |
|17||C$4.6 million||3.5 Mmcf/d |
(615 boepd sales)
|2.9 Mmcf/d |
|2.2 Mmcf/d |
|19||C$4.6 million||4.6 Mmcf/d |
(840 boepd sales)
|4.2 Mmcf/d |
|3.3 Mmcf/d |
|22||C$4.5 million||5.0 Mmcf/d |
(870 boepd sales)
|3.7 Mmcf/d |
|29||C$4.3 million||5.5 Mmcf/d||5.3 Mmcf/d|
2) Carmel Bay Exploration: Drilling results from Carmel Bay that was acquired by Black Swan last year are illustrated below:
It's clear that Carmel Bay's Montney wells have IP-30 between 2.4 MMcf/d and 13 MMcf/d with condesante ranging from 10 to 65 bbl/MMcf. In other words, the average IP-30 was 7.7 MMcf/d (or 1,283 boepd) with condensate of 37 bbl/MMcf.
3) Black Swan Energy: With DCET cost of C$4.5 million/well, Black Swan's best performing wells to-date produce on average 6 MMcf/d (or 1,000 boepd) with condensate at 33 bbl/MMcf and deliver >130% IRR at C$2.50/GJ AECO and US$50/bbl WTI, as illustrated below:
4) Leucrotta Exploration: According to the press releases here, here and here, Leucrotta's drilling results from its Doe and Mica acreage located in the oil window of the Montney play in British Columbia are shown below:
IP-120 at 700 boepd
(90% natural gas)
IP-30 at 890 boepd
(~80% natural gas)
IP-24h at 1,290 boepd
(87% natural gas)
IP-30 at 900 boepd
(~80% natural gas)
IP-30 at 447 boepd
IP-39 at 375 boepd
(82% natural gas)
IP-8 at 713 boepd
(50% natural gas)
And now experienced investors realize why Black Swan Energy stated in the latest presentation that well performance in the oil window is reduced. Clearly, Leucrotta's results are inferior to Black Swan Energy's, Carmel Bay Exploration's and Chinook Energy's ones.
5) Blackbird Energy: Blackbird has drilled three Montney wells thus far in Chinook's neighborhood in Alberta (Gold Creek and Knopcik), as illustrated below:
It's also clear that the Chinook's acreage in Gold Creek belongs to the Montney condensate corridor with the high condensate yields.
Blackbird Energy's drilling results from its three Montney wells are here and below:
|IP-24h at 1,768 boepd |
(~36% liquids, 0% oil)
|IP-24h at ~1,000 boepd |
(~78% liquids, 0% oil)
|IP-48h at 466 boepd |
(67% liquids, 0% oil)
For reference, it must also be noted that these wells have been booked at an average of 522 Mboe of 2P reserves per well, according to Blackbird's independent reserves evaluators, GLJ Petroleum Consultants.
The Balance Sheet For The Non-Tournament Part Is Pristine
All the bankruptcies in the energy sector over the last two years should teach us that the strength of the balance sheet is of the utmost importance. And when it comes to Chinook Energy's fundamentals, the balance sheet is stellar.
But before presenting some key points from the balance sheet, I have to point out that Chinook Energy's results are consolidated and currently include Tournament Exploration's results, because Chinook Energy currently owns a 70% stake in Tournament Exploration. And things will remain like this until the Tournament Exploration shares are distributed to Chinook Energy's shareholders by year end.
That said, this is what we know about Chinook's non-Tournament part that includes its Montney assets, based on the latest quarterly report (Q2 2016) and Peters' Information Memorandum linked above:
1) As of September 2016, it remains debt-free and holds approximately C$24 million in cash.
2) As of September 2016, it produces 3,436 boepd (~17% oil and liquids) thanks to re-starting previously shut-in volumes impacted by Station 2 pricing.
3) As of September 2016, NPV10 (P+P) is approximately C$100 million, thanks to the new gas handling agreement effective Sep 1, 2016, that increases reserve values (2P NPV10) by approximately C$30 million, according to the corporate news above.
And pro-forma the Tournament deal, Chinook Energy's LLR (Liability Management Rating) in Alberta stands at 4.92, which is significantly higher than its Montney peers:
Given also that most investors are backward-looking, I have to underline the following facts that will affect positively Chinook's balance sheet (the non-Tournament part) in Q3 2016 and the coming quarters:
1) Diversified natural gas sales thanks to the Alliance contract (effective May 1, 2016): Since May 1st, 2016, Chinook Energy has diversified away from weak Station 2 prices by securing firm transportation on Alliance to the Chicago market for approximately 1/3 of its Birley/Umbach volumes.
Therefore, since late Q2 2016, the company has been receiving for a part of its production Henry Hub pricing that currently is about $3/MMbtu or C$3.90/MMbtu, which is a huge price difference compared to just C$1.39/GJ (average realized price for AECO and Station 2) that Chinook received in the first half of this year, when it didn't have the contract with Alliance pipeline.
2) Netback increases by C$2.70/boe effective September 1, 2016: Subsequent to the end of the second quarter, Chinook announced that it executed a new gas handling agreement impacting the majority of its British Columbia natural gas production.
According to Chinook, this agreement will significantly improve go-forward drilling economics, bring base production back online and provide gas handling capacity for growth volumes as well as reduce operating costs by approximately C$2.70/boe on Chinook properties not held by Tournament Exploration.
Actually, Chinook's agreement is the same like Storm's recent agreement in Birley/Umbach with Spectra Energy (NYSE:SE) that is expected to result in Storm's corporate operating cost declining by approximately 15% to 20%.
3) Natural gas disruption in Canada in H1 2016 because of one-time, non-recurring events: Constraints and maintenance outages on the Spectra and TransCanada sales pipelines that began in late 2015 continued in the first half of 2016, and impacted negatively Station 2 pricing.
And due to the forest fires, this problematic situation became even worse in Q2 2016 when a lot of heavy oil production in western Canada was shut down for weeks as a precaution and because of disruptions to regional pipelines, further reducing natural gas demand and weighing heavily on AECO pricing.
4) Rising natural gas prices: Natural gas prices (Henry Hub, AECO and Station 2) in Q3 2016 have risen significantly relative to the first half of 2016. And the trend is upward thanks to the fundamental reasons presented in detail in my article here.
On that front, Chinook Energy currently receives for a significant part of its natural gas production Chicago Citygates price (Henry Hub price) that currently is about $3/MMbtu or C$3.90/MMbtu, while AECO and Station 2 prices have reached or exceeded C$2.50/GJ, which translates into a 70% increase compared to their average prices in the first half of 2016, as illustrated below:
To get a better idea about the specific locations associated with these three different prices, please take a look at the map below:
The Balance Sheet For The Tournament Part Is Healthy
Aside the previously-mentioned assets, production and 2P Reserves, this is what we also know about privately-held Tournament Exploration, which is 70% owned by Chinook Energy:
1) Tournament Exploration has 217.5 million issued and outstanding shares.
2) Tournament Exploration has about C$3.5 million cash and C$18 million debt, resulting in net debt of about C$14.5 million.
3) Tournament Exploration has a C$100 million credit facility and therefore, it has ample liquidity.
4) As of June 2016, Tournament Exploration had net operating income of C$11 million (annualized) and net operating income of C$8.16/boe, as illustrated below:
Given also that most investors are backward-looking, I focus on the following facts that will affect positively Tournament Exploration's balance sheet, increasing the value for Chinook's stake (70%) in the coming quarters:
1) Rising natural gas prices: This is the same reason that was mentioned previously. A bunch of fundamental reasons along with the gradual return to normalcy (i.e. no forest fires in Alberta) have pushed natural gas prices (Henry Hub, AECO and Station 2) significantly higher since early Q3 2016, and the trend is upward.
2) Rising oil prices: Although Tournament Exploration is a natural gas weighted producer in Alberta, it produces significant volumes of oil & liquids (34% oil/liquids, 66% natural gas). And there is no question that the trend for oil prices is upward.
Montney: Recent Next Door Deals And Peers' Valuation
I will deepen into all the recent Montney deals in my next article. But in this article, I have to briefly mention few of them that took place in Chinook's Montney neighborhoods (British Columbia and Alberta) to help you understand how I calculate Chinook's value in the next paragraphs. Specifically:
1) CIOC with Riverstone Seneca B.V. (Montney, Alberta): CIOC is a privately-held Montney producer and Chinook's neighbor at Gold Creek, as illustrated above. CIOC's development plan has been focused on the Upper/Middle Montney at Gold Creek and Karr, where delineation activity has proven the repeatability of the laterally continuous liquids rich fairway.
That said, US-based fund Riverstone Seneca B.V. increased its stake in CIOC in December 2015 and became the majority owner thanks to two deals. Before these deals, Riverstone owned approximately 41% of CIOC, as shown here and here. Specifically:
A) It made an offer and acquired an additional 13% (approximately) for C$128 million, as linked above. This means that CIOC's total market cap was valued at approximately C$1 billion.
B) It made an agreement with a shareholder of CIOC pursuant to which it acquired the shareholder's 2.9% equity interest for a total consideration of $18.8 million or approximately C$24.5 million. This deal means that CIOC's total market cap was valued at C$845 million.
In the meantime, we know that CIOC was producing over 10,000 boepd in November 2015. I will be generous enough to assume that CIOC was debt-free while also producing 11,000 boepd in November 2015. And I come to the conclusion that Riverstone Seneca paid at least C$75,000/boepd to increase its stake and become CIOC's majority owner.
More importantly, I start with this deal because Riverstone Seneca isn't just another fund. EOG Resources' (NYSE:EOG) former Chairman and CEO, Mark Papa, is a partner in New York-based Riverstone. And Mark Papa is "the Godfather" of shale oil, given that he was EOG's CEO from 1998 until 2013. He was one of the first into both the Bakken and the Eagle Ford and nobody can doubt EOG's proven success in both plays. Mark Papa chose to invest in CIOC this time. And CIOC drills next to Chinook Energy at Gold Creek.
2) Chinook Energy with RMP Energy (Montney, Alberta): In May 2016, Chinook sold certain of its assets located in the Gold Creek area for C$7.5 million. The divested assets included 15 net sections and related pipelines and production facilities. These assets produced 23 boepd (62% oil/liquids), had 0.14 MMboe of 2P reserves and NPV10 at C$0.9 million.
And I will be generous enough to value the stake in the production facilities at C$6 million, which leaves C$1.5 million for the producing wells, reserves and associated pipelines.
Therefore, Chinook sold these oily Montney assets at approximately C$65,200/boepd, C$10.71/boe of 2P Reserves and 1.67 times their NPV10.
Some might try to downplay this sale, but they judge too quickly for the following reasons:
A) Chinook was the majority owner and didn't own 100% of those production facilities. Therefore, valuing Chinook's stake at C$6 million is in line with similar plants in the area.
B) The vast majority of the energy deals include both producing wells and associated pipelines.
C) The Gold Creek deal above between CIOC and Riverstone has significantly higher key metrics.
3) Black Swan Energy with Carmel Bay Exploration (Montney, British Columbia): As linked above, Black Swan paid C$200 million for Carmel Bay.
At that time, Carmel Bay had 82,600 net acres in the liquids-rich Montney fairway, produced 815 boepd in Q1 2015 (78% natural gas) and owned 22.5 MMboe of 2P Reserves. Therefore, Black Swan paid C$243,900/boepd and C$8.89/boe of 2P Reserves.
4) Kelt Exploration with Artek Exploration (Montney, British Columbia): Last year, Kelt Exploration acquired Artek for C$307 million. At the time of the deal, Artek produced 5,400 boepd and had 46.4 MMboe of 2P Reserves and therefore, Kelt paid C$56,850/boepd (~39% oil/liquids) and 6.62/boe of 2P Reserves.
Also, it must be noted that Kelt paid these metrics despite the fact that Artek's balance sheet was very weak and Artek's negotiating power was very limited, if any. Specifically, at the time of the deal, Artek's net debt was C$81 million and its annualized CF was C$26 million, which translates into a D/CF ratio of 3.11 times.
5) Terra Energy's (OTC:TTRHF) natural gas weighted deal (Boundary Lake area, British Columbia): In late 2015, Terra Energy sold its assets in the Boundary Lake area (British Columbia) for C$10.615 million. Production associated with this asset was approximately 500 boepd (62% natural gas), and 2P Reserves was approximately 1.2 MMboe (~65% natural gas).
Therefore, Terra Energy sold these natural gas-weighted assets for C$21,230/boepd (62% natural gas) and C$8.85/boe of 2P Reserves.
And it must be noted that Terra Energy was a distressed seller with zero negotiating power in late 2015 when it sold these properties. Finally, Terra filed for bankruptcy in March 2016 due to its debt overhang.
6) Current valuation for junior and small intermediate Montney producers: Let's check now the valuations for the following Montney producers that drill next to Chinook's Montney properties in British Columbia and Alberta, as shown in the maps above.
Moreover, I must point out that all of them have natural gas weighted production and reserves, while carrying manageable debt or being completely debt-free like Chinook Energy (the non-Tournament part). They are not distressed firms trading at a discount.
The key metrics mentioned below have been calculated based on the closing prices as of last Friday (9/30/2016):
(*): Including the financing of Sep 2016.
(**): Including Deventa Energy's Montney vertical test well on the Pepper acreage.
(***): Including the behind-pipe production of 3,100 boepd (~85% natural gas).
(****): Pro-forma the financing of May 2016.
Assessing Chinook Energy's Total Value
As mentioned above, Chinook Energy consists of the non-Tournament part that includes all the Montney assets (British Columbia, Alberta) and the Tournament part that owns 70% of the issued and outstanding shares of privately-held Tournament Exploration.
And now, let's assess the fair value for both parts by using the aforementioned average key metrics.
1) The non-Tournament part: Let's summarize the previously-mentioned characteristics and key fundamentals for this part:
A) Let's assess the value for the Montney properties:
Per Production: 1,765 boepd x C$62,096/boepd = C$110 million.
Per 2P Reserves: 14.15 MMboe x C$13.09/boe = C$185 million.
Per NPV10: C$83 million x 2.37 times = C$197 million.
Average Enterprise Value: (110 + 185 + 197) : 3 = 492 : 3 = C$164 million.
B) Let's assess now the value for the other producing properties by using the key metrics of Terra Energy's recent deal in the same area that was described in the previous paragraph. It must be noted that Terra Energy was a distressed seller who filed for bankruptcy few months after the aforementioned natural-gas weighted deal.
Per Production: 1,657 boepd x C$21,230/boepd = C$35 million.
Per 2P Reserves: 4.14 MMboe x C$8.85/boe = C$37 million.
Average Enterprise Value: (35 + 37): 2 = 72:2 = C$36 million.
2) The Tournament part: I will start by saying that privately-held Tournament Exploration will go public. This comes as no surprise, because Chinook Energy and AIMCo (Canada's largest institutional investment managers) own 70% and 10% of Tournament Exploration respectively and they will monetize their investment once oil and gas prices improve.
On that front, I have contacted Chinook's management team more than once over the last months, and they have emailed me that they will have a liquidity event (i.e. an IPO) down the road. Therefore, I conclude that Tournament Exploration will go public sometime in 2017.
Per reference now the liquidation of the Tournament Exploration shares before the completion of an IPO, investors usually have two choices. First, some private companies have buyback programs, which allow investors to sell their shares back to the issuing company. Second, some private companies provide leads about current shareholders or new investors who have expressed interest in buying the company's shares.
Let's summarize now the previously-mentioned characteristics and key fundamentals for privately-held Tournament Exploration, pro-forma the deal with Chinook Energy of June 2016:
5,041 (66% gas)
2P Reserves (MMBoe)
21.26 (65% gas)
NPV10 (C$ million)
Net Debt (C$ million)
Credit Facility (C$ million)
Net Operating Income
(C$ per boe)
Clearly, this energy company isn't a distressed producer. In contrast, it has a healthy balance sheet and ample liquidity in the midst of consistently improving oil and gas prices. Moreover, it drills proven land in Alberta with numerous producing wells successfully drilled to-date by offset operators.
That said, I will conservatively assess Tournament Exploration's fair Enterprise Value by using key metrics that are below the key metrics for the healthy natural gas weighted producers and recent natural gas weighted deals in Canada. And I will elaborate on these producers and deals in my next article.
Per Production: 5,041 boepd x C$25,000/boepd = C$126 million.
Per 2P Reserves: 21.26 MMboe x C$5.5/boe = C$117 million.
Per NPV10: 192.2 x 0.7 = C$135 million.
Average Enterprise Value: (126 + 117 + 135) : 3 = 378 : 3 = C$126 million.
Given that Tournament Exploration has net debt of C$14.5 million, the market cap is currently estimated at C$112 million (minimum), and therefore, Chinook Energy's 70% stake is currently valued at C$78 million (minimum).
3) Total Enterprise Value for Chinook Energy's both parts: Let's sum it up:
Total EV: C$164 million + C$36 million + C$78 million = C$278 million.
Total Market Cap: C$278 million + C$24 million (in cash now) = C$302 million.
Chinook Energy's pps: C$302 million : 216.4 million shares = C$1.40/share (Toronto).
And again, this figure has been calculated based on conservative key metrics resulting from the peers' valuation and recent deals in Canada.
One more proof that this figure is the low end of Chinook Energy's fair Enterprise Value comes from the fact that we result in a significantly higher valuation based on another widely-used valuation model, the valuation per acre.
On that front, I will again use conservative key metrics per acre resulting from the recent deals among Canadian firms with healthy balance sheets. Specifically:
Chinook's Montney acreage: 67,000 net acres x C$4,000/acre (based on historical Montney transactions) = C$268 million.
Chinook's other producing acreage: 98,000 net acres x C$500/acre = C$49 million.
Chinook's Tournament part: ~70,000 net acres x C$900/acre = C$63 million.
Total EV: C$268 million + C$49 million + C$63 million = C$380 million.
Total Market Cap: C$380 million + C$24 million (in cash now) = C$404 million.
Chinook Energy's pps: C$404 million : 216.4 million shares = C$1.87/share (Toronto).
Aside my two articles published two years ago, nothing has been written about Chinook Energy on Seeking Alpha and other financial websites I am aware of. And as always, lack of coverage creates inefficiencies in the pricing of small caps, which is what makes them such wonderful investments for the fundamental and knowledgeable investors.
Furthermore, Chinook Energy's current hybrid structure coupled with the consolidated balance sheet make things even worse, because these factors don't help those few investors who follow this energy producer connect the dots and realize the tremendous valuation gap.
And on top of that, a significant part of those investors who follow this Montney player see the rearview mirror while being unable to see beyond the windshield, as usual. Actually, this comes as no surprise but it's one of the most common mistakes in the stock markets.
That said, these are the key facts associated with Chinook Energy:
1) If you like Leucrotta Exploration's, Blackbird Energy's, Storm Resources', Carmel Bay Exploration's and Black Swan Energy's drilling results in the Montney play, you should love Chinook Energy' ones from its Montney properties in British Columbia and Alberta. Numbers speak volumes and underline the quality of the company's Montney properties, as presented in detail in the previous paragraphs.
This is why, Chinook Energy's management team emailed me the other day:
"If you like Leucrotta Exploration (LXE.V) you should love the CKE story. CKE's Montney wells at Birley look every bit as good as the offsetting operators, if not better".
Given that the drilling results from both operators are illustrated above, CKE's management didn't tell me anything new. I knew that Chinook's Montney results were better than Leucrotta's, because I had already done my due diligence on both stories.
Actually, it's an axiom in the energy sector that the best drilling results are coming from the over-pressured reservoirs. And Chinook drills in the over-pressured, liquids-rich Montney fairway in Birley/Umbach while Leucrotta drills in the oil window where well performance is reduced, according also to Black Swan Energy's presentation above.
Nevertheless, I want to emphasize on the fact that I used key metrics that were significantly below Leucrotta's current key metrics, when I conservatively assessed Chinook's fair Enterprise Value in the previous paragraph. For reference, Leucrotta Exploration currently trades at C$78,000/boepd (~85% gas), C$18.25/boe of 2P Reserves (~82% gas) and 2.77 times NPV-10. If Chinook Energy had Leucrotta's key metrics, it should trade now at about C$2 per share (Toronto).
2) As illustrated above, Chinook Energy has built a huge drilling inventory in the over-pressured area of the Montney play in Birley/Umbach while its Montney wells are among the cheapest ones in the industry. They cost on average C$4.5 million and Chinook Energy estimates that its new Montney wells will cost about C$3.5 million each, as shown in the previous paragraphs.
For reference, Blackbird Energy's wells to-date cost more than C$7 million each and Blackbird Energy is working to bring the cost down to about C$6 million each.
3) Chinook Energy has a proven management team that is well known for their expertise and their "timing", because:
A) They exited the risky Tunisian assets at the top of the cycle unlocking tremendous value in the first half of 2014, as shown here.
B) They sold natural gas weighted, non-Montney assets in Alberta (the Gilby and Karr deals) in the second half of 2014 receiving C$72 million, which translates into about C$57,000/boepd, as shown here. In other words, they sold these natural gas weighted assets receiving top dollar when natural gas price was at about $4/MMbtu and we were still at the very beginning of the down cycle in the oil markets. Thanks to these two deals, Chinook Energy has funded the development of its Montney properties since early 2015 while significantly expanding its own plant in Birley/Umbach from 4 Mmcf/d to 29 MMcf/d, as illustrated below:
4) Chinook Energy's insider ownership is very high and reaches 42% (including Her Majesty the Queen in Right of the Province of Alberta's stake), according to the latest Sedar filings.
Therefore, management and directors are highly motivated about building the company's assets and get the most out of them.
5) Βy using average key metrics resulting from recent deals in Canada and peers' current valuation (for details please see the previous paragraph), I conservatively assessed that:
A) Chinook Energy should currently stand at C$1.40/share (Toronto), based on its production, reserves and NPV-10.
B) Chinook Energy should currently stand at C$1.87/share (Toronto), based on a valuation per acre method.
6) Many energy companies are too indebted to take advantage of rebounding oil and natural gas prices, while the financially strong and irrationally undervalued companies such as Chinook Energy are able to capitalize and outperform in this market environment.
Chinook Energy's outstanding acreage position in the Montney play, history of drilling top performing Montney wells and stellar balance sheet along with rising natural gas and oil prices that will meaningfully impact and enhance the Montney economics, are key reasons why Chinook Energy could be acquired by major Montney operators such as Canadian Natural Resources Limited, ConocoPhillips, Apache, Shell, Tourmaline Oil (OTCPK:TRMLF) and ARC Resources, or privately-held Montney producers with deep pockets such as Black Swan Energy, Todd Corporation, UGR, Saguaro Resources and Canbriam Energy that are backed by energy hedge funds such as Pine Brook, Warburg Pincus, Quantum Energy Partners, CPPIB and Kern Partners and build sizeable positions in the Montney play. Chinook Energy's strategic process review has just begun amid rising oil and natural gas prices, and next months will be very interesting.
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Disclaimer: The opinions expressed here are solely my opinion and should not be construed in any way, shape, or form as a formal investment recommendation. Investors are reminded that before making any securities and/or derivatives transaction, you should perform your own due diligence. Investors should also consider consulting with their broker and/or a financial adviser before making any investment decisions.
Disclosure: I am/we are long CKE.T.
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.
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