Canadian Oil Explorers Pump Profits Abroad
Smaller Canadian-based companies are exploring and producing in countries all over the globe, in areas that may present even greater returns in the coming years. Frederick Kozak, oil and gas research analyst at Canaccord Genuity, draws on nearly 30 years of experience in the field to focus on investment opportunities in locations ranging from New Zealand to Colombia and Egypt. In this exclusive interview with The Energy Report, he discusses hospitable jurisdictions (it's not what you think) and which companies are flourishing in them.
Companies Mentioned: Apache Corporation - BPZ Energy Inc. - CGX Energy Inc. - Gran Tierra Energy Inc. - HRT Participacoes em Petroleo SA - New Zealand Energy Corp. - Nexen Inc. - Pacific Rubiales Energy Corp. - Petrobras - Petrominerales Ltd. - Repsol-YPF S.A. - Tag Oil Ltd. - TransGlobe Energy Corp. - Tullow Oil plc
The Energy Report: It seems the oil market has defied the expectations of all of those who were predicting $5/gallon ($5/gal) gasoline this summer. What happened to the $130/barrel ($130/bbl) oil that people were talking about?
Frederick Kozak: When oil gets into triple digits, $100+, $110, $120/bbl, it really starts impacting the North American economy, particularly the U.S. As gas approaches $5/gal, people start cutting back, which impacts worldwide demand. Combined with issues in Europe, China and other world political and economic events, the markets get nervous. The price of oil has turned around to reflect, perhaps, a less rosy economy for the next 12–18 months. The number of contracts that are traded on a daily basis on the NYMEX certainly outnumber real physical daily oil production by a larger multiple. Any way the wind blows influences the paper trade and it's not blowing in their favor right now.
TER: What are your oil price expectations for the foreseeable future?
FK: Our long-term view is for $100/bbl Brent with West Texas Intermediate (WTI) at around $92.50/bbl through at least next year. That translates to $100/bbl Brent with a permanent differential reflective of the increasing demand from undeveloped parts of the world. Over the last 10 years, the Chinese have doubled their per capita consumption of crude. There's still a huge amount of consumption growth potential there. So, is $40/bbl oil ever feasible again? Certainly on a spike down, but the latest numbers out of the oil sands show that $65/bbl is the break-even number. That might be the floor. However it trades, it's probably going to be higher than that.
TER: How do the prospects look for oil exploration and production companies (E&Ps)?
FK: North America has seen a wonderful resurgence in oil production due to newer technologies. The shales and tight oil sands that were previously uneconomic at $30, $40 or $50/bbl are exceptionally economic now. Canadian oil production has also increased. Roughly 75% of the world's crude oil reserves are in the hands of national oil companies, some of which are not friendly to the Western world. That really limits where people can go. My analysis indicated that one of the best places in the last five years for oil exploration has been in South America, in Colombia.
TER: You cover a pretty broad range of companies. Most of these are Canadian companies looking in a lot of places outside of Canada. What are your criteria for companies you want to cover?
FK: I mentioned Colombia, but there are other countries I'm covering, including New Zealand as well as Egypt. I like countries with favorable business climates that are friendly to Western business practices, good fiscal terms and the ability to take money in and out of the country without onerous currency controls.
TER: Besides Colombia, several countries in South America are getting a lot of attention from oil explorers. What is the big appeal?
FK: Let's start at the bottom end of the spectrum with Venezuela, which has huge natural resources of heavy oil in the Orinoco belt and a government that is extremely unfavorable to Western interests. As a result, Petróleos de Venezuela S.A. (PDVSA), the national oil company, was once producing in excess of 3 MMb/d. About 10 years ago, Hugo Chavez started firing the competent oil and gas people and started replacing them with ones you might call political appointees. As a result, the country's oil production has gone down. The government also nationalized a number of projects and took away the commercial viability of foreign oil and gas companies to do business there. As long as he and people of his ideology are running that country, as rich as it is in resources, it's not a place you can do business.
Argentina now appears to be turning in that direction with the nationalization of Repsol-YPF S.A. (REPYY:OTCPK). I cover three small oil and gas companies in Argentina, and I downgraded my outlook for them. As rich as the country is in natural resources, the current government is still influenced by the policies of Peron and is doing some very odd things. Although it's not a stay-away-from country, it's much less attractive and that is reflected in the share prices of other public companies involved there.
At the other extreme is Colombia, where I first got involved in 2007. My catalyst at that point was the second election of President Uribe. In many South American countries, you get one president who makes a bunch of changes and then he's gone after one term. Being around for a second term basically allowed Uribe to institutionalize the first four years of changes. That's when I thought it was the time to be investing in Colombia.
For many years, people thought about Colombia in terms of Miami Vice and the Colombian drug cartels and missed the fact that the country had been at civil war for nearly 50 years. It has great oil and gas potential with a number of very significant oil discoveries, including Cano Limon, Cusiana-Cupiagua and others. Most of the country was unexplorable because of the problems with the various guerilla groups.
Once Uribe started getting that under control, it became attractive from a security perspective. Also, he recognized that the Ecopetrol contracts of the 1990s had become so onerous that nobody was investing there, so he had the Colombian fiscal regime completely revamped for new exploration blocks. As a result, Colombia has gone from 525 Mb/d in mid-2007 to nearly 1 MMb/d today. That's nothing short of remarkable given that the government is also looking at potentially 1.5 MMb/d total production in the next five years.
That's one of the reasons the oil and gas community has focused on it. Many of the oil and gas companies involved in Colombia are Canadian-listed or with Canadian senior management teams. We're entrepreneurs and we're all over the world, exploring for oil and gas. Surprisingly, you can count the number of public American oil and gas companies operating in Colombia on one hand. There have been and are a lot more private enterprises still operating in Colombia that are U.S. based, but surprisingly few public ones.
TER: How about Brazil?
FK: Brazil has huge offshore potential. I'm less of a fan of Brazil, and I put it somewhere in the middle of the list because I'm wondering which direction it's going to head. Brazil dwarfs the rest of the South American economies and is less inclined to have foreign capital come in. There are foreign oil and gas companies operating there, but it has not opened up like Colombia. Because it has so much work to do in the offshore sector, there is some discussion as to whether or not Petrobras (PBR:NYSE; PETR3:BOVESPA) will open onshore production to foreign capital exploitation. I have been watching with great interest what HRT Participacoes em Petroleo SA (HRTPY:OTCBB) has been doing up in the Solimoes Basin. It's a Brazilian company that went public in Brazil with a number of North American private shareholders.
TER: So what's higher on your list?
FK: I would rank Peru after Colombia, ahead of Brazil.
TER: Even though there are potential political problems there?
FK: I think that perception has yet to be established. The president has well-documented past socialist leanings but he has kept a number of the key pro-business advisers and government ministers, even civil service people in those positions under a previously more business-oriented government. We are seeing examples out of Peru where things are working just fine.
Gran Tierra Energy Inc. (GTE:NYSE; GTE:TSX) has a working interest in Block 95 in the Marañon basin, which was assigned to it without any timing issues or onerous changes to its oil and gas contract terms. Similarly, Pacific Rubiales Energy Corp. (PRE:TSX; PREC:BVC) is going into Peru now, on a joint venture deal with BPZ Energy Inc. (BPZ:NYSE). While that deal has just been announced and hasn't proceeded through the regulatory process, indications are there shouldn't be any issues related to that.
Peru has a very robust mining industry and there have been a bunch of changes to that. It does have a very robust natural gas industry, but on the crude oil side, it is very under explored. Peru appears to be a very good business environment for oil and gas companies. Some people have compared it to Colombia 10 years ago.
Pacific Rubiales remains my top pick and has been for a couple of years. When I first met the management team in Bogota in 2007, they presented the plan for the Rubiales oil field. I've seen many business plans come and go and not work out. That is why I'm usually skeptical. My technical background and experience in oil and gas engineering indicated that Pacific Rubiales' plan could work. Of all of the companies I've ever looked at in my career as an analyst, going back more than a decade, this is the only company with a management team that has delivered exactly what it said it would five years ago, virtually on time and on budget from an oil field that is probably going to exceed production expectations as the year progresses.
It has a very strategic thinking team that ran Petróleos de Venezuela S.A. back in the good old days. It also has an enviable inventory of exploration lands in Colombia, and it has been very good or very lucky in finding heavy oil, which it continues to do best.
The joint venture in Peru with BPZ Energy is another very logical example of taking advantage of great technical expertise it gained in Lake Maracaibo in Venezuela, that's similar to the shallow, offshore water off northern Peru where BPZ's assets are. I very much like what Pacific Rubiales is doing and can see how 100 Mboe/d today, in five years could be developed into 170 Mboe/d.
TER: What else do you like in that area?
FK: In Colombia, I like Petrominerales Ltd.'s (PMG:TSX) exploration inventory. The company struggled for the last half of 2011 with its exploration program in the Colombian foothills, but over the last couple of months, it seems to be having success. We just need the news on the testing of its more recent wells in the Corcel trend to see if it's back on track. I like its exploration inventory in the Colombian foothills, where it just finished drilling on a potential high-impact well called Bromelia. It will be testing that over the next two to three months to see if it's made an interesting discovery there.
TER: You also cover New Zealand, which is an area most people don't associate with oil and gas production.
FK: I have followed New Zealand's oil and gas industry for more than 10 years. It has to import the majority of its crude oil because only one-third of its domestic consumption comes from within in the country.
I cover a company called New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX), whose president was the president of the very first company I wrote a research report on as an analyst when I first started. Fortunately, for me, he was successful. Otherwise, I might not be here today. So, when I look at oil and gas companies, regardless of where they are, I always look at the people first. As president, he's successfully run a number of public and then private oil and gas companies in the last 10 to 15 years. I know that the company management, with him at the helm plus its technical people on the ground in New Zealand, is quite viable.
The company has an enviable position in the Taranaki Basin in New Zealand, the only currently producing basin in the country. I like its land base. I rank it up there with the best of the companies that are operating in New Zealand right now. It has been lucky on its first two wells. It's producing around 1,000 boe/d, but those wells are limited until it ties in its gas production. It has great conventional exploration potential, and like its next-door neighbor, Tag Oil Ltd. (TAO:TSX.V), which I do not cover, it has a very large land base on the east coast of New Zealand's North Island, which is potentially oil-shale prone. That could become a very interesting catalyst for both of the companies in the future. Right now, I'm more interested in what New Zealand Energy is doing on its conventional stuff.
TER: What do you see for upside on its stock?
FK: My target price is $4.50, but it's a highly risked target price based on its exploration inventory. The company has over 20 exploration locations that it could be drilling in the next 18–24 months. Where could the stock go? I have an official target and another number in my mind that might be a double of that. It's going to depend on its exploration success in the basin in a very underexplored mostly 100% working interest land base. I've looked in detail at all the prospects and I have to say it is extremely impressive. Time will tell.
TER: Another couple of areas that haven't had much publicity or visibility are Egypt and Yemen. You cover a company that's pretty active in those two countries. What's going on there?
FK: TransGlobe Energy Corp. (TGL:TSX; TGA:NASDAQ) is one of my favorite names right now. I've followed the company for 12 years, so I am extremely familiar with it and its management. I just came back from Egypt where the company ran an analyst trip field trip to update everybody on its properties and operations. Yemen is where TransGlobe got started. TransGlobe situated itself right beside Nexen Inc.'s (NXY:TSX; NXY:NYSE) producing Masilla field in eastern Yemen. It was directly offsetting that with a small amount of production net to it, and then on the western side of the country, right beside existing infrastructure and existing oil and gas. That production net to them, if it was all onstream, which it's not right now because of pipeline disruptions due to the tribal issues that are ongoing in Yemen, would be about 2,500 bbl/d. The company's total production today is 17 Mbbl/d roughly. So it's become much less material to it. At some point in time, it's going to divest itself of Yemen, but not at this point and, certainly, not when production is shut in. When it's producing, it spins off really good cash flow. So that's valuable for it to finance other activities.
TransGlobe got into Egypt about four years ago when it acquired a 2,800 bbl/d field that had been undercapitalized for a number of years, doubling that field's production to about 6,000 bbl/d over time. It has also made a very significant discovery in a formation that nobody had paid any attention to, which appears to be pervasive throughout the land. Its current production is all on the Gulf of Suez within 10–20 kilometers (km) of the ocean and a very short distance to get the oil to port for export. This has been the focus of its operations, growing that production to about 17 Mbbl/d today.
Egypt just had a bid round, which closed at the end of March. The successful bidders should be announced sometime this summer. The company has bid on all the lands around its current production, which if successful, will really set it up for a lot of future exploration and production potential. Its management team has been very conservative in running the business and it presented its roadmap to 40 Mbbl/d to the analyst and investor community in the trip to Egypt. The company's current assets are probably good enough to get it to 30 Mbbl/d. With success in the upcoming bid rounds, it's not a far cry to get to 40 Mbbl/d.
The bid round was mostly focused in the Gulf of Suez region, but the company also acquired a number of blocks in the western desert of Egypt, which is where the big companies are operating—Apache Corp. (APA:NYSE) et al. TransGlobe has two discoveries that are going to be brought onstream—one in the middle of this year and one at the end of the year. And it's about to spud a very material exploration well in a block that it's just acquiring that is a 200 MMbbl prospect size. If that's successful, it changes the game for it all over again. I like TransGlobe because of the management, the prospect inventory and the production potential. I can't say enough good things about the company and its potential. The stock had been an absolute champ this year since mid-December, until it put out a really good first quarter and the market decided that it didn't like the company anymore and sold the stock off. I think it's a very attractive company at this valuation.
TER: Are there any other attractive opportunities that you'd like to talk about?
FK: One company that is an interesting one from an exploration perspective is also operating in South America, but it's offshore. That's CGX Energy Inc. (OYL:TSX.V), which I cover and have a $1.85 target price on. It just drilled a dry hole offshore Guyana that cost it $71M. It drilled that 100%. It also partners with Tullow Oil Plc (TLW:LSE) and Repsol in an adjacent block on a well that's costing $160M, of which it has 25%. It could be one well away from either being a hero or not. CGX has been around for a long time, but it's drilling in a basin where very few wells have been drilled. Tullow and Repsol are known explorationists, particularly Tullow, which has had great success around the world, offshore in this very same play type. Tullow just drilled a successful well off French Guiana. Now, it's moved into offshore Guyana in a similar basin with the same play type. Everybody has their fingers crossed, and if this well doesn't work for CGX, the share price is probably going to be reflective of very expensive wallpaper.
TER: That's a pretty expensive bet, isn't it? Even 25% of a $160M well is a lot of money.
FK: Yes, it is.
TER: But on the other hand, the upside is that if it hits, the payback can be pretty quick.
FK: Exactly right.
TER: Based upon what you're expecting for the oil markets in the coming months and years, what investment strategies would you suggest for playing this market?
FK: It's been a challenging market, no question. Investors should be looking at oil companies as opposed to natural gas companies, in friendly jurisdictions. I have what I call the five Ps, and I alluded to three of them: first and foremost, people; secondly, exploration prospects; thirdly, production; a very important one is profitability; and lastly, the politics, and how well they're politically connected.
You can trade Argentinean stocks, but I'm not a fan of actually owning them for a long term. Colombia, I would own long term. It has proven itself to be a very good environment for investment.
Similarly, Egypt is going through real political change. A lot of the things you see on the evening news and the headlines are just that, headline risk. Through the entire Arab Spring last year, TransGlobe did not lose a single day of production. It is being paid on time by the Egyptian government. Egypt relies on three things for its income. Two of those are tourism and oil and gas. So I wouldn't hesitate, despite the headline risk and the fear, to invest in quality companies in Egypt, particularly TransGlobe.
TER: Thanks for joining us today and for some very interesting ideas.
Frederick Kozak joined Canaccord in early 2007 and has nearly 30 years of oil and gas industry experience in his role as an oil and gas research analyst at Canaccord Genuity. Kozak previously worked as a research analyst at a Canadian boutique investment firm, where he was ranked the #3 Stock Picker for Oil and Gas in Canada for 2005 in the annual StarMine Analyst Awards. Since being at Canaccord, he has added to that award with the #3 Earnings Estimator award for 2009 and the #2 Stock Picker for 2010 for Oil and Gas in Canada, as recognized by StarMine, as well as being recognized by Zack's Investment Research as being #1 Stock Picker, North America E&P companies. Kozak started his career as a petroleum engineer and has also worked in the oil and gas industry in financial analysis and corporate planning. Kozak holds a Bachelor of Applied Science in geological engineering from the University of British Columbia and a Master of Business Administration from the Ivey School of Business at the University of Western Ontario. He is a registered professional engineer in the province of Alberta.
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DISCLOSURE: 1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
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May 26th, 2020
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