Cardium Oil Play Valuations Setting Up Big Year for M&A in 2010

Commodities / Oil Companies Dec 14, 2009 - 03:52 PM

By: Keith_Schaefer

The new Cardium oil play in Alberta is rapidly approaching the stature of Saskatchewan’s famous Bakken play – and this is very good news for investors in Canada’s junior oil and gas sector.

The four year old Bakken play has created huge shareholder wealth for investors, as companies like Crescent Point Energy and Petrobank bought out junior after junior after junior to increase their land base and production profile.

The same thing is now starting to happen in Alberta’s Cardium play. And valuations (read: stock prices) are getting much richer, much faster than what happened in the Bakken.

As an example, TSX listed Result Energy is a Cardium-focused play that was just taken over and re-capitalized by the management team from TriStar Oil and Gas, a Bakken play that itself was bought out in August 2009.

Brett Herman and his TriStar team announced several acquisitions immediately, and one Canadian analyst estimated they paid $275,000 per flowing barrel for them. As comparison, the average Canadian listed junior trades at about $60,000, the intermediates at $71,000, and if it’s a natural gas weighted producer, it can be as low as $30,000.

Even the leading juniors in the more profitable Bakken play – Painted Pony Explorations would be a good example of this – trade at $140,000 per flowing barrel.

The Result Energy transaction had an immediate effect on the other junior players in the Cardium play. Two other bigger Cardium players – West Energy, Midway Energy – saw their valuations increase that day. Even Bonterra, a $30 stock with a large Cardium land position, had a jump of 6%, or $1.89/share.

Wellington West Capital immediately upped their target on Cardium junior producer Berens Energy by 10% to $2.20 on the increased valuation that the Cardium producers started receiving this week.

Why are valuations increasing so much?

As background, both the Bakken and the Cardium are “tight” or “unconventional” plays, where the oil is hosted in a rock, as opposed to a more porous, and usual sand formation.

They were well known but uneconomic zones until a few years ago, when advancements in horizontal drilling and fracing technologies allowed them to be exploited. The Bakken is ranked by most Canadian analysts as the most profitable oil play in the country now, with Cardium as #2.

With the Cardium in particular, there is very little geological risk. It has been drilled through thousands of times to get to the oil in the more porous, productive zone below it. The market loves these low risk plays that are very “repeatable” – each new well is likely to produce just as the one before it.

Thirdly, these new technologies are continually improving the economics in these formations. Four years later, companies are still increasing production from Bakken wells, and increasing the overall amount of oil recovered from the formations. The Cardium is a younger play, only a year old, and as management teams tweak the way they drill and frac these wells, it may one day get even closer to Bakken economics.

(Of course, being so young, another year or two of exploration in the Cardium may find it’s not near as repeatable as the Bakken is at all!)

A final benefit the Cardium play for investors, is that it is rescuing moribund, natural gas weighted juniors that could otherwise go bankrupt with current low gas prices. This could be a strong catalyst for increased mergers and acquisitions in the Cardium in 2010, as there is a huge valuation gap between these gas weighted producers with Cardium lands, and the higher priced, pure Cardium oil producers.

Unlike the Bakken, most of the Cardium had already been staked when it was discovered that oil could now be produced from a second, tight oil formation. And many of these companies were heavily gas weighted, and heavily indebted to their bankers – with truly little hope to give investors through 2009 and 2010.

The valuations on these natural gas companies reflected their poor balance sheets and cash flows. But these companies’ stocks have been revitalized by their Cardium land positions. Many have seen large gains in the last quarter of 2009 as investors discovered who had Cardium lands. Companies like Berens and Bellatrix Explorations (the former True Energy trust) are examples of this – both have more than doubled in the last 90 days. And companies like these still have low valuations compared to the pure oil producers in the Cardium.

Just who will emerge as the Petrobank or Crescent Point of the Cardium has yet to be seen, but investors can expect significant M&A activity in 2010, as the Cardium is highly profitable, and there is a large gap in valuations.

A partial list of companies with Cardium Formation properties include:

Arc Energy Trust AET.UN-TSX

Bellatrix Explorations BXE-TSX

Berens Energy BEN-TSX

Bonterra Oil and Gas BNE-TSX

Enerplus Resources ERF.UN-TSX

Midway Energy MEL-TSX

NAL Oil and Gas Trust NAE.UN-TSX

Nexstar Energy NXE.A-TSX (just bought out by Result Energy, RTE-TSX)

Penn West Energy Trust PWT.UN-TSX

PetroGlobe Inc. PGB-TSXv

West Energy WTL-TSX

I own positions in Berens, Bellatrix, Midway, and West.

About Oil & Gas Investments Bulletin

Keith Schaefer, Editor and Publisher of Oil & Gas Investments Bulletin, writes on oil and natural gas markets - and stocks - in a simple, easy to read manner. He uses research reports and trade magazines, interviews industry experts and executives to identify trends in the oil and gas industry - and writes about them in a public blog. He then finds investments that make money based on that information. Company information is shared only with Oil & Gas Investments subscribers in the Bulletin - they see what he’s buying, when he buys it, and why.