Plus: Thom Calandra on Nevada, Trueclaim & More

Danny Deadlock writes and researches for Stockhouse's Ticker Trax once a week. Stockhouse and Thom Calandra launched the Ticker Trax service in November 2008. Please see www.tickertrax.comnow for more.

Today’s report is about Alberta’s ProspEx Resources (TSX: T.PSX, Stock Forum; High of $1.37 since profiled to Ticker Trax subscribers), an energy producer weighted to natural gas and natural gas liquids (NGLs). The commodity is out of favour right now but starting to turn from a bottom (see chart).

Over the past decade I have tended to pick only a few oil and gas companies per year … yet have been fortunate to see many bought out. The last in 2010 was Great Plains (TSX: T.GPX, Stock Forum) for a 65% gain – much lower than we were hoping for because the company managed share structure poorly.

Natural gas supply & demand

There is a lot of negative talk about the natural gas sector and, for the most part, it’s all correct. Prices have been driven to yearly lows. Without an extremely cold winter on the eastern seaboard of North America, it’s unlikely we'll see much change through 2011.

Companies are tapping massive shale reservoirs. This has drawn foreign investments (to Canada) by the billions, and that capital is feeding the current gas oversupply. At the same time, low prices are helping demand. In the eastern U.S., gas demand for electricity generation was up 48 per cent between September, 2008, and September, 2010. There is plenty of regulatory development at the state and a federal level that is positioning gas to gain market share in the U.S. power sector (mid to long term).

Many producers earlier this year shut in gas to conserve the economics of the field, but they still need to pay the bills and often are forced to pay for plant capacity (within the distribution system), so they need to generate cash flow.

Storage and liquids

Natural gas may be stored in a number of different ways. It is most commonly held in inventory underground under pressure in three types of facilities. These are: (1) depleted reservoirs in oil and/or gas fields, (2) aquifers, and (3) salt cavern formations. (Natural gas is also stored in liquid form in above-ground tanks).

Most existing gas storage in the United States is in depleted natural gas or oil fields that are close to consumption centers. Conversion of a field from production to storage duty takes advantage of existing wells, gathering systems, and pipeline connections. Depleted oil and gas reservoirs are the most commonly used underground storage sites because of wide availability.

Natural Gas Liquids (NGL)

These are components of natural gas that are liquid at surface in field facilities or in gas-processing plants. Natural gas liquids can be classified according to their vapour pressures as low (condensate), intermediate (natural gasoline) and high (liquefied petroleum gas) vapour pressure.

Western Canada accounts for the majority of NGL supply. Natural gas liquids are initially extracted from natural gas at field plants. There are almost 700 active plants in Canada and over 600 are located in Alberta.

In Western Canada, nine facilities called straddle plants extract incremental amounts of ethane and propane from natural gas. They are located on the major gas pipeline systems. The initial products from all plants are usually NGL mixes. These mixes are usually sent to fractionation plants to be separated into individual products such as ethane, propane and butane.

Once extracted, NGLs are usually transported from Alberta to Sarnia, Ontario, and to the U.S. via three pipelines.

Fighting herd

Right now the hot equity sector in natural resources is metals/minerals. Oil is doing very well but natural gas stocks are trading near their lows. When it comes to the natural gas stocks, you have to be extremely careful of balance sheets. Many of these companies took on huge amounts of debt. In 2011 it’s going to cause serious problems. I rarely touch an oil/gas stock if the debt is higher than 1x annual cash flow. Right now I see many natural gas stocks with debt closer to 2x estimated cash flow.

I am following ProspEx because it’s a high-quality producer with a clean balance sheet, nice share structure and a price well below book value. The hope is that large producers begin to shop around for undervalued natural gas inventory and facilities. It's still not cheap to drill and it’s risky.

ProspEx Resources (TSX: T.PSX; $1.34 Canadian)
www.psx.ca

Note: ProspEx just sold 4,954 net acres of rights to shallower zones in Alberta that are non-core (it had no intention of drilling in 2011). This raised $8.1 million, which reduces debt to $22 million. This does not affect the high impact deep drilling on the same land and there are no wells, production or reserves associated with the transaction. It’s worth noting that ProspEx received more than $1,600/acre for land it has little interest in, yet the company as a whole still owns 85,000 net acres in Western Canada.

> Shares Outstanding: 61 million/ Market Cap $78 million

> Net debt estimate to Dec 31st is $22 million (36 cents/share)

> Book value of property, plant & equipment is $147 million ($2.41/share)

> Estimated tax pools available for tax reduction: $126 million (also valuable to others)

> Cash flow in the range of about $18 million annually.

> Target 2010 exit rate: 4000 boepd (barrels of oil equivalent per day) - 80% natural gas

> 85,000 net undeveloped acres (Western Canada)

> Approximately 200 mile trend from Kakwa to Pembina (west central Alberta)

> Breakeven gas price approx. $2.00/GJ

While gas prices are low near $4 per GJ, the natural gas liquids (NGL’s) are where the money is - they are averaging $57/bbl right now. A good part of PSX's gas production will have the liquids associated with it and this brings up the overall $ revenue per barrel equivalent.

For the best indication of value and managed risk, we simply need to look at their most recent financing that closed in October when gas prices were rock bottom. Even with this poor gas price and a stock near the 52-week low, Prospex was able to raise $5.5 million at $1.75/share. It did this with some of the top firms in the oil & gas sector: Cormark Securities. Peters & Co., CIBC World Markets, Stifel Nicolaus Canada and Wellington West Capital Markets.

Big hits

The last couple of wells had terrific production rates. This summer at Kakwa in central Alberta the 13-8 well had a final rate of 23.4 million cubic feet per day - this is a huge hit for a gas well. The mandate: Target five times the production for twice the capital cost using horizontal wells.

The first three Kakwa horizontal wells averaged 230 bbl/d liquids plus 6.5 mmcf per day gas. These are expensive horizontal wells but they generate substantial and long-term cash flow even at current commodity prices.

Trading on PSX can be thin at times but between now and Christmas we may see tax loss selling in the $1.25 to $1.30 range. The only thing that may mess with this is a rise in gas prices during this past week. And yes, I own 10,000 shares of PSX.

Thom Calandra: Thanks Danny. TT Subscribers, events are stirring for several Ticker Trax-covered companies. John Carter’s Trueclaim Exploration (TSX: V.TRM, Stock Forum) just reported what appear to be thick assay results (channel samples) for its Scadding Gold Project in Ontario, Canada’s Sudbury District. Trueclaim is also active with silver prospecting in Arizona, USA. I do not own the shares. The miniscule market capitalization of the company makes Trueclaim worth a look-see. Please see data via Stockhouse.John Carter at age 58 has about 30 years in the mining business and across related property areas. He owns more than five percent of tiny Trueclaim, thanks in part to the 1.5 million shares he received in exchange for his property interests. In the past four months, he has bought another 1.6 million shares of Trueclaim in the open market. Eric Plexman is CEO. … On the Nevada front, I will be publishing more on Thomas Klein’s Golden Phoenix (GPXM) and its interests in Nevada, in Ontario and in Peru. Our visit to the Nevada joint venture, Mineral Ridge with Peter Hawley’s Scorpio Gold, took place this week and was enlightening. Once again, an orphan equity with a commanding manager in Mr. Klein and an expansion strategy that encompasses Nevada, Ontario (Shining Tree district) and Peru. (More: Powered By The Deal.) … There is more. There appears to be a desire on the part of asset managers to purchase blocks of shares in Colombia gold prospectors. I note this based on a couple of notes received this week. Colombia is a so-called “grass-roots” area that has seen equities of gold, copper (and oil) prospectors and producers soar in the past 18 months. Please exercise caution. There is a lot of hype … this week included … yet I stand behind projects that I 1. Have seen with my own eyes; and 2. Featured in Ticker Trax and made available to paying subscribers in our Library. … I am looking at non-gold prospects in the segments of tantalum, niobium, tellurium, scandium. … We await a feasibility study for the Kitsault molybdenum mine owned by Avanti Mining (TSX: V.AVT, Stock Forum), a former Planetary Prospect of this service and a stock whose shares I own. … Finally, I am as stated several times here – for portfolio diversifying -- selling a portion of my stakes in Great Panther Silver (TSX: T.GPR, Stock Forum), Endeavour Silver (AMEX: EXK, Stock Forum) and (TSX: T.EDR, Stock Forum), Candente Copper (TSX: T.DNT, Stock Forum) and Great Basin Gold (TSX: T.GBG, Stock Forum). All appear to be achieving internal targets and public goals. Yet these miners’ gains this autumn of 2010 have – as I joked with Great Panther CEO Robert Archer last week – “hijacked” my portfolio.