It wasn’t too long ago that Federal Reserve Chairman Alan Greenspan issued a warning about the shortage of natural gas in the United States. “Today’s tight natural gas markets have been a long time in coming, and distant futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon,” he said in 2003. Yet, only a few short years later, savvy drillers found ways to unlock a flood of shale gas. Now the U.S. is trying to figure out what to do with the abundance, and companies are racing to line up export permits to send LNG to Asia.
That story is well known. What is less known, but equally momentous, is a similar shale gas revolution unfolding in Canada, albeit to a lesser degree. Several years ago Canada had plans for seven LNG import terminals in order to satisfy domestic demand. Shale gas production has upended that equation, and Canadian companies scrapped plans for all of those terminals. Now, Canada wants to build export terminals to sell its gas overseas.
Of particular importance is the Montney Formation in Alberta and British Columbia. Not well known – particularly outside of Canada – the Montney Formation rivals the Marcellus Shale in the sheer size of its natural gas reserves. The Montney Formation may hold somewhere between 250 and 350 trillion cubic feet (tcf) of natural gas, compared to the Marcellus Shale, which according to estimates has between 225 and 520 tcf.
And the Kitimat LNG project on British Columbia’s west coast will provide an outlet for shale gas from the region. Originally intended to be an import facility, it will be turned around for export through a joint venture between Chevron Canada and Apache Canada. This will allow Alberta and B.C. shale producers to find new markets in energy hungry Asian countries like South Korea, China, and Japan.
There are several ways to play this trend for investors, but I like finding the small companies with huge upsides. By that I mean low-cost operators, positioned in resource-rich areas, with strong markets nearby. To be sure, these small companies are risky, but they fly below the radar and precisely because of their small size, there is enormous room to grow.
One high-risk high-reward company is Blackbird Energy Inc. (TSXV: BBI.V), which just announced its purchase of Pennant Energy. Blackbird is a nano-cap ($9.45 million market capitalization) stock that trades on TSX-Venture. It is a small oil and gas company in Alberta and Saskatchewan, which are the two largest oil and gas producers out of all of Canada’s provinces, combining for 90% of the country’s oil output.
It has produced a small amount of oil from the few wells it has drilled, but it has snapped up acreage in the right areas. For its fiscal year 2013, Blackbird produced a mixture of natural gas, natural gas liquids, and crude oil for a total of around 160 barrels of oil equivalent per day. The company’s management says that it hopes to drill successful wells, and replicate and scale them. This, they argue, will allow them to become the next “great junior producer.”
There are several reasons why I like this company:
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1. It just made a smart acquisition. Blackbird Energy announced on February 18, 2014 that it would acquire the remaining shares of Pennant Energy Inc., with the consolidated company retaining Blackbird’s name. The acquisition of Pennant offers complementary assets to Blackbird’s portfolio and allows the company to achieve some economies of scale. The combined Blackbird will merge the two companies’ stakes in the Bigstone Montney Project, a natural gas and liquids rich play in northwest Alberta. Montney is Blackbird’s bread and butter; its highest producing asset and a tract it thinks has huge potential (more on that below). The consolidated company of Blackbird and Pennant will now own 50% of the project, as opposed to the separate companies each operating their own 25% stake. The story is similar for its Mantario Oil Project, located in central Saskatchewan. Last November, Blackbird successfully struck some oil in the Mantario. It is now producing over 20 barrels of oil per day. Building on that initial success, BlackBird hopes to go bigger. It plans on drilling its first horizontal well in the Mantario project in the second quarter of 2014, at a cost of less than $1 million. Brining Pennant’s holdings on board gives Blackbird a 100% stake in the project.
2. It’s holdings in the Montney Formation. It right now produces more than 60 barrels per day, with plenty of room to grow. The play’s decline rates are flatter than other comparable shales, with high estimated recoveries. It is also rich in natural gas liquids, which is more lucrative than dry gas. The Montney Formation is going to be a big story for years to come, and Blackbird seems to be in a good position here. Management is optimistic that it can parlay its success from this project into further growth.
3. Blackbird’s neighbors have had great results. Blackbird has holdings in an area that has proven to be fertile. It owns seven parcels near Delphi Energy, a similar company operating in a similar environment. Delphi Energy has drilled several wells that are producing around 1,300 barrels of oil equivalent each. These wells have net present values of $25-$26 million. Based on the good numbers from Delphi Energy is producing nearby, there is no reason to think that Blackbird can’t see similar results.
4. Similar companies have exploded. Blackbird is not paving new ground here; it is following in the footsteps of other companies. Tiny drillers are risky, but when they blow up, they blow up big. As mentioned above, Delphi Energy (TSE: DEE) is a similar company to Blackbird. It operates in Alberta and its stock traded as low as $1 per share in early 2013. Now it’s up to $2.50, a 250% increase. Kelt Exploration (TSE: KEL), which operates in B.C. and Alberta is another example. It traded below $6 per share in the spring of 2013, but is now around $11.50. Rock Energy (TSE: RE), a heavy oil driller in western Canada, trades at $4.40 per share, up from around $1.10 a year ago. Rock’s discovery and successful production from the Mantario play is encouraging for holders of Blackbird stock. Blackbird has similar holdings in the Mantario, and Rock’s success suggests Blackbird has a good chance of doing the same in its Mantario Oil Discovery.
5. Management has a good strategy. The company’s strategy for “growth through carefully targeted acquisitions,” as it laid out in a press release, makes sense in the case of picking up Pennant. It gives the combined company more production per share and more cash per share than the individual companies had separately. The compatible and complementary holdings of the two companies made their marriage a no-brainer. It also is consistent with the company’s strategy of pursuing internally-generated growth – that is, maintaining a high degree of ownership over operations, and developing projects for long-term value. Blackbird has showed a penchant for successfully drilling wells, producing a small amount of oil (dozens of barrels per day), bringing in some cash from that early production, and redeploying that capital to grow its production portfolio. That’s how you gotta do it as a small player – slow but steady growth, smart acquisitions, efficiency gains, and an appetite for risk, but with some patience.
Blackbird’s future entirely depends, obviously, on its ability to avoid drilling wells that come up dry. As a small company, it has little room for error because the costs of drilling account for a much larger portion of the company’s value than a large oil company. A few wrong decisions and it will be out of business. But based on the results from similar companies operating in the same formations, Blackbird has a better shot than most companies trying to get off the ground. Many of its prospects involve shallow wells with high certainty, and it operates in proven areas that are already producing oil, natural gas, and natural gas liquids. A big question mark hangs over whether or not B.C. will get in the way of the Kitimat LNG export terminal, which would limit the market for gas coming out of the Montney.
The company is still posting negative earnings per share, but is heading in the right direction. Its assets have low decline rates compared to other plays. It operates a lean operation with low overhead. It has some cash flow from the few wells that it has producing. And its recent acquisition of Pennant allows it to achieve greater economies of scale. Small companies always are high-risk, but keep an eye on Blackbird and as it works to become the next “great junior producer.”
By James Burgess of Oilprice.com