There is still lots of upside left in Canadian oil and gas stocks, with record-high revenues expected in the fourth quarter.
The surge in oil and natural gas prices has driven Canadian oil and gas stocks dramatically higher this year. Is the party about to end? For an answer, Stockhouse turned to respected oil and gas analyst Scott Inglis, who is managing director at top-ranked institutional brokerage house FirstEnergy Capital Corp. in Calgary, the center of Canada's oil patch. At FirstEnergy, the nine-year veteran sees a lot of what is going on in the oil and gas business because his firm is the lead oil patch underwriter and is among the top three brokerage houses in oil and gas stock trading volumes on Canadian exchanges, something which is quite impressive given that the firm does not have any retail clients.
His view is that oil and gas stocks have a further 30% to 40% upside in the coming year, even with oil and gas pricing remaining stable and not counting any boost that could occur for some stocks from exploration plays. Mr. Inglis identifies his top picks among the companies he follows and also identifies some companies which could have big exploration news in the coming weeks.
Companies among his top picks are: Talisman [T.TLM], Canadian Natural Resources [T.CNQ], Rio Alto Exploration [T.RAX], Genesis Exploration [T.GEX], Velvet Exploration [T.VLV], Ventus Energy [VTU], and Petronet Resources [T.PNT].
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StockHouse: What do you think is the outlook for oil and gas pricing in the coming months, and what do you think will happen to oil and gas stocks in that period of time?
Scott Inglis: Just regarding pricing, we're currently seeing, in Canadian dollar terms, the best pricing the industry has ever seen. Even if you compare current prices to the last peak in the oil and gas market, which was Q4 1997, we're right now about $2 a barrel higher for light oil, at $30 a barrel Canadian, and about $5.00 a barrel higher for heavy oil, at $28.00 Canadian. Natural gas prices are $1.40 a thousand cubic feet higher than they were in the last peak in the market cycle in Q4 1997. So we're currently staring at the best prices that the industry has ever seen. Q4 of 1999 corporate net-backs will be 20% higher than they ever have been in history.
The fundamentals for natural gas are very strong in Canada and the U.S. We think gas prices are going to remain strong for several years. But for oil, once OPEC starts to increase production, which is likely going to happen in either Q4 or Q1 of next year, we see some vulnerability and less predictability in the oil price. We still think we don't see prices going much below $17 per barrel.
Oil and gas share prices are still well below all time highs in terms of the oil and gas producers index peak of about 7,200 in Q4 1997. So we still see a lot of upside in the stocks as they start to discount the kind of fundamentals that we are seeing right now in commodity prices.
There are other things happening within the industry, other than prices, but obviously those kinds of prices are going to drive record financial results in the 4th quarter of this year. A lot of companies will be posting results well ahead of previous historic highs. Canadian Natural [T.CNQ] is an example. The best quarter they ever had for cash flow per share is about $1.45 and they will do over $2.00 in the 4th quarter of this year.
We think that all of the fundamentals are there for continued strong stock price performance in the sector despite having seen gains of in the index of about 70% from the bottom in February of 1999. We still see another 30 or 40% upside.
StockHouse: Which stocks have the best upside potential?
Scott Inglis: The international companies in Canada are particularly good value. They tend to be more oil levered and oil prices have moved a long way in a short period of time. We don't think that move has been fully discounted in the stocks. Talisman [T.TLM] would be our top pick in the internationals. They are bringing on their Sudan production that is going to add, on a quarterly basis, 40-45 cents a share in cash flow by Q4 and just when oil prices have strengthened. They bought Rigel recently to increase their exposure in Canada for gas and in the North Sea for oil. So they did a timely acquisition there. And we think those two events will be a good catalyst for moving the stock higher and we can see the stock at $65-$70 over the next 12 months, trading at $43 right now.
Canadian Natural Resources [T. CNQ], again a senior domestic producer, has a lot of upside. It has been the best in Canada historically in terms of reinvesting cash flow, and has recently made the acquisition from BP Amoco of their heavy oil assets. We do see a good market for expanding heavy crude oils in Canada into the mid west U.S. which is the primary export market for Canadian heavy crude, particularly given the restraint in supply coming from Venezuela and Mexico. We think there is a 2 year window of opportunity for Canada to move volumes higher, and Canadian Natural, being focussed on cost control, is the right kind of company to grow in that business, which can be highly cyclical. So focus on cost controls is important to be profitable, and we see that stock between $45 and $50 dollars within 12 months.
In terms of gas, we think the best gas-levered producer (90%) is Rio Alto Exploration T.RAX], which consistently grows production by 15-20% annually. They are the lowest cost gas producer overall and we think they will be able to continue to drive pretty impressive growth in per share results. In 2000, their cash flow per share will be up 46% from 1999 with a similar number for earnings. We expect that their valuation can move higher based on a consistent track record of generating double digit growth production and cash flow on a per share basis. One year target is $31.
StockHouse: What about one or two smaller companies?
Scott Inglis: Genesis Exploration [ T. GEX] is one that we like. It is an intermediate size producer. We see their volumes increasing quite a bit through year-end. They have been a really successful explorer and found a 25 million cubic feet a day field last year in Alberta called Girard. They have also been successful acquiring and exploiting assets, so they really have both aspects to the business down. They have been timely in their acquisitions. They bought oil when oil was $12.00, and high quality assets. They have a pretty strong management team that could double their production over the next 3 years. They will be expanding their shareholder base. They will get to be larger and recognized for being one of the better emerging companies out there. So we see that stock at $13.50 over the next 12 months, trading around $10 right now.
In terms of small cap stories, there is a handful that we like. Velvet Exploration [T.VLV], which has probably the most exciting thing going: a deep foothills gas project that they have tied up in west central Alberta near Wild Cat Hills where PetroCanada [T.PCA] has had some pretty phenomenal results. And they got a really nice block of land on the Stoney Indian reserve, which has huge upside potential for them. One year target of $7 or $8 if they have success on the exploration front.
StockHouse: When will we know on that?
Scott Inglis: They will be drilling oil in the 4th quarter but it's a multi-well exploration program. They are going to be bringing in some partners to help finance that and so it should be fairly exciting through the winter as they drill their wells.
We also like a company called Ventus Energy [C.VTU], which has only been around for about a year. The stock is around $8.50. We see it in the 11.50-$12 range in the next 6 to 12 months. This is really kind of a reincarnation of the management team that had been successful in the last market cycle which is the previous former management of Terragon Oil and Gas. So really it's more of a management story. They do have quality assets but they are building up their asset portfolio right now. And we see it as being a company that has all the depth of management experience to grow to be a 25,000 barrel a day producer and they only do about 4,000 right now. Primarily their growth over the previous 12 months has come through acquisition.
StockHouse: Are there any companies that might have some announcements coming in the next few weeks from summer drilling ?
Scott Inglis: Yes, one stock that I like here that has results coming short term is Petromet Resources [T.PNT] . It's trading at $5.25. I have a 12 month target price of $7.00. They have a deep gas well being drilled now in an area called Steep Creek, which is nearby where Chevron had some really good success over the last 2 years. Chevron has 2 of the best wells that have been drilled in the last 3 years in an area they call Cutbank. Two of their wells have come on at approximately 30 million cubic feet a day. So they have really batted the ball out of the park in this particular play. And Petromet is drilling a similar target to that, it should be down to it in 3 weeks. So, I wouldn't be surprised to see some positive news coming out there. They have a 100% working interest in that well.
StockHouse: Does your target reflect that?
Scott Inglis: No. I don't put any possible exploration results in my target prices.
StockHouse: Are there any others that might have some results coming in the next month or two?
Scott Inglis: Obviously Berkeley [T.BKP], Elk Point [T.ELK], Richland [T.RLP] and Paramount [T.POU] are all involved in the East Lost Hills play and there will be some results coming out of that in the next little while.
StockHouse: Thanks for your time, Mr. Inglis.
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