₪ David Pescod's Late Edition January 24, 2008
AN INTERVIEW WITH ANDY GUSTAJTIS
OIL & GAS ANALYST WITH DOMINICK AND DOMINICK
(As of January 22, 2008)
When times were a little bit better, no one had a hotter hand in the oil and gas game than Andy Gustajtis, picking some of the hottest winners over the last year. Now the market isn’t nearly as generous and some of Andy’s stars have waned just a bit, so it’s time to hear his view on the economy and the markets.
David Pescod: So Andy, first of all, what’s going to happen with the economy? Is it a recession we are facing? Is it stagflation? Is Asia big enough that it doesn’t matter and demand over there will carry us all?
Andy Gustajtis: David, I think it is the latter. I think we are into a multi-decade bull market in commodities. I think the analogy we can draw in 2008 is very similar to what we saw back in the 1950’s and the 1960’s as the OEDC countries began to industrialize post the Second World War. We had essentially 20 years of growing demand for fundamental commodities and I think we are very much in the same picture. India and China are just beginning to industrialize and I don’t think that’s going to get aborted.
I don’t know if there is going to be a recession in the U.S. The indications are that the housing market is going to be under severe pressure for a considerable period of time and that has been a large driver of the U.S. economy. Also, the US Consumer is pretty heavily leveraged, so it’s possible we will see a slow down. If there is a US recession, I just don’t see a huge decline in what I care most about – OIL. We in North America are not going abandon our automobiles, demand for oil will not cease. There will be some softness but common sense tells us demand will continue to grow. There may be a slow down but the way Canadian oil and gas stock have been hammered is down right silly! Besides that, the big drivers are Asia and China and I don’t see that changing.
Natural gas has been a big problem in North America in the past 12 months. A recession would probably not bode well for natural gas prices recovering much from where they are now, but they are not that bad!
Gas prices are $1.00 per mcf higher than they were a year ago and in historical terms, gas prices are certainly better than we saw many years ago. There is a problem out there in terms of drilling demand; the service companies I think are all whining. I have been talking to a number of companies and they are being offered rigs today for prices they haven’t seen for three or four years. So the costs of getting your wells drilled will certainly help the E&P companies.
I think the oil and gas business in Western Canada is overcapitalized and I have felt that way for pretty much of the last decade and I think we are going to continue to see rationalization. I have seen this week four companies merge. We saw Talisman taking over a small company RSX Energy Inc. and I suspect that consolidation will continue throughout 2008. As a result we may see far fewer companies at the end of 2008 which I feel will be healthy and it will represent a more rational allocation of capital to this resource basin. The real opportunities in Western Canada are in heavy oil, tar sands and unconventional gas – they will attract capital, perhaps at a slower rate than we’ve seen in the last few years, but the returns should continue to be attractive especially if costs come down.
D.P: Now trying to predict where oil and gas prices will be, what kind of parameters are you looking at for let’s say the next year? Is it between $80 and $100, or higher or lower?
A.G: I have been a big proponent of the peak oil theory for pretty much the last ten years and I think we are beginning to see the evidence of the peak oil scenario unfold. I believe oil will be triple digits for a considerable period of time. I feel, once the price breaks through that $100 psychological barrier it will stay above that for many years.
D.P: Having said all this, do you still like some of the big international plays much more so than Western Canada?
A.G: If you look at the opportunities in Western Canada in conventional oil and gas, I think you’ve got to expect a very mediocre rate of return. Generally, you are going to find small fields and small pools, but most companies in this basin are not going to be involved in companymaker discoveries. Having said that, there is always an exception to all rules and somebody may stumble along and find a 50 million barrel oil pool in Western Canada, but they are going to be pretty rare.
D.P: Now let’s get to some specific names, particularly names that your name has been associated with such as Corridor Resources, which was an exciting discovery and who would have thought natural gas in New Brunswick? It had a huge run. What would be your latest take on a stock that’s been halved, like many other stocks of late?
A.G: I’m disappointed in terms of what’s happened to stock price, but in light of what the overall markets have been doing, I guess it’s not unexpected. I am of the opinion that McCully, the gas field in New Brunswick that Corridor discovered, will in the fullness of time prove to be a multi-TCF discovery. So far, they have drilled 23 successful wells in the upper portion of that field known as the Hiram Brook Sands. The Company has just released their budget and guidance for 2008. I am hoping this is an exercise of under-promise and over-deliver.
Both their production and cash flow guidance were about 30% less than I am hoping for. After discussing this guidance with the Company one gets the sense that their intentions was to give a very solid base of 25 mmcfpd for their net interest but my target of 35 mmcfpd is not unreasonable.
D.P: Their production numbers so far have been a little bit disappointing, but what kind of a number should this company be worth at that production number and of course, the big question is, the Dawson Settlement – the deep stuff. Seismic says if it’s there, it could be enormous.
A.G: Before we get down to the Dawson Settlement I guess we have to find out how big this Frederick Brook shale is and what kind of commerciality they are going to get out of that. They are drilling a well now with the intention of trying to get down to the Dawson Settlement, but there is also a lot of interest in terms of trying to prove up the Frederick Brook shale. The company has a December year-end and they began producing gas commercially in the third calendar quarter of 2007 and I am anticipating that for 2007 they will have a modest cash flow of about $13 million or $14 million. I am expecting their cash flow for 2008 to be somewhere in the range of $50 to $70 million (the $50 million is the Company’s guidance the $70 million is my estimate) per share this is $0.60 to $0.85. That would give a cash flow per share multiple to the company in the range of 10 to 7X. Corridor has not been a stock that you’ve been able to buy on a cash flow multiple up until now, but getting down to $6.00, this stock is trading at a pretty respectable multiple considering that I think this gas field is going to last for 20 years.
D.P: Wow! So, what would be your target?
A.G: If the Frederick Brook shale proves to be commercial, the potential resource would be multi-TCF of natural gas and TCF of natural gas is worth a couple of billion dollars so you see the prize is huge.
If the Dawson Settlement is gas charged and we may have something to talk about at the end of March that would be incremental.
D.P: Based just on the Hiram Brook Sands, would $10 be do-able?
A.G: I think the Hiram Brook which is where all the gas to date has been found will justify over 100 drillable locations and I think in the fullness of time, that this zone alone will probably support such a share price.
D.P: Connacher Oil and Gas is one of the plays in the heavy oil business that you’ve been following and I suspect we are all a little bit disappointed. Does it surprise you that it’s taking so long to get production going?
A.G: No, I think everything is pretty much on schedule. Their Pod-1 was constructed in 300 days, they started steaming for 90 days and are getting bitumen production as we speak. Production will be ramping up through 2008 and I can see them reaching design capacity by the end of 2008 with possible cash flow north of $140 million for 2008 with a fourth quarter of over $50 million or over a $1 per share annualized..
D.P: And then of course, hopes for Algar or Pod-2?
A.G: That’s another 10,000 barrels a day so within 18-24 months from now this company conceivably could be producing 20,000 barrels a day of bitumen and probably another 3,000 barrels equivalent of gas and conventional oil with possible cash flow of about $300 million a year.
D.P: You had some pretty lofty targets a while ago?
A.G: I think in terms of the resource market, all we’ve had is a correction in an upward trending bull market. I have very little reason to want to move off my very bullish longer-term outlook for resource stories. I think Connacher certainly could be a double-digit stock within the next 12-24 months.
D.P: Good. We are always glad to hear that! Now, an associated company is Petrolifera Petroleum, and it seems every analyst from Warren Verbonac to Malcolm Shaw at Wellington West – are all aware of Petrolifera and their targets in Peru and the enormity of that. Now with Petrolifera trading at almost a third of where it was, your thoughts on Petrolifera?
A.G: It’s a cheap stock. I liked it at $15.00. Oil prices in Argentina are capped at $42 a barrel, but even at that oil price given the fact that the company should be able to get up to 14,000 or 15,000 barrels a day in Argentina, they should have a cash flow of $2.00 a share. The stock is trading essentially at three times cash flow.
D.P: Now how big are these targets in your estimation?
A.G: Camisea, which Hunt is developing, are multi-TCF world-class type targets. The oil prospects that they’ve got on the northern block are upwards of a couple hundred million barrel-type targets. So it’s somewhere between 200 million barrels for the oil and multi-TCF for the gas.
D.P: They got a shot at it sometime in the second half of this year, correct?
A.G: I don’t think they’ve announced the spud date but I do believe they’ve been able to get a suitable rig and I think their plan is to either try and see if they can drill a well before the end of this year or early part of next. But I haven’t seen or I don’t recall having seen an actual commitment on their part when they are going to spud.
D.P: I guess it comes time to the favorite question…if you could only buy one stock today in the oil and gas sector, what would it be for timeliness now?
A.G: I can’t help but think the way that Connacher has gotten beaten up here with all the stars lining up. They are totally funded right through to development of Pod-2. They don’t have to raise any equity. I am of the view that oil prices will stay upwards of $100 for a considerable length of time. In Pod-1 it looks like it’s a great project, all the early indications are that he’s got an extremely attractive SAGD project there. I just think that the Connacher looks to me like a pretty good bet.
D.P: Thank you so much for your time Andy!
I enjoy speaking with you David and you have been very kind to myself but I want to say that D&D Securities is an IDA and CIPF Member and the comments I have made I believe reliable but I can not represent that such information is accurate or complete and it should not be relied on as such. I no longer consider myself an analyst and actively work at investment banking. Any opinions expressed herein reflect our judgment at this date and are subject to change. D&D Securities and/or employees from time to time may hold shares, options or warrants on any issue included in this interview and we have actively participated in financing Corridor, Connacher and I have participated in Petrolifera financing in a prior firm.
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