MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING MONDAY, MARCH 1, 1998 (2)
TOP STORY
Early Spring Sees Gas Prices Blossoming
The Financial Post
Natural gas stocks are breaking out of the sector's four-month slump, posting significant gains as talk of an early spring contributes to expectations of higher commodity prices.
Rio Alto Exploration Ltd., Northstar Energy Corp., Anderson Exploration Ltd., Petromet Resources Ltd. and Canadian Natural Resources Ltd. are some of the oil and gas producers whose stocks have bounced up since the beginning of February.
After a mild winter, spring breakup is expected to arrive early in Western Canada, putting on hold some producers' drilling programs, said Peter Linder, an industry analyst with CIBC Wood Gundy Inc. in Calgary.
Drilling programs could be cut short by two to three weeks, said Don Herring, managing director of the Calgary-based Canadian Association of Oilwell Drilling Contractors.
"It's a physical issue," he said. "When frost starts to come out ... it's more difficult to move in the rig," particularly in areas where there are no permanent roads and drilling depends on deep frost penetration.
When combined with new pipeline capacity, scheduled to be added by the fall, and expectations of a colder winter next year, it adds up to lower supplies and a better outlook for natural gas prices - and higher cash flow for gas producers.
"The institutional interest has been greater on gas stocks than oil stocks since the beginning of the year, but in the last two weeks, we have seen even greater enthusiasm," said Tom Budd, a managing partner at Griffiths McBurney & Partners in Calgary. "That's why the rapid pick up in share prices."
The spot price for natural gas in Alberta was $1.66 per gigajoule, up from about $1.40 per GJ earlier in the winter, despite high inventories.
Some analysts expect prices to rise as much as 100% next year to fill new capacity on the Foothills-Northern Border Pipeline network, which is expanding by 700 million cubic feet a day, and later on the Alliance Pipeline network, which will transport an additional 1.3 billion cubic feet a day.
Combined, the additions will boost export pipeline capacity of about 11 billion cubic feet a day by close to 20% by the end of 1999.
"The industry always assumes winter is going to be normal," said Brent Friedenberg, president of Brent Friedenberg Associates Ltd. "And under that assumption, next winter will be colder than this winter, which will be positive for prices."
Budd says investors are selectively returning to the sector after withdrawing from oil and gas stocks across the board last October, when prices started softening for both oil and natural gas.
While oil prices continue to disappoint, the outlook for natural gas is improving and investors are now seeing the buying opportunities, he said.
FEATURE STORY
Fallen Idol Renaissance Energy Still Has Talent
Globe & Mail
There was a time, not so long ago, when Renaissance Energy occupied a special place in the oil patch firmament. The Calgary-based producer was everything that other oil and gas companies wanted to be -- it not only drilled the most wells, it racked up double-digit rates of growth so consistently that its stock traded far above its peer group.
Those days are no more. Like a Hollywood star whose box-office bomb wipes out all traces of former glory, the past six months have transformed Renaissance from a perennial Oscar favourite into just another working stiff. The company isn't doing dinner theatre alongside Ralph Malph from the cast of Happy Days yet, but the glory days are clearly over.
That said, however, there are those who feel the pendulum of perception may have overcorrected when it comes to Renaissance. A recent analysts' survey found three out of five rate the company a "buy" or a "strong buy." Robert Gillon, a veteran industry watcher with John S. Herold in Massachusetts, says the stock "looks pretty cheap" at current levels.
The shares have dropped from the $45 range last June to close at $29.20 on the Toronto Stock Exchange yesterday, a fall of more than 35 per cent. It's not the largest tumble in the battered oil and gas sector by any means, but for Renaissance it has meant a substantial demotion from top industry pick to oil patch also-ran. Any premium the stock once commanded has vanished.
Renaissance's version of Kevin Costner's Waterworld or Warren Beatty's Ishtar was a report in mid-1997 that it was not going to make its targets for the year. From another company, this would have been disappointing, but nothing to get too upset about. From Renaissance, however, it was a bombshell -- the company's production and cash flow have been as dependable as Peter Mansbridge being nominated for a Gemini every year.
As the year progressed, things steadily worsened. The effect of higher production costs -- one of the causes of Renaissance's problems -- was quickly exacerbated by falling commodity prices. As a company that is leveraged primarily toward oil, and fairly heavy oil at that, Renaissance started to look even worse by comparison with producers who had the luck or wisdom to focus on natural gas, which has brighter prospects.
It might be too strong to say the response to Renaissance's fall from grace has been a feeling of betrayal, but there's no question it has been a shock to many to find out that the company is actually mortal. When your track record of steadily increasing profitability is so long and unblemished that one analyst (who shall remain nameless) even refers to you as a "bar mitzvah stock," a return to reality can be a painful process.
The reality is this: Although Renaissance has said it will cut its capital budget dramatically, and focus on gas instead of oil, the company is in for a difficult year and probably will never return to the kind of glory days it enjoyed in the past. Cutting spending means slower growth, and that means the stock will be given a lower multiple.
Nevertheless, there is a case to be made that Renaissance is still a strong company -- not a Tom Cruise, perhaps, but a solid Gene Hackman or Nicholas Cage. In the company's year-end results released last week, cash flow was down 8 per cent from the previous year and profit was about 36 per cent lower, but there were bright spots as well.
For one thing, Renaissance managed to cut costs by 22 per cent to $6.57 a barrel, significantly lower than the industry average of about $9. It also added reserves equivalent to three times the amount of oil and gas it produced during the year. And the company still has the largest undeveloped land bank in the industry, at about 10.8 million acres.
Another crucial factor, Mr. Gillon says, is that Renaissance "still has the same high-quality management" that everyone praised when the company was a superstar. And, now that the industry as a whole is under increasing pressure, strong management is even more of a necessity.
There has been talk that the company is looking to do a takeover of a smaller company, such as Pinnacle Resources or Archer Resources. This speculation has made some observers nervous, since Renaissance has never made a major acquisition, preferring to grow internally. As a result, it has avoided some of the fevered bidding wars the industry is prone to.
Admittedly, the days of the fevered bidding war are long gone, and Renaissance could probably find a relatively cheap target. However, Mr. Gillon says the company would have to "communicate very clearly to shareholders why it was making such a major change in strategy -- not that they're not capable of pulling it off, but I don't think they need to."
At current levels, Renaissance is trading at about six times its cash flow per share for last year, and at about 5.5. times some estimates for this year's cash flow. That puts it at or below the average for its group. Will Renaissance ever be the box-office draw it was in the past? Probably not, but it could still turn in a respectable showing.
FEATURE STORY
Numac Energy Scales Back On Heavy Oil Production
The Financial Post
Numac Energy Inc. said yesterday it is cutting 3,000 barrels of heavy oil from 1998's expected daily production, a move likely to boost the Calgary-based company's cash flow.
The company now predicts it will average 21,000 barrels and 160 million cubic feet of gas a day.
The firm is reviewing options for its Manatokan heavy oil property. It has scrapped plans to spend $40 million on the property, near Cold Lake in eastern Alberta, in addition to shutting in high marginal cost wells.
Manatokan is now producing between 2,200 b/d and 2,500 b/d, down from 3,200 b/d at the beginning of the year. The thick crude sold for $6 a barrel in January but operating costs were closer to $9.
With the drop in oil prices the move didn't come as a surprise to analysts.
"Everybody's doing it. It's right across the board," said Toronto analyst Andy Gustajtis of HSBC James Capel Canada Inc.
Wilf Gobert, a Calgary analyst with Peters & Co. Ltd., said it would have been surprising if Numac hadn't made such a move.
With four billion barrels of reserves, Manatokan is still a core property for Numac, said Dale Hohm, vice-president of finance. "At some time, it will be a very valuable resource again. Now is not the time to divest of such an asset."
The company has cut capital spending to $124 million for 1998, a reduction of $16 million from the initial budget.
Numac spent $314.4 million in 1997, including buying the Canadian oil and gas assets of Wainoco Oil Corp. The purchase helped boost cash flow and production.
Earnings in 1997 dropped to $12.6 million (13› a share) on revenue of $257.1 million, down from $16.9 million (18›) on revenue of $240 million the year before. Cash flow climbed 5% last year to $128.2 million.
FEATURE STORY
New Technology Fuel For Oil Services Growth
The Financial Post
Options on Western Atlas Inc. (WAI/NYSE) and other oilfield services were particularly active in light of the US$7.7 billion merger deal announced Thursday between Halliburton Co. (HAL/NYSE) and Dresser Industries (DI/NYSE).
In the past, Western Atlas itself has been the target of takeover rumors.
Such speculative activity demonstrates the eagerness on the part of option traders to find the next takeover. It also demonstrates the cost of speculation.
Premiums for Western Atlas options were bid up sharply. Implied volatility rose as high as 85%, which is in the upper end of a range that has seen option implied volatility between 69% and 95% over the past five weeks.
Despite the frenzied activity, the Philadelphia Oil Service Sector Index, symbol OSX - remains a good buy. (Chart is featured daily in this column) The price-weighted index of 15 leading oil service companies closed last week at 103.35, down from a high of 140 last November. For number crunchers, that constitutes a major correction for oil service stocks.
The result of so much uncertainty surrounding crude oil prices, and, perhaps, in light of the Halliburton-Dresser deal, is an opportunity for contrarian investors to take a position.
Options on the OSX are trading with implied volatility of 48%, which is half the price accorded to the option on the individual oil service stocks.
At least one U.S. securities firm - Southwest Securities - is talking up the oil service sector despite the fact crude is selling for less than US$15 a barrel.
Southwest analyst Fred Mutalibov suggests that current pricing pressures are nothing new.
Oil service firms have suffered through volatile markets for the past 20 years. Historically, crude has ranged between US$15 and US$25 a barrel. We may simply be at the lower end of another trading range.
More to the point, price may not be a major issue.
Mutalibov argues that technological advances, rather than crude oil prices, will be the driving force behind the future fortunes of oil service companies.
"The key fundamental difference between the early '80s energy boom and the current cycle is that, while the former was driven by speculations on rising commodity prices, the latter is driven primarily by newly commercialized technologies, such as 3-D seismic, multi-lateral drilling, sub-sea completion, and floating production."
So, technological advances improve the success of exploration projects, which, in turn, increases the operating margins for oil and gas companies.
So far so good.
No matter what happens to the price of oil, exploration activity is ongoing. And a lower crude price simply means that oil companies need the best technology to increase the odds of finding new discoveries.
Therefore, the goal is to own the latest technology.
There is also an interesting supply-and-demand imbalance in the oil service industry.
For example, since 1986, the supply of oilfield equipment has been declining.
Demand, on the other hand, has grown rapidly in the mid-90s, after bottoming in 1986.
The cost of renting a jackup (most common type of offshore drilling rig) has risen more than 100% since mid-1995, explains Mutalibov. Normally, that would create opportunities for jackup manufacturers to ramp up production.
Not so. Today's jackup rental rate is still well below replacement day rates, or those needed to justify new construction.
Mutalibov expects day rates to rise for all classes of rigs, though at a slower pace than a year ago.
Stronger management in the oil service industry is also a positive. We are talking here about managers who went through the late 1980s energy meltdown - and have learned first hand the downside of over capacity. Such lessons, while costly, are not likely to be repeated. New oil service equipment is for the most part pre-leased and secured by a term contract.
The oil industry has gained some support from government agencies, with domestic tax relief and incentive programs that encourage oil companies to boost production of hydrocarbons. Notable among the incentive programs is the Royalty Tax Relief Act of 1996. In this case, the U.S. government wanted to stimulate development of the deepwater portion of the Gulf of Mexico.
That being said, the real benefits of government policies have accrued to South America. According to Mutalibov, three factors favor increased exploration and development by domestic and international oil companies in the Latin America region - privatization of state owned companies, political stability and tax relief. All three spell demand for the oil service industry.
Of course, with opportunity comes risk.
If crude prices stay below US$15 a barrel for a long time, some of the potential exploration projects will not go forward quickly.
There is also the problem of finding skilled labor. In the early 1980s boom, it was easy to attract workers to the oil fields. (There simply wasn't much opportunity in other industries.) Today, there is a general labor shortage across all industries, which puts a strain on the oil industry.
Finally, as the costs for oilfield services and equipment rise, it will choke off some of the marginal projects. That means a smaller universe of otherwise profitable projects for oil and gas companies.
Writes Mutalibov: "The key is whether cost efficiencies from implementing new and expensive technologies outweigh the increasing costs for oilfield services and equipment."
In the end, the Halliburton- Dresser merger tells us that the industry likes itself.
The merger has also raised the stakes for option traders on the individual stocks, but not to the same extent on the OSX index.
If you want to play the oil service sector, then buying calls outright, or as part of a bull call spread (i.e. buy say an OSX Sept 100 call and sell an OSX Sept 120 call) allows one to speculate prudently.
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