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Since crude prices sank below US$100 a barrel three years ago, investors in oil stocks have been sending one clear message to companies: Stick to your knitting.
Nowhere is this more apparent than in Canada, where the benchmark index’s top-performing, post-crash energy producer — Parex Resources Inc. — is a small company focused on extracting one commodity from one geographic region. Parex is one of only four stocks in the 50-company S&P/TSX energy index that have gained since July 30, 2014, the last day oil closed above US$100 a barrel.
The gain by Parex shows how investors have taken a liking to small producers who focus their operations in one region and aren’t too adventurous with their capital spending. While their diminutive size may seem like a disadvantage in a business dominated by behemoths, being small allows producers to provide investors with a clear picture of their plans and to wring out costs that larger operations can’t avoid.
“They’re just more focused, more focused on costs,” said Ken Lin, an analyst at Paradigm Capital in Calgary. “In a lower price environment, the lower cost operator is the better operator.”
Parex, based in Calgary, produces oil in Colombia through both new wells and by reactivating old fields using enhanced-recovery techniques. The company also held assets in Trinidad & Tobago when it was split off from Petro Andina in 2009, but sold them to focus on its more promising Colombian operations. The shares have gained 11 per cent since oil slipped below US$100. The broader energy index has slumped 33 per cent.
In a lower price environment, the lower cost operator is the better operator
Ken Lin, analyst
Driving Parex’s gain has been a debt-free balance sheet and an ability to increase its reserves and production entirely out of its cash flow, said Lin, who in a recent note nominated Parex as perhaps “the best oil and gas company in the universe.”
Chief Executive Officer David Taylor said that the company will continue to focus on Colombia, rather than try to transport its expertise elsewhere.
“We know how to do business here,” Taylor said in an interview from Bogota, where he spends four to six weeks a year. “We have a very strong team here, we understand the geology. Why would we change what we want to do?”
Prime Land
A similar story comes from Advantage Oil & Gas Ltd., the third-best-performing Canadian energy producer since the oil crash. Advantage owes its success to a concentration on producing natural gas from a prime land position in Alberta’s Montney shale formation and production costs that are among the lowest in the industry, CEO Andy Mah said in an interview. Advantage had corporate cash costs of 73 cents per thousand cubic feet of gas equivalent last quarter.
Mah says the company was an early adopter of a philosophy that junior and intermediate energy companies need to structure themselves to be able to generate long-term profitability and corporate returns, rather than simply develop an asset and sell themselves to a major within five years. While shares of Calgary-based Advantage are down 7.8 per cent since July 2014, that’s outperformed both the energy index and the price of natural gas, which has slid 23 per cent.
‘Peaks and Valleys’
“There are probably going to be less of those peaks than valleys, and you have to be able to make money in the valleys,” Mah said in an interview. “At US$100 oil, were a lot of companies doing everything they could to minimize their costs? I would say probably not.”
Investors are tired of seeing oil and gas companies take cash flow that they are generating from one asset and plow it into other assets that don’t generate the same returns, said Justin Anderson, an analyst at Mawer Investment Management Ltd. Energy producers could attract investors who normally wouldn’t consider them by sticking only to a clearly defined set of assets and by paying only special dividends, instead of regular quarterly dividends, he says.
“If you find some great new play, start a new company,” Anderson said. “And execute under that strategy and have investors invest under that new asset.”
However, the big, diversified players haven’t fallen too far out of favour. Suncor Energy Inc., Canada’s largest oil company by market value, is the second best-performing producer in the energy index since the crash. Canadian Natural Resources Ltd., which produced more than a million barrels of oil equivalent a day last quarter, is the fourth.
For many investors, more important than size or focus is how companies allocate capital, and on that front, Suncor and Canadian Natural both took advantage of the downturn to acquire billions of dollars of assets in deals that analysts have generally viewed as bargains.
“Good management teams understand when to do land capture, when to build infrastructure, and then when to push on the pedal for growth,” Paradigm’s Lin said. “Very few teams are good on that.”
Bloomberg.com
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