Discounts Hiding in Plain Sight (Natural Gas) Peters & Company, one of Canada’s most experienced oil & gas investment banks, recently published an excellent report on the rate of return on North American oil & gas plays ranging from “Barnett Shale” to “Mississippi light oil horizontal wells”. Lloydminster conventional heavy oil, vertical wells were amongst the best performers in the North American energy sector.

1. Agcapita Update
June 4, 2012

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Conventional Heavy Oil: Conventional heavy oil is not be
of two asset classes in the energy space. One is a less-
be confused with its capital intensive and costly brethern
focused on part of the Canadian oil sector - conventional
ta on W rce ntio
A few weeks ago I wrote about the investment prospects
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Peters & Company, one of Canada’s most experienced oil
unconventional heavy oil or “oil sands”. It is heavy oil - less
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NORTH AMERICAN OIL AND NATURAL GAS PLAYS: RATE OF RETURN AT CURRENT STRIP PRICES
1

3. Agcapita Update (continued)
report on the rate of return on North American oil & In addition, the wells are inexpensive and shallow,
gas plays ranging from “Barnett Shale” to “Mississippi entailing less risk. All of these factors go to
light oil horizontal wells” (Read Full Report Here). generating higher rates of return.
Lloydminster conventional heavy oil, vertical wells
were amongst the best performers in the North Natural Gas: For the extreme value oriented investor
American energy sector with an average rate of return with a long-term horizon, NG is trading at historic
of 150% - the second highest in the industry. Only lows. More research from Peters & Company shows
“Bluesky Seal Multilaterals” with a return of just over that prices have to recover to around $4/mscf to
200% were superior. $5/mscf from current levels at $2/mscf in order for
operators to make money.
When investing in conventional heavy oil in
western Canada, you benefit from two discounts: If prices do not rise then production will decline.
1) the discount of heavy to WTI prices and 2) Or more accurately, operators are going to shut in
the discount of WTI to global prices. As such, production (voluntarily or via bankruptcies) which in
Lloydminster conventional heavy oil represents a turn will drive prices back to break-even levels.
relatively inexpensive oil BTU. We also believe that
fundamental drivers are in place for continued low We believe that NG assets with large reserves and
and even declining heavy oil differentials: modest production levels necessary to maintain
– Declining heavy oil production from Venezuela & leases can be re-structured to create a low cost-of-
Mexico carry long position - one which demonstrates distinct
– Improved pipeline capacity projected over long cost, volatility and return advantages over:
term – traditional long NG futures exposures which due
– Heavy oil refining has highest margins relative to to contango currently in the forward strip incur
other crudes material roll losses; and
NORTH AMERICAN SHALE GAS PLAYS: CANADIAN NATURAL GAS PLAYS THAT MATTER:
BREAK-EVEN NATURAL GAS PRICE (HALF-CYCLE) BREAK-EVEN NATURAL GAS PRICE (HALF-CYCLE)
US$/mcf C$/mcf
$6.00 $4.50
$5.50 $4.25
$4.00
$5.00
Median: US$4.49/mcf $3.75 Median: C$3.58/mcf
$4.50 $3.50 Strip Price: C$3.38/mcf
Strip Price: US$4.05/mcf
$3.25
$4.00
$3.00
$3.50 $2.75
$2.50
$3.00 Marcellus Granite Cana Eagle Ford - Fayetteville Haynesville Barnett Haynesville Arkoma Eagle Ford - Horn River Glauconite Montney at Cardium Hz. Wilrich Hz. Notikewin Hz. Montney at Montney at Montney at Deep Basin
Wash Woodford Liquids Rich Louisiana Texas Woodford Dry Gas Hz. Kaybob Hz. Dawson Hz. Town Hz. Resthaven Hz. Gas Verticals
Gas
2

4. Agcapita Update (continued)
– investments into operating NG producers which – Lloydminster conventional heavy oil assets in
come with 1) material bankruptcy risk and 2) have 2012 at a rate of return more than 50% higher
built in cost structures which make shutting in than most North American energy plays
their entire production bases and going passive – Small Medium Enterprises (“SME”) in western
long NG difficult. Canada at around 4-5 times earnings, generating
rates of return almost 4 times private equity
Obviously this is more an investment for deep value averages in other developed markets
investors with a long investment horizon but to find – Natural gas assets at $2/mscf when industry
a large, liquid asset class with such a pronounced break-even levels may be 2 to 3 times higher than
margin of safety in today’s markets is rare and must this
be considered (Read More).
None of these investments were/are particularly
In many ways these two investments speak directly hidden or hard to analyze - hence the concept
to the idea of “discounts hiding in plain sight”. Many of “discounts hiding in plain sight”. It is just a
investors are sceptical that deeply discounted, straightforward matter of looking beyond the short-
value investments can be found in today’s efficient term and trying to understand the underlying value
capital markets and yet as an investor you could/can drivers.
acquire:
– Farmland in Saskatchewan in 2008 at an average
of $400/acre, while today prices average over
$600/acre
3

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to enter into any transaction. Additional information is available by contacting
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