Goldman Sachs upgrades E&P Sector to Attractive

Goldman Sachs upgraded the E&P sector to Attractive and said that natural gas prices are near a bottom. They believe that prices could hit $6/mmbtu before the end of the year. They say that E&P stocks reflect low long term natural gas prices and see a 28% upside to their target prices. Reasons for their optimism include:

1) More coal to gas substitutions,
2) Broader demand appears to be improving,
3) A potential 100 to 140 rig count reduction that is unlikely to reverse until gas prices significantly improve, and
4) More moderate storage builds.

Goldman Sachs says "the Street is too bearish" and "E&P stocks are attractively valued after pullback." The Street is overestimating summer storage builds and prices will rise. They are upgrading E&P stocks to Attractive from Neutral because natural gas prices are near bottom and likely to rise in the coming months and they see limited downside to natural gas prices.

Canadian Spirit Resources Inc. (SPI) is one the companies that we expect to see improved share prices as gas prices and sentiment improve. We should see a reversal of recent weakness with:

1) The upcoming Sproule Resource Report to be released shortly,
2) The completion of the c-A48-I horizontal well into the lower Montney, and
3) The spudding of the c-18-I horizontal well into the upper Montney in June.

The risk/reward of SPI is still very attractive due to its exposure to some of the best Montney land available and a well funded JV partner in Canbriam. Analysts are saying that SPI's story is among the best out there and several have recently issued very upbeat research.

Calculating SPI's net asset value

Using the resource numbers and unbooked resource values from the previous posts, we can calculate the Net Asset Values of Canadian Spirit Resources Inc. (SPI) Since there is a range of the potential resource in place and potential recovery rates, several scenarios can be run. In addition, we can use the low, mid and high values for the unbooked resource from Goldman Sachs’ recent report.

Resource numbers range from 100 bcf/section to 350 bcf/section as publicly stated by Talisman Energy (TLM) for the Montney shale in the Farrell Creek area. TLM also stated that recovery rates range from 10% to 30% (it’s worth noting that SPI stated that recovery rates based upon public data are estimated at 30% to 50%). Goldman Sachs’ values for unbooked resource range from $0.30/mcf to $0.68/mcf.

We have calculated the net asset value using the following three scenarios (note that the highest recovery rate used in the valuation is 20%):

Low Range: 100 bcf/section, 10% recovery rate and $0.30/mcf
Mid Range: 225 bcf/section, 20% recovery rate and $0.49/mcf
High Range: 350 bcf/section, 20% recovery rate and $0.68/mcf

Assets included in the net asset value calculation include: $10.1M of cash, $15.0M of present value to SPI from Shell’s capital expenditures in the Gething coals, $10.2M of present value to SPI from Canbriam’s capital expenditures in the Montney shales, $6.5M of present value from $45.9M in SPI tax pools, and $4.0M of present value for infrastructure related to the Spectra tie-in. No value for the unbooked resource in the Gething coals has been included.

Note that there are higher range scenarios that have not been calculated. Recovery rates can be much higher than 20% and once SPI moves their prospective resource into reserves, much higher values can be assigned to the recoverable gas. This would translate into even higher net asset values than have been calculated!

Under the 350 bcf/setion and 20% recovery rate, NAV ranges from $7.58 to $15.99/share. Currently, Canadian oil and gas companies are trading at 1.7 times their net asset value.

Goldman Sachs' unbooked resource values

Goldman Sachs issued an updated report on Chesapeake Energy Corp. this month, see earlier post. Within that report, they calculate a net asset value for the company. They assign low, mid and high values for unbooked resources per mcf. The most comparable unbooked resource that they assign a value to is the Marcellus Shale. The low value for that shale is $0.30/mcf, the mid value is $0.49/mcf and the high value is $0.68/mcf.

Given the success that Talisman Energy is having with their Montney shale horizontal wells, the low, mid and high values are comparable. Canadian Spirit Resources Inc.’s (SPI) potential recoverable resource in the Montney shale is 0.46 to 1.62 tcf at a 30% recovery rate. Using these values for SPI’s unbooked resource clearly shows a much higher value than is reflected in the current stock price.