Dear readers: these are very good days to be invested in energy (of the right kind). Both Uranium and Oil are breaking out. let’s cover Uranium:
We reviewed the WNA symposium in London a week ago. This was a chance to “check the temperature”, of the industry. Kuppy and Mika Alkin were both there and came out very optimistic. In a sense, the industry is sleeping, uncaring for the incoming price squeeze. this is the best recipe for an “upside crash”.
Meanwhile, the upside momentum continues, see price below:
My favorite resource analysts, Goehring & Rozencwajg also came out strong with a piece on Uranium.
The intersting thing is, that all this activity is happening while Sprott Physical Uranium Trust, is still not at a siginificant preimum to net asset value. This means they are not able to use their cash or issue new units and use them to buy more Uranium. the gap is closing, and we only need one good day with funds flowing to start that flywheel effect. once that happens, watch up for a rocket ship.
Moving on to oil, the deficit and KSA+Russia tighetening are being felt strongly, with WTI pushing over $90/bbl. While we may see some correction in the near/mid term, I remain convinced we are in a super bull cycle. With that in mind, I’d like to share a potential stock to look at. One that I am holding, but remember this is not a recommendation and I am not a financial advisor.
The current bullish oil market outlook, coupled with still out-of-favor energy stocks, makes E&Ps with leverage to higher oil prices particularly attractive. Surge Energy (OTCPK:ZPTAF) (SGY.CA) is one such candidate. Like Cardinal Energy (OTCPK:CRLFF) (CJ.CA), Surge can be held for both capital appreciation and income. Its shares generate enough free cash flow to offer more than 80% upside at current oil prices. Meanwhile, its shares, currently trading at $8.75, offer a safe 5.5% dividend yield that is more than three-times covered by free cash flow. If oil prices remain at current levels, Surge’s dividend coverage increases to four times. As such, there exists ample room for dividend increases.
I believe the company is likely to allocate a growing proportion of free cash flow to dividends and repurchases over the coming quarters if WTI remains at or above current prices.
Surge Energy’s Operations
Surge Energy operates in several conventional plays in the Canadian provinces of Alberta and Saskatchewan. Its primary plays are shown in the map below.
Source: Surge Energy website.
The company’s production consists of 87% liquids—96% of which is crude oil—and 13% natural gas. Like Cardinal Energy, Surge’s decline rate is 23%, which approximates that of Gear Energy (OTCQX:GENGF) (GXE.CA) and other smaller conventional Canadian E&Ps, though it’s higher than Cardinal Energy’s peer-leading decline rate of 12%.
Surge targets low-risk conventional reservoirs that generate high returns on capital due to their low risk, low cost, and low decline rates. It describes its productive assets relative to other Canadian E&Ps in the following graphic.
At Surge’s current production rate, it has approximately 13 years of drilling inventory for its proved and probable reserves and 9 years of drilling inventory for its proved reserves. While significant relative to U.S. shale producers, Surge’s reserve life is actually among the shortest for public Canadian E&Ps. The reserve length will act as a constraint on the company’s production growth unless it can replace its reserves at a greater rate than it depletes them. In the last year, it boosted its proved and probable reserves by 16%, primarily due to an acquisition of acreage from Enerplus (ERF). The reserve increase was essentially a wash on a per-share basis due to Surge’s issuance of 12.5 million shares shortly after the deal closed. The equity issuance diluted its 84 million share count by 15%.
Huge FCF Torque to Higher Oil Prices
We estimate Surge breaks even on a cash flow basis at $50 per barrel WTI, assuming an AECO price of $2.50. Investors with a bearish view on oil prices should avoid Surge, and probably all other E&P stocks, for that matter.
For Surge to generate a 12% free cash flow yield on its current $8.75 stock price, WTI would have to decline to $67 per barrel. Since we believe a 12% free cash flow yield is appropriate yet conservative, given the risks associated with Surge, we estimate that $67 per barrel is the oil price that is currently being discounted in its market valuation.
The chart below details our estimates for Surges’s free cash flow per share amid different oil price scenarios. It illustrates the company’s tremendous free cash flow torque to higher oil prices. The figures in the chart assume an annual production rate of 25,000 Boe/d, $200 million of annual capex, zero realized derivatives losses, and realized NGL prices that equal 50% of the realized WTI price.
With all the above in mind, Surge energy is very interesting to look at, if you believe, like I do, that we are going higher for longer with oil.
That’s all for this week, next week I am off on work related travel to Spain, so I may not be able to update you. But I promise you it will be one hell of a week!