Where To Look In This Volatile Oil Market: Tim Murray

It hasn't been a very exciting year for most energy stocks, but therein lies the opportunity for selective buyers with a longer-term view. In this exclusive interview with The Energy Report, Tim Murray, oil and gas analyst at Desjardins Securities, explains why he prefers small-cap producers in this market environment and discusses a few favorites he expects will outperform.

The Energy Report: The last time you spoke with us in January, you were expecting oil prices to stay in the $80–100/barrel (bbl) range, which they pretty much have. Where do you think they are headed now?

Tim Murray: We still believe this range is realistic for the remainder of this year and into 2013. The last downturn in crude seemed to stem more from negative sentiment than a change in the supply-demand balance. West Texas Intermediate (WTI) bounced off ~$76/bbl recently, which was the low back in October, so this is a level we will be watching very closely if it were to be breached.

TER: What effect is the move back down into $80/bbl going to have for oil companies' exploration and development plans?

TM: Companies are definitely going to have to reassess their exploration and development budgets, if they are budgeting anything close to $100/bbl WTI. Most juniors in the Canadian space use cash flow plus debt to manage their future drill programs. We've already seen several companies in my space cut their capital programs. Whitecap Resources Inc. (TSX.V:WCP) trimmed its capital program, as did Bellatrix Exploration Ltd. (TSX:BXE), Second Wave Petroleum Inc. (TSX.V:SCS), Raging River Exploration Inc. (TSX:RRX) and Longview Oil Corp. (TSX:LNV). We expect others will probably have to do the same and we don't see any junior or small-cap companies expanding programs at this time. Most midcaps have a lot more balance sheet flexibility and we don't envision midcaps in general needing to cut budgets unless we see a sustained oil price closer to $75/bbl.

TER: Do you think a lot of companies were beginning to think that $100/bbl was the new base and planning around that or were they skeptical as to how long that was going to last?

TM: Most were still using around $95/bbl oil, and hadn't been putting $100/bbl in their internal budgets. I don't think anybody was saying that it's the new base, as most are accustomed to the large swings in commodity prices.

TER: Natural gas, on the other side, has been the sick sister. After peaking in 2008 over $10/bbl, it's been hanging around the $2-2.50/bbl level, about as low as it's been for the last 13 years. Is anything on the horizon to cause much of an improvement or is it stuck in that range?

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TM: For the summer, we feel an average Henry Hub price of $2.50–3 is realistic and natural gas has been trading higher than that recently. We need to see storage levels come off before price levels appreciate materially into the fours. Storage levels are running at all-time highs in Canada, and in the U.S. as well. Drilling has eased in Canada and the U.S., which will help reduce the supply equation; however, a lot of the oil resource plays have gas associated with them.

Natural gas is really a landlocked commodity in North America and until the means are available to reach other markets such as Asia, prices will remain relatively depressed. Looking longer term in Canada, we may see the first LNG facility at Kitimat, which would give producers access to the international market. But this isn't expected until 2017.

TER: Other than the ongoing financial problems in Europe and whatever the crisis du jour is in the Middle East, do you see anything on the horizon which could cause oil or gas prices to move much in either direction?

TM: Middle East tension is always the biggest wild card, and the ongoing debt situation in Europe will continue to grab headlines. The one other wild card that people are aware of but have a difficulty putting a time frame on is the duration of the European embargo on buying Iranian crude that started July 1. We're also watching crude supply levels, which are quite high. From a North American standpoint, in the last two to three years, the spread between Brent and WTI has favored the Brent markets. Long term, we do think that spread will close, but it could take anywhere from three to five years.

TER: Companies in the oil and gas services business have to be affected by what is going on in this market. Are there some interesting opportunities out there or do you think that the impact is too negative on them at this point?

TM: Definitely, the service sector traded down as oil moved lower, which is not a big surprise. Our oil and gas services analyst here has been recommending Precision Drilling Corp. (TSX:PD) between the $6–7 range. The stock has been fairly volatile the last month and is currently north of $8.

TER: So, generally, the service business is not a hot market opportunity these days.

TM: It's not as hot as it was before. The good thing in this cycle is that the balance sheets of the Canadian service companies are generally good, giving them the ability to ride out a lower pricing environment. Many are paying small dividends that can easily be increased if activity levels ramp up. It may not be the hottest space, but there are definitely a lot of good valuations on many of the stocks.

TER: So what's your outlook at this point for oil stocks in general?

TM: Our theme really hasn't changed. We still continue to look for good management teams, good balance sheets and asset bases that can show per-share growth for the next three to five years. The other key is liquidity, as investors and larger institutions don't want to be stuck with a stock that they cannot unload. For my coverage universe, I prefer my small-cap names over the juniors as they have bigger production profiles, generally better balance sheets and liquidity.

TER: Back in January, you talked about a number of midcap and small-cap companies. Can you give us a little update on what's happened with them since then?

TM: My two favorite names then were Whitecap Resources and Spartan Oil Corp. (TSX:STO). Spartan is up this year, about 10% compared to the GMP Junior Oil & Gas Index, which is down ~17%. Whitecap is down ~15%.

Tim Murray joined Desjardins Securities in July 2011. Prior to this, he was an oil and gas analyst for almost six years at several investment boutiques covering junior and mid-cap companies. He also spent over a year at AltaGas Income Trust performing risk and credit analysis on natural gas and power assets for the company's midstream business and served as an investment advisor for three years. Tim was awarded the CFA designation in 2003.

DISCLOSURE:
1) Zig Lambo of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Energy Report: Equal Energy. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.

3) Tim Murray: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

Written By: The Energy Report