The search for pre-production oil and gas winners

Running a screen on the pre-revenue (or low revenue) oil and gas players shows where investors are currently happy to assign value – top of the charts in terms of price-to-book value (P/BV) are Chariot (CHAR), which has an offshore Morocco gas project (and has recently been covered by Simon Thompson), Pantheon Resources (PANR), which has a large onshore Alaska field staked out, and Eco Atlantic Oil and Gas (ECO). 

There are some downsides to using this metric – exploration companies can only book proven and probable reserves (2P) on their balance sheet as assets so, before that level of certainty is achieved, projects won’t be as highly valued. This therefor pushes the ratio higher. That is one reason why Pantheon comes out as being priced at five times its book value, as it has reported good exploration results but no resource yet. 

Source: FactSet

Why buy/sell

The idea of stranded assets has taken hold in recent years – the fear that oil and gas prices fall so far that existing projects will lose cash-generating ability and thereby their value, leaving owners with massive writedowns. 

But oil and gas bulls argue demand will continue to rise due to the global growth outlook, even as electrification ramps up. Adam Rozencwajg from commodity analysts Goehring & Rozencwajg forecast 10 per cent oil and gas demand growth by 2030, pointing to demand from countries going through a period of economic development in the $2,000 to $20,000 per capita GDP range – which includes China, Brazil and Indonesia – that usually means “huge growth in energy demand”. 

“It is a unique moment in history – and one that requires huge amounts of incremental energy,” he said. 

At odds with this view are organisations like Carbon Tracker, which say new projects will likely end up selling into a market where demand has collapsed because of electric vehicles and other electrification options. “It will take three to seven years for new assets to reach first production, essentially the end of the decade…by which time policy action and deployment of renewable technology will be eroding that demand quite rapidly,” said Carbon Tracker head of oil, gas and mining Mike Coffin.

BP (BP.), which has several major projects before the green light stage, errs on the side of stasis. In its 2022 energy outlook, the major put 2030 demand at exactly the same as 2019 based on a scenario where current policy and technology momentum is maintained. If efforts ramp up to hit net zero carbon emissions by 2050, then 2030 demand could be 10 per cent below current levels of around 100mn barrels of oil per day. 

Evaluating the options 

With Chariot covered last month, company number two on the P/BV ranking list is worth looking at in more detail. Aim-traded Pantheon owns 100 per cent of the Theta West onshore oil asset in Alaska. It recently announced a 61 per cent increase in the barrels of oil in place estimate for the area to 17.8bn barrels. This is a very early-stage estimate and a long way from the 2P reserves metric that is more meaningful, but investors are already piling in, sending its market capitalisation through £1bn last month. It has since fallen back from that peak but is still trading 57 per cent higher than the start of the year, at 127p. 

Management sees itself as being in an ideal position given its 100 per cent holding of the asset and proximity to existing pipelines, cutting infrastructure requirements to bring the project into production. That ownership allows Pantheon to hand over stakes to companies who would fund construction and further exploration, without highly dilutive equity raises or additional debt. Existing shareholders have tasted this already, however – the company raised $96mn (£78mn) at the end of 2021 through a combination of equity ($41mn) and convertible debt ($55mn). 

Analyst Charlie Sharp at broker Canaccord Genuity said last month establishing a value for Theta West was “challenging” without a “better understanding of the likely number of wells, infrastructure requirements and capital/operating costs associated with such a potentially very large development in Alaska” as well as independent verification of the resources.

Trading or investing

Of course investing in pre-revenue companies is not all about waiting until the project gets to production, as companies can trade higher pre-production than once cash starts rolling in. And just because commodity prices have a better outlook than a few years ago, projects can still be uneconomic. 

Buyers of Eco Atlantic in 2019 will regret holding on for future cash flow after initially positive news from the Joe and Jethro assets in Guyana. Eco hit 175p a share before crashing on bad news about the field, and has traded between 25p and 40p since then. However, following a deal in March that saw it take more offshore Guyana territory, broker Peel Hunt declared its client Eco Atlantic had "one of the most exciting pure exploration portfolios in the sector", so a comeback might be on the cards. 

Another cautionary tale is Valeura Energy (VLU), which ran into issues with a non-conventional gas project in Turkey. It turned out to be too unconventional and now the dual Aim-Toronto Stock Exchange-listed company, which has shifted focus to Thailand, finds its market capitalisation worth less than its $39mn in cash holdings. 

One of Pantheon’s neighbours in Alaska’s North Slope, 88 Energy (88E) also provides an example. A well test result that arrived in March was hyped by a broker as “one of the biggest wells of 2022”, but the outcome was “reservoir quality at this location is insufficient to warrant a production test”. The company’s share price was 2p and it is now trading around 0.7p.  

Applying those lessons to Pantheon (potentially misleading given it has already had its 'yeehaw' share price rise), there are a few considerations for potential punters: it is not yet commercially viable, given the level of work done so far, and the next evaluation could find a major issue with the field. There is also no guarantee a partner will come onboard given the current strategies of the majors. There are bull points, too: it is a conventional project in a proven area (unlike Valeura’s Turkish asset) and the farm-down option means the company is in a good position to finance construction if Theta West does prove commercial. 

Punting on assets that are not commercially proven is a double gamble – they might prove to be duds or oil and gas prices could shift back to a bear market, or both, and the best prices are right now. But then again, Rozencwajg could be right, just as he was when predicting a significant price spike in oil last year, and greenfield projects might soon become hot properties once more.