Three “Penny Oil” Teaser Picks from Chuck de Castro

By Travis Johnson, Stock Gumshoe, August 1, 2011

I’ve recently had a lot of folks ask me what the “Idea of the Month” articles are like for the Irregulars, and what people get as paid members of the site. The basic answer is “more of the same,” though for the smaller group of paid members I am freer with my opinion and I do make more specific suggestions about investments that I like.

The Idea of the Month articles are always about some investment that I find appealing — sometimes a mainstream stock pick, sometimes a tiny stock or a REIT or even (gasp!) a fixed income investment (OK, I’ve only picked bonds once). And it so happens that the Idea of the Month article a couple months ago was inspired by a teaser ad … and that teaser ad is again circulating, about some “penny stocks” in the oil space. So I thought I’d share that with the readers on the free site here.

What follows is an excerpt from the Idea of the Month article that I published in mid-May. I was intrigued by and suggested investing in the three stocks that were being teased by Chuck de Castro for his Penny Oil Speculator ($1,950/year), so I solved those teasers for the Irregulars and shared what I thought was the best one to get interested in first. I have since bought that stock, but otherwise do not own any of the stocks mentioned below. I also wrote about a few other things that month, like the ridiculous valuation being afforded to the Mongolian Growth Group (still ridiculous, in my opinion), but what follows is the meat of that article about de Castro’s three picks — it has not been updated or edited since it was first published on May 13.

But anyway, let’s move on to the investment opportunities I wanted to profile for you this month. As I said, the ideas came in a teaser ad and it’s one that I haven’t written about before — the ad came out on May 9, so it’s still quite fresh. I like the idea of some small cap oils that are “pre-vetted” by Chuck DeCastro, not because he’s always right but because he’s been active in the sector for a long time and I’ve learned about some interesting ideas from him in the past, and I’m still a believer in the long term bull market for oil and gas even if we do, as some expect, get a 20% haircut to oil prices this year if the Middle East fails to produce another revolution.

Let me walk you through it, with quotes from the teaser, and talk about each of the stocks:

Here’s De Castro’s first batch of clues:

“One is a penny oil sitting on a huge property in Peru’s richest oil region. A major US oil company drilled on this property 22 years ago and found oil, but didn’t think it would be profitable because oil was then going for $13 a barrel.

This tiny $35 million company picked up the property, and at $100 a barrel it looks like it may have as much as $34 BILLION of oil. A major South American oil company saw the drill results and is putting up the money to do the drilling in exchange for a piece of the action.

“The potential here? Just think about $34 billion of oil versus a $35 million market cap. This is how I get 1,000% and 2,000% profits for my subscribers.”

So who is it? This sounds like it has to be Veraz Petroleum, which trades at VRZ in Canada and VRZPF on the pink sheets. They are roughly a $35 million company — though a bit below that now, the stock took a hit this morning and now trades at about 62 cents.

I assume that the drop in price is due in part to recent concern about the Peruvian election campaign and the talk of windfall profits taxes for miners that has folks nervous about the direction of Peru’s government under whoever the new leader turns out to be, but it’s always a guessing game to speculate on what moves a $30 million stock — a single seller could easily cause the shares to spike if no one was lined up to buy that day. Veraz indicates in their investor materials that they have contracts that determine their level of taxation and royalties for at least the next several years, and Peru is generally a low-tax state by South American standards anyway, so I’m not particularly worried about the impact of a higher tax or royalty regime. Another possible concern, as long as we’re on the “negatives” topic is the relationship with native tribes, there has been some uproar about oil development in the Peruvian section of the Amazon which caused ConocoPhillips, for one, to bug out just yesterday from a project near the Ecuador border, but that’s a ways away from Veraz’s key position in the middle of the country.

The bigger concern for Veraz is going to be their operating results, and the next opportunity for us to learn something about those will be late this year, when we get results from the exploratory drilling that they’re obligated to do in their lead (ie, most advanced) project area.

Veraz has a junior working interest (20%) in three huge exploration tracts that are operated by Petrominerales, the big ($3 billion or so market cap) Colombian oil success story — which means that their partner is a company that can fund most of the exploration and that also has proven local experience in exploration, development, and relationships with local governments and indigenous groups. There is obviously some downside from possible political threats and from the results of their operations, but there are catalysts this year — they will be drilling at least one exploration well and probably three, starting in the third quarter, so good results could help the stock tremendously. Bad results or dry holes would be, well, bad, and the other exploration areas, while also potentially interesting, are not as far along (more likely to see seismic results than drilling from those) and probably won’t be helping or hurting the stock in the near future.

They are drilling their first holes into an area where there is some known oil, Block 126 in the Ucayali Basin, but the numbers are all over the map — Occidental Petroleum drilled there in 1989 and reportedly had “completion issues” and sealed it up, but believed there to be a lot of oil, 56 million barrels, though only 7 million were classified at the time as “recoverable.” Later third party studies put the number far lower than that, more like one or two million recoverable barrels, and Veraz itself thinks those estimates are far too pessimistic and it has its own internal estimates (none of which are verified or backed up by third parties, and these are probability assessments of oil that has not been “discovered” yet, so take it with a big grain of salt) of a “low case” of 30 million barrels and a “best case” of over a billion barrels.

I’d classify this one as a bet, to be sure, and wouldn’t put too much into it … but I think the pessimism about Peru, and the fact that they’re tiny and a junior partner, is probably putting this stock lower than it would be otherwise considering the near term catalyst of drilling results expected later this year, and I like that they are riding with a larger partner who’s shouldering much of the cost. Veraz seems adequately capitalized for this year’s drilling, with much of their share of the cost already covered by their partner due to earlier deals, but if the first drill result or two is disappointing the shares would very likely take a hit and they’d have to raise more money to continue, probably on worse terms — you have only to look at Gran Tierra Energy (GTE) to see what happens when drill results don’t play out. GTE, despite the fact that they are huge in comparison (almost $2 billion market cap) and far more diversified with active projects in other countries, dropped in value by more than 5X Veraz’s entire market cap when they announced a dry well in Peru earlier this year. Veraz’s website is here, and their latest investor presentation is here.

And the next idea passed along by the DeCastro teaser? Here are the clues:

“My second reco is another tiny company that’s beating the oil majors to the punch in another huge shale oil play, only in Quebec.

“They just announced their first test drill results, and they were great. The company already has several joint-venture offers. The oil giants
are beginning to pile into the region, but this little tiny company has locked up 2.7 million acres, right in the heart of it.

“Get in now and I think you have another grand-slam home run, like BNK Petroleum. I don’t know if you’ll get the 4,100% profits that BNK delivered, but I think you have a good shot at multiplying your money 10-fold or more.”

The Quebec shale plays arguably carry at least as much political risk as the Peruvian oil projects — but it’s not because of indigenous uprisings or possible tax increases, it’s because of the fear of polluting the water table that has folks around North America very wary of the hydrofracking that makes these kind of shale plays viable. I’m not going to step into the debate about this — I think shale oil and gas is likely a critical part of our energy portfolio, but I also think I’d be nervous if someone was doing hydrofracking near the aquifer that supplies my water … like most things, it’s probably not as black-and-white as the folks on either side would have us believe. Shale oil, however, seems to cause less environmental concern and consternation than shale gas … and this is a shale oil play.

So which Quebec play is this? There are several shale companies active in Quebec, including Molopo Energy, Talisman, Questerre Energy, and more … but he must be teasing Petrolia (PEA in Canada, PTOAF on the pinks). Petrolia has a huge chunk of the prospective onshore oil territory in Quebec, they claim that their 2.7 million acres is 17% of the total oil leased land in the province, and their parcels are in the very appealing (at least so far) area around the St. Lawrence River, including particularly Anticosti Island, which they and their partner Corridor Resources (CDH in Canada, CDDRF on the pinks) have pretty well locked up for exploration. Corridor is a much more diversified company and is about four times larger, Petrolia is really just about Quebec shale oil, both on Anticosti Island and on the neighboring Gaspe Peninsula — if you look at the diagram on their website, it’s clear that they’ve staked the company on shale oil in the region while pretty much all of the other explorers are looking for natural gas in the extension of the Utica Shale a bit to the South. You can see the status of their projects here, which include both shale oil on Anticosti and several conventional oil targets on the Gaspe Peninsula (which might require stimulation).

The results of their core analysis on Anticosti indicate some real potential for it to become a substantial shale oil play, and partly for that reason, though it’s early days yet, the shares spiked up from around 50 cents to where they stand now, right around C$1.60. The stock is still tiny considering the possibilities of the Macasty shale and their huge land position, so I like it as a long-term speculation that this will become a “land rush” shale play like a smaller-scale version of the Bakken — and yes, I say “speculation” because it’s really, really early to be making that bet. As they say on their website, “The Company’s growth is largely linked to its ability to prove that Quebec’s subsoil contains hydrocarbons in significant quantities and that their development is financially feasible.” They’re partway there, and I think they’re a much more interesting bet than the natural gas explorers in the region. There’s definitely oil there, and they have partners for some projects and plans to bring on partners to help with others in Gaspe drilling this year, so I like their chances to have more positive catalysts this year.

Corridor Resources, their partner on Anticosti Island, by the way, might be an interesting play that’s slightly more diversified, with real operations and a producing gas field (McCully)– I mentioned them early on a couple years ago when the price was about half what it is now, and it’s not going to go ballistic with big oil news like Petrolia might, but it certainly has a lot of exposure to the potential on Anticosti if you think Petrolia is too speculative. I’d go with Petrolia myself.

And lastly, we get to a natural gas player in the politicized Marcellus Shale — here’s the pitch:

“Third is a tiny penny oil that got into the Marcellus shale formation before it (Marcellus) became famous as the largest natural gas field in America. The company nailed down 43,500 acres in the heart of the formation, on the cheap. But even so, they didn’t have the money to develop it.

“Now, one of America’s natural gas giants is ponying up $195 million to do the drilling in exchange for half of the action. So far, the partnership has drilled 18 new wells, and they’re expected to begin production shortly. That will more than double this small company’s output. The partnership will drill another 36 wells over the next 2 years, which we think will triple output again.

“So this pipsqueak penny oil is on track to increase production 6-fold in less than 3 years — at almost no cost to itself. Performance like this
in energy hungry America does not go unnoticed on Wall Street. This is why I’m telling my subscribers to expect their shares to go ballistic.”

This one is Epsilon Energy (EPS in Toronto, EPSEF on the pinks), which does indeed have 43,500 gross acres (27,500 net) in the most prospective portion of the Marcellus in NY and PA (they also have an interest in another 40,000 or so acres in Ohio that they don’t seem very interested in at the moment). They are also producing in the Marcellus in PA, and small amounts of natural gas from conventional reservoirs in NY in the deep Trenton-Black Formation. What makes Epsilon stand out in this crowd is they’re cheap, they’re profitable, and they have farmed out a lot of the expense of developing their Marcellus acreage to Chesapeake Energy (CHK). Chesapeake is the company that’s planning to invest $195 million in total in Epsilon’s shale development, and they’re a great partner to have in the region — only the first $100 million of that is spelled out in the real near term, but they do plan to spend $195 million “in the framework” of the deal, whatever that means, you can read the press release from last year here if you like.

Epsilon also pays a decent dividend of about 2%, in addition to trading at a pretty attractive valuation of about 12X forward earnings (the trailing valuation is a bit stiffer, 46X last year’s earnings — the jump is expected to be from the Chesapeake-partnered production), and they’ve been buying back stock pretty consistently over the past year (though they also issue stock options, so that dilutes that impact). They have a bunch of other prospective projects beyond NY and PA, including some holdings in the Bakken Shale on the Saskatchewan side, a junior position on a large amount of Utica Shale natural gas properties in Quebec, and a prospective project in Mississippi for oil. They also hold a large exploration tract in Ethiopia that they’d like to partner with someone, in an area where no real exploration has taken place, ever, but they see reason for optimism in the geologic formations and in oil seeps — they also used to have a project going in Yemen, not sure what happened to that one but I wouldn’t be surprised if they bugged out (the challenges there at the time, several years ago, were apparently largely bureaucratic — it would probably be far crazier for them there today, and Yemen is no longer mentioned on their website). But really, it’s all about the Marcellus in the near future — that’s where effectively all of their real production comes from, and where essentially all of their proved and probable reserves are (roughly 100 BCF), so do note that Epsilon is effectively giving you exposure only to natural gas in the near term, and if natural gas prices collapse again or Marcellus production is cut off for any reason, their shares would likely collapse — the stock is around C$3.60 right now, and Epsilon’s own estimation is that more than 60% of the per-share value of their assets is in the PA Marcellus (though they think just that section alone is worth $4, and that the company overall should be worth almost $6 based on their land holdings and joint ventures).

Epsilon carries no debt, positive earnings, and positive cash flow, and thanks to the Chesapeake farm-out they appear to have enough cash on hand to cover their exploration commitments to Mississippi and in their Bakken partnership, which will suck up close to $10 million each this year, along with their lighter commitments. They announced earlier this year that their production should be hitting about 14 Mmcf/day mid-year (about now, that is) and that the number should double by the end of this year, so there seems to be both a really solid balance sheet and financing/partnering plan, and some real potential for actual earnings growth right now. After looking at itsy bitsy juniors lately Epsilon seems like a very solid bet with a market cap of about C$180 million, though it is, of course, still tiny compared to the big natural gas players.

So there you have it — I’m borrowing a spectrum of three interesting picks, two little guys in oil and one somewhat larger and much more established one in natural gas, and I think now might be a good time to pick up a little bit of each for a slightly diversified speculation on energy prices in the coming years. I do not own shares in any of these stocks … and I will not trade in any of these stocks for at least three days. All are quite small and illiquid, so please be careful if you decide to buy any of them after you do your own research — they’re all small enough to get a bump if it turns out that a large number of our relatively small group here decide to buy the shares, and if so the stock will probably come right back down … limit orders and patience are usually the order of the day. If I were speculating on these stocks today I’d probably look first to Petrolia, but I think it’s wisest to spread your bets around with small speculations like this.

That’s the end of the excerpt — as I suggested to the Irregulars, I also looked first at Petrolia and did later buy and still own some shares, that stock has shot up on a good resource report, and Veraz took a hit from the election in Peru but has recovered somewhat. Epsilon is still at roughly the same price. I do not otherwise own any of the stocks mentioned above and will not trade in any company mentioned for at least three days.


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2 Comments on "Three “Penny Oil” Teaser Picks from Chuck de Castro"

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Sniper
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Sniper
August 1, 2011 4:12 pm

Anticosti Island has always been a favorite of white tail deer hunters, myself included.
Wonder what oil exploration will do to the wildlife population. The island is 136 mi. long and 34 miles wide.

adam
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adam
August 2, 2011 5:20 am

room enough, i would have thought for oil,deer, and hunters!

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