(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)
Usually market action alone isn't enough to prompt me to write on a note on an individual stock, but Valeura Energy's (VLE.TO, last $0.55) recent trading has me raising an eyebrow. A lot of different elements define share price direction for periods of time, and as we all know... stocks go up and stocks go down. I once asked a veteran Bay Street trader what his view was on what determined general market and individual stock direction. His answer was, "It's simple, stocks go down when there are more sellers than buyers. Stocks go up when there are more buyers than sellers." While the simplicity of his answer seemed a bit silly at the time, there's a pure wisdom to it that can't be ignored. You might think you have the best stock in the world, but if you're the only one that's buying it, you probably won't be happy with the share price performance. Similarly, when a feeding frenzy is on in a particular stock it can feel like money is falling out of the sky as buyers outbid each other day after day.
There are a number of things that go into determining the buyer-seller balance and one of the most important things is short-term sentiment... and when it comes to small cap stocks, press releases are one of the key drivers of sentiment. Press releases provide a point-in-time sample of a company's progress. They provide something for analysts and investors to chew on, evaluate, and maybe even act on. The same news can sometimes be perceived as "bad", "good", or "neutral" by different investors depending on a number of factors specific to each investor. In Valeura's case, an interesting situation has developed whereby short-term disappointment from the company's side-show shallow drilling program has taken centre stage while the "main act" deep, basin centred gas accumulation (BCGA) play is waiting patiently in the wings. If anything, the deep gas play has never appeared to be more promising, and yet investors appear to be selling the stock because of a disappointing set of shallow gas results.
Now, first things first, I'm not going to be a VLE apologist. The most recently reported shallow gas results leave much to be desired. Even the company used the dreaded words "production additions . . . are below expectations". As a result, VLE management is going to hit the pause button on the shallow gas program, probably have a heart-to-heart with the technical team, re-evalaute the prospect portfolio and hopefully come back to the program in 3 months or so with a better success rate. Generally shallow gas drilling success rates with 3D seismic should be in the 60-70% range, but lately Valeura has been making the shallow program look a lot more difficult than the market thinks it should be. Some investors are clearly fed up and have sold the stock down to levels not seen since late 2015. I'd like to say I can't blame them, but after thinking on it a bit, I think the sellers are missing the bigger picture. Enter the BCGA...
The Valeura's game-changer BCGA play has never been more advanced. Statoil, the 11th largest oil company in the world, has funded the drilling of the first (4200 metre) deep well into the BCGA cell where gas shows were noted throughout the target interval. These gas shows were seen completely outside of structural closure, which is a positive indicator for the potential presence of a BCGA. The well encountered 1,300 metres of overpressured section with a 0.79 psi/ft pressure gradient, which means it is nearly 100% overpressured. That overpressure means that if gas can be liberated from these rocks it will have a lot of energy behind it, which may translate into high flow rates. An extensive multi-stage fracking and testing program is being designed that will commence late in Q3 2017 and I'm sure that the completion program will evaluate a couple/few different completion methods.
This is exactly what long-term VLE investors have been waiting for... shallow gas or no shallow gas, for the next 4-6 months the sentiment behind VLE will likely be driven by speculation on the deep gas results. The prize is enormous and the speculation sound. You don't speculate to get 10-20% returns, you speculate to try to make 500%+ returns.
As a result, VLE can probably best be viewed as a call option at this point. There is clearly some terminal value in the company and its infrastructure and VLE currently trades at around its 1P after-tax NPV10 and less than half of its 2P after-tax NPV10. And the call option has a good length on it... Statoil is currently proceeding with Phase 2 of its earn-in (a US$10mm, 500 square km 3D survey) and will have to either pay VLE US$5mm or drill a second well in Phase 3 (and I suspect that Statoil isn't just being nice by shooting the Phase 2 3D survey). That means that the dream of a big payoff is alive through mid-2018 at least. In terms of the size of the potential payoff, history has shown that the BCGA play could be worth anywhere between zero and a billion dollars. That might seem like a ridiculous range, but it is probably about right. Both Falcon Oil and Gas and BNK Petroleum reached the $500mm-$1B market cap club when sentiment was at their backs in BCGA plays in Hungary and Poland, respectively. If VLE gets a good flow rate out of the BCGA with Statoil as its partner, it would be hard to argue that VLE would not be going to at least to the hundreds-of-millions market cap range. Heck, even at a $200 million market cap, VLE would be up around 400% from current levels. So, from 55 cents, I figure that I can lose mayyyybe 50% or ultimately make up to 500-1000%. That means that the market is implying a something like a 5-10% chance of success for the BCGA. If VLE was $1 right now, I might not be sounding the alarm, but at 55 cents? Hmmmm...
Now, I'm by no means saying that this BCGA is without risk, because it's still a high risk venture any time you are trying to prove up a new play, but Valeura is literally on the doorstep now. This is what people who own the stock "should be" playing for... It's been a very long road to get to this point and yet investors are showing the most disinterest in nearly two years. Worse yet, this disinterest seems to stem from a lack of success on the shallow-gas program, while the data on the deep gas has never looked better. And to top it all off, when VLE gets a hold of a brand-new 3D survey over the rest of the Banarli licence, the shallow gas program could end up with a new breath of life of its own as fresh targets are identified in an area with very little current seismic coverage.
My long-winded point is that, as a speculation, Valeura has entered very interesting share price territory. As a long, I'm sure as heck not going to sell now because of a shallow gas program funk when I think that multi-dollars-per-share are on the table from the deep play. In hindsight, the time to sell some stock was after Statoil farmed in and the share price was in the $1.25-1.50 range, but back then it seemed like the shallow gas program would bridge the gap through to BCGA results. Live and learn perhaps, but throw in the towel now? No way, not me. I suppose one could make the case to wait and "buy the news" if VLE's first well result is good, but I have no idea what the price will be by then and I'm already long the stock, so that option is moot for me. Does new money chase VLE right now? Probably not, but in a few months when BCGA results are closer anything is possible. Two things I've learned over the years are that 1) timelines are seldom what you think they are and 2) buzzing from high-impact story to high-impact story like a well-timed bee is pretty much impossible. I like the VLE bet today as much as I ever have, so the case to own it is as strong as ever for me.
At the end of the day, I think it's also important not to forget the fact that Turkey is a country of 80 million people that imports 99% of its gas. It is also has the highest rate of energy demand growth among OECD countries over the last 15 years. Those are two undercurrents that I think will ensure that VLE will always have a market for whatever gas it can find and that the price for that gas is likely to be much better than most other gas markets out there.
All that VLE needs to do now is prove that they have the goods, because speculative interest can only take you so far. Right now VLE investors are hanging their heads low, but things are almost sure to perk up once deep test results approach. Time will tell.