3 oil stocks that Nugget Capital finds attractive despite low commodity prices

low commodity prices can be a tailwind for some

With commodity prices coming back to earth, differentials across the board expanding and uncertainty surrounding the macro environment continues to weigh-in on broader investor sentiment, it is more important than ever to understand what type of trading climate we are in. Gone are the days, at least for now, where you could pick a cat from a hat and end up as a winner as energy lifted with the “inflation trade” and rising interest rates. Going forward, to find winners in the energy space we believe you will have to be rather judicious with company specific catalysts in your selection.

We think that lower oil and natural gas prices presents both risk and opportunity. For the larger ambitious acquirer, we think a lower commodity price climate presents opportunity to pick up assets using better acquisition metrics. For the royalty player, we think lower commodity prices also poses a tailwind in the shorter term as it allows for royalty company to pursue deals using lower oil prices which typically pay off more as commodity prices rise and operators drill.

Other tailwind factors exist too. Consider the amount of steam that SAGD oilsands players (MEG, SCR, ATH, CNQ, SU, IPCO) must produce with boilers using natural gas input which is a major cost, the decline of natural gas prices poses a meaningful tailwind for SAGD producers. Also consider that normally into winter, diluent (C5+) or condensate, tends to trade at a premium to WTI as thick flowing bitumen must be blended to lower viscosity to allow free flow of liquid in the pipeline. This year condensate is stuck between par and a discount into cold season, presenting another tailwind to oilsands players that must blend aprox. 30% of a barrel using diluent, either imported from the U.S. or produced in the Montney. Big savings.


SOURCE ROCK ROYALTIES (TSXV: SRR)
Source Rock Royalties presentation

Source Rock Royalties is a very little known royalty player operating mainly out of Saskatchewan. Essentially a one-man-band led by corporate lawyer gone oilman Brad Docherty. The company has never had a cash flow negative quarter and this year upped their dividend by 9% and still has a low payout ratio while trading at a multiple typically reflective of an E&P likely due to smallscale operation and lesser known name still trading on the venture. Armed with a significant cash balance ($0.17 cents per share of $0.80), a downturn in commodity prices may actually turn out to be a tailwind given smaller players may be lured into selling royalties allowing companies like Source Rock to acquire on the cheap on assets that will see more production during better times. With a number of ambitious and growing smaller active junior players in southern Saskatchewan, we think it’s possible that Source Rock can find some good deals amidst lower commodity prices. We are very excited to see what Saskatchewan juniors bring given the renewed interest in the area as the bigger players depart to chase the Montney. We think this could present significant opportunity for Saskatchewan-focused smallscale royalty player like Source Rock.

TOTAL ENERGY SERVICES (TSX: TOT)
Total Energy Services presentation

Total Energy Services is the most mispriced oilfield service name we can find in Canada. Trading below 3x EV/EBITDA and recently attained net debt free status, we think Total is in position to play conqueror and is likely on pursuit for a domestic acquisition. The last two driller acquisitions were done at no premium as the lack of buyers has created limited opportunities for smaller players to be demanding on expectations. Total’s CEO has been buying stock regularly for the past few years and ranks near the top of any insider for the level of commitment. Total’s revenue is spread out across 3 countries almost equally (USA, Canada & Australia) with multiple service lines. Canadian onshore drilling is dominated by the most drill happy clients in the energy space including Crescent Point, Surge and Baytex. We think 2024 is likely to be a good year for Canadian on-shore drillers targeting light oil and oilsands, given that Transmountain Expansion is scheduled to be complete in 1H 2024. With very little investment, a pressing labor shortage and driller consolidation and discipline our bias is skewed to the upside for the Canadian drilling rig count.

STRATHCONA RESOURCES (TOT: SCR)
Strathcona Resources presentation

We wrote about Strathcona last week in our Substack article Strathcona Resources, a rare add to the NCP energy alpha fund. We are of the view that this name currently suffers from extreme illiquidity, negative stigma from the prior Pipestone Energy deal which took the ticker public and overall lesser known status as the company has only been a publicly traded issuer for about one quarter. Trading at a substantial discount to other oilsands peers and below $40k on a boe basis, we see significant room for this name to rally in the next year, especially as capitulation selling exhausts and we exist tax loss selling season. Two hidden catalysts for this name would be their 2024-2025 organic growth plans, which will see the company boost output by 25,000 boe/d for a cost of only $25,000/boe and also building a wasteheat recovery unit which is projected to save power at existing facilities. Strathcona being one of the largest liquids producers in Canada may also be on the pursuit for more M&A, another potential tailwind to the company despite lower commodity prices as it allows to pick up high quality assets at better prices then otherwise. As trading liquidity frees up, we think the multiple will see natural expansion. This is likely to come as the company pursues M&A, which may be tough to do given current valuation. Adam Waterous, the CEO at Waterous Energy Fund, founded Strathcona Resources countercyclially in 2017 when nobody believed in Canadian energy or the oilsands, so we have great confidence in his team’s abilities to take advantage of any downturn.

Thank you for reading and as always, if you have any questions or comments please leave them in the comment section.

Yours truly,
Roger Lafontaine
Partner, Head Trader & Research Analyst, Nugget Capital Partners