Hidden Treasures in Junior Explorers

Some companies will go wherever the oil is...even if that means venturing into war-torn areas. Here's David Popowich's debriefing on Egypt, Kurdistan, and which junior explorers to watch for in this exclusive interview with The Energy Report.

The Energy Report: David, investors need to see big potential returns before they're prepared to shoulder jurisdictional risk. How do you recognize a quality story outside of the typical North American investor's comfort zone?

David Popowich: We look for extraordinary production and reserve growth potential. It's true that the risk is greater in the international oil and gas space than it is domestically. Therefore, the potential returns should justify the higher risk.

Investors looking for near-term appreciation need to watch the operational catalysts, which usually coincide with drilling events. Sometimes a small- or mid-cap producer can prove up material reserves with just a single well.

The Energy Report: What are the dynamics between the seniors and the junior firms moving into former war zones?

David Popowich: This is where junior exploration and production (E&P) companies typically enjoy first-mover advantage. Juniors tend to enter frontier exploration areas first, and once they reduce exploration risk and prove up resources, the deep-pocketed seniors come in, often through partnerships or acquisitions of the junior companies.

The Energy Report: Let's talk about Egypt. What is the ownership dynamic between the Egyptian government and foreign oil and gas companies?

David Popowich: You could almost describe it as a partnership, as both parties have a vested interest in successful exploration and development.

Oil and gas companies operating in Egypt enter into production sharing agreements (PSAs) with the Egyptian government for each block that the company has an interest in. Terms are laid out under the PSA highlighting the share of production that each party will receive, and this can vary across blocks with royalties and taxes paid out of the Egyptian government's share.

Oil and gas producers in Egypt are currently awaiting the results of the 2012 Egyptian General Petroleum Corporation (EGPC) bid round, in which the government tendered 15 blocks. Bids have been submitted by interested parties, and results are expected by the end of the summer.

Egyptian politics have been in the global headlines quite a bit since last year's revolution, culminating in the recent election of President Mohamed Mursi. But while the presidential election generated a lot of news coverage, it has had little to no operational impact on Egypt's oil industry.

TransGlobe Energy (TGA), a company that I cover, reported minimal impact to its operations, even at the peak of the revolution. The company drilled 47 wells in Egypt last year and grew production by 22% year over year. This year, TransGlobe will probably grow production by another 55%.

The Energy Report: Could the EGPC bid to increase TransGlobe's land base in the West Gharib area move the stock?

David Popowich: Yes, I would definitely expect it to move the stock. All year, we have been highlighting the EGPC bid round as what will probably be the single biggest operational catalyst for TransGlobe in 2012. The company could nearly double its existing land base in Egypt for very little cash outlay. This could be a potential game changer for the company.

The Energy Report: Let's move on to Kurdistan. Now that it's opening up for exploration and development, what is the political climate like for explorers?

David Popowich: Political risk should certainly be a consideration for people looking to invest in oil companies with exposure to Kurdistan. The Kurdistan Regional Government (KRG) halted oil exports through Iraq over four months ago, after it alleged that the Iraqi central government owed more than $1.5 billion to oil companies operating in the Kurdistan region.

We have seen encouraging signs recently, however, as the KRG has recently resumed oil exports, albeit at a reduced rate. The KRG is trying to build confidence with the central government as it resolves outstanding oil and gas issues.

Nonetheless, the resource potential of Kurdistan is thought to be immense. The US Geological Survey estimated that Kurdistan holds more than 40 billion barrels (40 Bbbl) of proven oil reserves, and 25 Bbbl of potential reserves. There are not many other opportunities around the world to secure this kind of resource potential.

Several material discoveries have caught the attention of the world's oil giants, which have started to acquire land positions in the relatively underexplored region. Most if not all of the prospective land has been taken, leaving new entrants with little choice but to acquire existing blocks in the area. This is occurring through corporate acquisitions or deals with the KRG. In other words, Kurdistan is increasingly becoming the domain of the supermajors.

The Energy Report: Are any juniors making waves there?

David Popowich: WesternZagros Resources (Vancouver: WZR) is our top pick in Kurdistan. It looks like it's sitting on what is potentially a billion-barrel discovery at Kurdamir, which the company is currently testing.

WesternZagros has also topped up its bank account with a $56 million cash infusion from Gazprom (OGZPY) and a $57 million private placement by Crest Energy International. This should allow the company to execute an expanded capital program through 2013.

The Energy Report: Let's leave the Middle East and shift gears to Southeast Asia. What's the situation there for E&Ps?

David Popowich: Thailand is not traditionally regarded as a global oil powerhouse, but Coastal Energy (CENJF) has operations offshore Thailand, and it's one of our top international E&P picks right now. Coastal also recently entered Malaysia, where it signed a small field risk service contract with Petronas, Malaysia's national oil company.

Coastal made a significant (potentially more than 200 million barrels) discovery at Bua Ban North in 2011. We think there is good visibility for Coastal to grow into a 30,000 bbl/d producer from this discovery, which could increase on further exploration success. Coastal is about to recommence high-impact exploration drilling, beginning with the Buried Hill prospect.

The Energy Report: Is the international oil and gas space suitable for retail investors?

David Popowich: Every investor has a different risk profile, so you should carefully consider your personal situation before investing in more speculative oil and gas stocks. Generally speaking, global success rates for frontier exploration are 20% or less.

You should do your research to make sure you will be rewarded with a symmetrical return if you are prepared to absorb this kind of risk. Keep an eye on company press releases, and potentially its partners' press releases. If a company is successful, it will make sure the market knows about it!

I also look for signs of insider buying, which are positive in that they indicate management views their own company's stock as a good investment.

David Popowich has covered Canadian-listed international explorers and producers for Macquarie Securities in Calgary since September 2009. He has worked in the investment industry with Tristone Capital, prior to its sale to Macquarie, since February 2006.