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Feb 28

Buying into Pan Orient

I decided to take a position in Pan Orient energy yesterday after the company released the following results from their L53-DST3 (L53-D EAST) Exploration well off the coast of Thailand.

Pan Orient is pleased to announce that the L53-DST3 appraisal well is currently on a 90 day production test flowing 38 API degree oil at a rate of 1,200 barrels per day through 8.8 meters of perforations between 1,142.7 meters to 1,163.2 meters true vertical depth (“TVD”), within an interpreted gross hydrocarbon bearing interval extending from 1,119 meters to 1,187 meters TVD with approximately 20 meters TVT of net oil pay.

This is the second successful well for Pan Orient in what they are calling the L-53-D prospect. The first well, which was drilled in early January, had equally good results.

Pan Orient is pleased to announce that the L53-D2 exploration well is currently on 90 day production test flowing 27 API degree oil at a rate of 1,015 barrels per day through 17.8 meters of perforations between 1110.8 meters to 1154.7 meters measured depth (860 to 890 meters true vertical depth), within one of six conventional sandstone reservoir intervals interpreted as oil bearing based on oil shows while drilling and open hole log and pressure data analysis.

It’s worth pointing out that these two wells are producing from different sets of sands. The first well produced from an interval 860m to 890 true vertical depth (TVD), whereas the second well produced from an interval 1,119m to 1,187m TVD. In the news release for the original L53-D2 discovery well Pan Orient described 6 potential producing zones:

the L53-D2 exploration well, drilled into the L53-D East exploration prospect, encountered approximately 65 meters of interpreted net oil pay averaging 20% porosity within five to six separate conventional sandstone reservoirs between the depths of 550 to 940 meters. This interpretation is based on numerous pressure data points indicating oil pressure gradients, oil shows while drilling and independent third party open hole well log analysis

Its too early to say whether all 6 zones will be as profilic as the first two appear to be. If they are though, this could turn into a major discovery for the little company.

About the little company

Pan Orient is pretty small, so it doesn’t take a huge discovery to have a big impact on the company. According to the January presentation on the company’s website, there are currently 56.7M shares outstanding, with a little over 60M fully diluted. As of the same presentation company has $58M of working capital, so there doesn’t appear to be any immediate financing concerns.

How much oil is there?

I’m somewhat confused about the prospective reserves in the L53-D prospect. The reason is that it is not completely clear whether the OOIP estimates being provided by various sources are for the L53-D block or for the entire L53 concession, and likewise it is not clear whether the OOIP estimates provided by the company were for one zone or for all 6.

From the company’s presentation, which was put out before either of the two discovery wells were drilled:

The company was assigning somewhere between 4.2MMbbls and 12.3MMbbls of oil ot the L53-D prospect.

A recent report from Paradigm (posted on the investorsvillage board, which is a great source of information on the company) suggested the following resource for the entire block:

The L53 fault structure is targeting 30–50 mmboe of potential recoverable reserves in three faulted compartments. Management believes each compartment has the potential to add 3,500 bbl/d

Where my confusion lies is that there is some suggestion that the resource estimates for the L53-D block only refer to a single set of sands, and that with 6 sands being intercepted there is actually a much bigger resource at stake.

This point was articulated clearly by an Investorsvillage poster algrovenew, who wrote the following:

I don’t think most people have fully grasped the significance of this discovery. The aerial extent might be limited, although still significant. However, what is really significant is the layering of the production zones. Take whatever aerial extent you want (2 to 6 sq. km, depending on whether the other fault blocks are saturated or not) and then multiply by 3 or 4 or 5 times.

The point that the pre-drill estimate may have been far too low was echoed in another post by sculpin, who I believe was posting a piece of a Paradigm note:

The L53-D2 discovery well and the L53-DST3 appraisal well have evaluated the first of three fault compartments of the L53-D East Structure. Results to date have been better than pre-drill estimates and could result in a substantial increase in reserves. The mid-case pre-drill resource estimate of the L53-D East structure is 7.4 million barrels (Figure 1).

What’s the discovery worth to the company?

As of the last reserve report POE had 32MMbbl of proven and probable reserves of which 7.4MMbbl is proved. Of note is that most of these reserves come from “volanics” which are reservoirs in offshore Thailand that have proven themselves prone to watering out and under-producing estimates. These new discoveries are more traditional sandstone reservoirs, which should be be deemed less risky by the market than the volcanics. Even the mid-point of the original prospective resource estimate (7.4MMbbl) would be a significant addition to reserves.

Macquarie placed the following valuation of the original prospect (my bold):

Pan Orient’s most recent P50 resource estimate for the L53-D East prospect is 7.4mbbl. The terms of the L53 concession are similar to Pan Orient’s core assets at L33/44, where Proven reserves are worth ~US$23.00/bbl (PV10AT, ~US$90.00/bbl crude pricing). On an unrisked basis, we estimate the L53-D discovery would be worth C$2.97/sh. Pan Orient indicates that it has at least two other fault compartments to test in the vicinity of this discovery, which would be additive to our unrisked valuation.

Pan Orient is not expensive

Even before the discovery Pan Orient was not trading at a high multiple. The company produced a little over $13M of cash flow in both the second quarter and the third quarter off of production of about 2,000 bbl/d. That puts the company at a trailing cash flow multiple of 5x, and at a trailing EV/boe of $90K. Of course with the two new wells the company will presumably be able to nearly double production, and as per the last news release they have plans to drill a number of development wells in the area starting in May, which should increase production further.

Buying a stock up 25%

I hated to buy the stock at $4.20 yesterday, up 25% for the day. I really had to plug my nose to do it. And it may turn out that I got carried away in the short run; I always find it difficult to can tell if a short term blow off top is upon a stock, and with further drilling delayed until May it may very well be that the stock settles back down into the 3’s before moving higher.

I am fairly confident however that the stock will eventually move higher. Even taking only what is current known, the stock should be able to trade at least a couple dollars higher as they drill more wells and bring production up to 6,000-7,000 bbl/d. If a few of these other zones prove productive, well then the potential is even greater.

Feb 26

Week 34: Its a bull market (for the moment)

Portfolio Performance:

Portfolio Composition:

Trades:

Europe to the sidelines (for the moment)

Eric Reguly had a worthwhile article in the Globe and Mail this weekend. He outlined the reasons why Greece and Europe are still as badly off as they were a couple of months ago. Apart from the markets perception, nothing has changed.

The basic problems in Greece, and in the rest of the periphery, he says, remain.

The country’s economy and its social fabric are unravelling at an alarming pace and the second bailout, combined with a sovereign bond haircut, will do next to nothing to stop the horror show.

So why is the market rallying when these problems have not gone away?

I think that there are a lot of similarities between the markets reaction to Europe today and the reaction of the market in 2007 and 2008. During the housing crisis, what drove the market down was not so much the fear of falling housing values, as it was the fear that falling housing values would cause banking problems.

At times, when it appeared that the housing problems were going to create only housing problems, the market rallied. When the spillover to the banking system was evident, the market fell.

There are different types of bear markets. There are bear markets that are economic and those that are financial. When an economic bear market hits, some sectors get hit hard, some get hit, and there are always some that actually don’t do too badly at all; the idea being that there is always a bull market some where.

When a financial bear market hits, everything goes down. Because in this case what drives the bear market is a lack of liquidity to buy stock. So all stocks fall. To be sure, this eventually hits the economy and causes a financial bear market, which happened in late 2008-2009 and compounded the problem. But there is a fundamental difference here in that during an economically driven bear market, though it may be more difficult a stock picker can still pick stocks. In a financial bear market you can’t pick anything and you just have to get the heck out.

How this relates to today is seen in how the market does not seem to care whether Greece goes into a severe recession. This is because Greece is an insignificant spec in the world economy. The market only cares if the problems in Greece spill over into the banking sector and cause banks to fail, not lend, seize up, and other worrying verbs, thus precipitating another financial bear market.

I wrote a long piece on the LTRO a month ago. As it turns out this has been the most popular blog post that I have ever written. This is somewhat unfortunate because this isn’t intended to be a blog about Europe, I am not an expert on macro economics or on banking, and the post is only tangentially related to the purpose of this blog; the stocks I own. At any rate, in the post I argued that the LTRO may have a short term psychological impact, but over the long run it wasn’t going to do much for the Greek, Portugese, Italian and Spanish economies because none of the problems those economies are having have been dealt with.

I still think this will be the case. Reguly highlighted the reasons why (referring specifically to Greece) in his article:

Labour costs remain too high. The economy is sinfully undiversified and laden with low-value industries, like stuffing tourists onto cruise ships. Corruption is rife. The tax-collection systems are primitive. The professional protection rackets – from truck drivers to doctors – remain intact. The country lacks a working land registry. The bureaucratic red tape leaves entrepreneurs and land owners in despair.

This is all really bad stuff. And its stuff that applies in large part to Italy, to Spain, and to Portugal. However, what is forgotten, and what I think I neglected in my post about the LTRO, was that while all this is true, it was also true a year ago, two years ago, long before Greece came to be a headline and before it began to cause markets to collapse.

The LTRO has accomplished an extremely important objective and that is that is has (temporarily) removed the mechanism for a banking collapse. The banks in Europe were on the precipice because they were overlevered (see my analysis of Deutsche Bank which remains levered at an insane 60:1) and they faced problems funding that leverage. Now, with the help of the LTRO, the banks are still overlevered but can get all the funding they want from the ECB.

Juggling Dynamite

I was listening to the Canadian money program Money Talks yesterday. The had Danielle Park, who writes the blog Juggling Dynamite, on as a guest. You can listen to the interview here by selecting the 10:00 am segment for February 25th. Parks basic argument is that this rally is a sham. Its built on liquidity, will die by liquidity, and there is no evidence that the economies of the world are getting better.

The main theme is the incoming recession… its already underway in Europe, Japan and the UK, what has been going the last several months is all about liquidity injections again, but the reality is it doesn’t fix things, we don’t have any solutions, debt has to be written off…

She argues that individual investors have to be very careful right now. They have to be careful about chasing the market up here, careful about jumping into dividend stocks to try to get a bit extra yield, and to be extra careful about fixed income because the yield you are getting there are miniscule. She has some very good comments about how dangerous the current environment is to the individual and moreover, how criminal it is that central bankers continue to punish savers and try to force risk averse individuals into risky assets.

Now, if you look at what I have done over the last few weeks, I have moved from almost 50% cash to basically no cash. So I must be completely at odds with her assessment right?

Wrong.

I think she’s dead on.

This is a false rally. This is a liquidity driven rally. This remains “the banks in Europe are not going to implode tomorrow so they must be worth more today” rally, which is not a positive pronouncement about anything other than that the end of the world is postponed.

CNBC had Lakshman Achuthan on this week to talk about his recession call from a few months ago. Last week I talked about how one of the indicators I follow, the ECRI’s WLI, was perking up, and that this perhaps portended to a strengthening US economy.

Maybe I have been too quick to look for confirmation. The counterpoint is that it is indeed simply a liquidity driven event. Achuthan also argues, much like Park, that it is. Central bankers are printing money and that money has to go somewhere. Real economic activity is weak and so the money goes into speculative investments instead. Achuthan said that given the amount of money being pumped into the system, he is surprised that the WLI has not risen more than it has.

Here’s the entire clip:

But what can you do?

So rally is on weak legs. Nevertheless, its a rally. If you recognize it as a liquidity driven rally then really, what you want to invest in (temporarily) is liquidity driven stocks. If you look at the stocks I am buying lately, they are exactly that. I am doing the right thing, even if perhaps I have not fully understood the reasons.

I like to call the junior gold explorers, companies like Geologix, Golden Minerals, Canaco, little liquidity eaters. The stock price of these sorts of companies have much more to do with the availability of liquidity then they do with the price of gold. That is plain to see by looking at a chart of any stock in the sector. Every stock suffered through 2011 even as the price of gold rallied hard. Every stock soared beginning in 2012 once the LTRO was announced and it became clear that liquidity would be in abundance again.

But these are trades. I do not expect to be holding any of these stocks 2 years from now. Absent some sort of paradigm shift like a move to the gold standard, these are stocks to hold for the run up and then cut loose when it looks like they are turning the taps off again.

But in the mean time, in the words of Jesse Livermore, from whom I stole my blog title and my avatar:

“But I can tell you that after the market began to go my way, I felt for the first time in my life that I had allies- the strongest and truest in the world: underlying conditions”

The underlying condition right now is one of liquidity. It is not the intent of this blog to philosophize (too much) on the eventual consequences of such liquidity. There are plenty of folks, like the wonderful Ms. Park, who are already describing those consequences eloquently. The intent here is to try to evaluate those conditions clearly, and to describe how I am acting to capitalize on those conditions.

For the moment anyways, that means that I own stocks.

Of course next week could be a different story.

Feb 26

Atna Resources, Coastal Energy and the 80-20 rule

I do not know if an 80-20 rule has ever been expressly stated for a portfolio. However I do feel that such a rule exists. Anecdotally, I am pretty sure my portfolio follows an 80-20 rule of sorts. 20% of the stocks I own are responsible for 80% of the gains. Or thereabouts anyways.

If you take a look at the gains in my current online portfolio you will notice the following:

Atna and Coastal make up a massive amount of my current gains.

Albeit this is far from scientific but it is not the first time that I have noticed that I make all my outperformance from a couple of stocks. In 2010, I’m pretty sure that most of my gains were due to Tembec, Mercer and Avion Gold, all of which tripled or better. In 2009, it was Western Canadian Coal, Grande Cache Coal Mirasol Resources and Teck Resources (call options), all of which rather insanely increased some 5x to 10x during the year. 2007 and the first half of 2008 was all Potash and Agrium (in the second half of 2008 nothing went up but puts and the dollar).

A couple of points come to mind:

1. Do more of what’s working

First of all, you have to know when you’ve got a winner and when you have a winner you have to add to it. I have done this of late with Atna. I bought more Atna this week at $1.30 after having bought more at $1.15 after having bought more at $1 after having bought more at 90 cents. I have bought it all the way up. I did the same thing with Coastal (though that acccumulation was unfortunately interrupted by the European fiasco) during the first half of last year, as it ran from $4 to $10.

Of course the obvious question is: Why not just buy more of the position at the start? It’s a great idea if you know the winners in advance. Unfortunately you don’t. At least I don’t.

I come up with lots of ideas. Some turn out to be really good ideas. Some turn out to be so-so. I’ve gotten better at it over the years, so less turn out to be full-on stinkers. Yet I still get a majority of so-so ideas that do nothing, and a couple winners that go to the moon. And I generally have very little idea at the beginning which one an idea is going to be.

Take for example PHH right now. This one feels to me like it could be the next big winner. It’s worked out so far. I have been adding some on the way up. But do I know whether the stock is going to be $25 or $12 6 months from now? Nope. It could go either way. Nevertheless when it hits $16 I will add more. And when it hits $18 I will add more again. If then, it gets to $25 it will be a big winner and I will be talking about PHH like I am talking about Atna and Coastal. On the other hand, if PHH goes back to $12, I will likely carry a much reduced position in the stock, if I am not out entirely.

2. Don’t give stock tips

This leads me to my second point. Giving advice on an individual stock, such sharing a stock pick with a friend or relative, or putting the name up on an investment board, is dangerous when taken out of the context of the portfolio as a whole. My portfolio has had between 12 and 20 stocks in it over the last 8 months. Unless I know which two or three are going to be the big winners (I don’t) then trying to give someone a tip is a losers game. There is an 80% chance (give or take a few percent) that I am going to give them a loser (or at least not the big winner)

Feb 26

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Back into Geologix

I was out of Geologix for a couple of days (part of my sacrificial purge) but I decided to jump back in this last week after my thoughts on the liquidity situation crystallized. If we are indeed going to be liquidity driven for a time, then you might as well own the stocks most sensitive to it.

The basic premise behind Geologix remains what it was when I first bought the stock a few months ago:

The PEA that was published on Tepal a few months ago put the NPV5 of the project at $412M based on $1000/oz gold and 2.75/lb copper. Geologix has $14M of cash on hand. With 145M shares outstanding, the market capitalization of the company was $28M at my entry price of 20 cents. That puts half the market cap in cash and the other half in a project with an NPV that is nearly 10x the value of the company. Something has to give here.

The market capitalization has increased since that time but its still a fraction of the overall NPV of Tepal. In other words, there remains plenty of room for the speculative elements to move the stock higher.

Tepal remains a fairly high start-up cost, fairly high operating cost, deposit that will only go ahead at a decent copper and gold price. Thus Geologix is acutely sensitive to the market perception of liquidity (it needs money to build the mine) and the future (Geologix needs high metal prices to make the mine economic). Whether it all comes together an the mine gets built is anybody’s guess, but so long as the liquidity is a flowin I believe the market will be inclined to look positively on the potential, while ignoring the risk.

New Drill Holes

On February 16th Geolgix announced the results of infill drilling at Tepal. There were some higher grades in these result (though we are still talking about extremely low 0.7-0.9 g/t grades). Below is a cross section that identifies a couple of the higher grade holes against the lower grade historic holes.

As you can see from the intercepts, the deposit does hold together rather well across a long length. In addition, the North deposit, where the mining will start, takes well to the shape of a pit. If it wasn’t that the grades were so low, it would be quite a nice little deposit.

The higher grades in these recent holes do perhaps bode favourably for better economics early on. That could help the NPV of the project. As stated by the CEO of Geologix in the news release:

“We are pleased with these latest results as eighty (80) of the last ninety-one (91) holes being reported encountered mineralization equal to, or greater than the Company’s internal North Zone cut-off and represent the final data required to complete the upgraded resource estimation currently being conducted by Micon International Limited. Additionally, multiple holes drilled within the central portion of the North Zone returned intervals of gold and copper grades well in excess of the 2011 Preliminary Assessment North Zone’s mine plan average grade of 0.37 g/t gold and 0.24% copper. These elevated grades found over substantial intersections support the potential for the North Zone to host a sizable higher grade starter pit which could positively impact Tepal’s production profile, specifically within the critical early years of the project’s mine life.”

Bottom Line

I’m still unsure whether Tepal will ever become a mine or not. It just seems like such a low grade. It will inevitably put the company on a knife edge between being profitabilty and cost overruns, and wil require an able operator with a strict eye on the budget. Every mistake will be amplified. Nevertheless, the mine is not yet built and so that is not really my concern. In this period of liquidity, I am willing to put some dollars into Geologix on the expectation that the market will push the stock back up to its pre-euro-crisis levels in the 60 cent range. This does not seem unreasonable given that the case can be made that in a perfect world Tepal would be worth $3 per share. Its kind of like Greece and the rest of Europe: why worry about tomorrow before its here?