As Canadian Crude Plummets, Find the Natural Gas Opportunity

First of all, Canadian oil and gas companies are THE hottest investments on the junior scene. They are taking risks around the world right now that have unbelievable potential payouts (Kenya and Iraqi Kurdistan, for starters) and they tend to have stellar management that translates into solid efficiency. 

It's a long list that stretches around the world in terms of exploration and production, but here we will focus on one strong bet--but its natural gas, not oil. And this is where the Canadian juniors excel: They are leaders in balancing a production mix of natural gas and oil, and more recently, natural gas liquids (NGLs).

Before you say "ugh", natural gas-who wants to invest when the market is glutted and prices are cheap-consider this: Condensate (natural gas liquid) produced from natural gas wells is NOT in over supply. It is in high demand and is in fact trading in a pricing tandem with crude oil.

Let's look more closely at condensates-and Canada, because this is the key. Canadians are scrambling for more condensate because it's what they use to add to their heavy tar sands to render it light enough to flow through the pipelines. Right now, Canada can't get enough condensate. In fact, it has to import it from Texas. So its value as a commodity-as well as pricing in line with crude-makes Canadian juniors focusing on condensate very attractive.

And in terms of natural gas liquids (NGLs), condensate has maintained a stable price even though there have been major increases in production. 

This brings us to Western Canada's Montney Shale and condensate-rich Donnycreek Energy (DCK).

First, let's look at Montney Shale, of North America's largest economically viable resource plays:

•    6.6 million acres!
•    50 trillion cubic feet of gas
•    Tremendous long-term potential
•    First well drilled in 2005
•    90% of wells in the Upper interval; 10% of wells in Lower interval

Now let's look at Donnycreek.

Donnycreek, out of Calgary, holds 232 gross sections and 159 net sections of petroleum and natural gas rights prospective primarily for Montney liquid rich natural gas resource development. It has three core areas: Kakwa, Wapiti and Chicken--all in the Deep Basin area of west central Alberta.

As per its 13 December operations update, Donnycreek launched production at its Kakwa "13-17 Well" on 1 December. Though flow has been hindered a bit by downstream liquids processing bottlenecks, he well has flowed a production day average of 750 bbl/d of condensate and 3.7 mmscf/d of natural gas (1,367 boe/d gross; 444 boe/d net). They are also expecting additional condensate recoveries of between 30 and 130 bbl/mmcf. Donnycreek has a 25% working interest in this well, plus 10% GORR and 75% working interest before payout. After payout, we're talking about a 50% working interest. 

The company also has a 50% working interest in Kakwa well "14-30", which should start flowing this month (January 2013). A third Kakwa well (3-19) should be spudded by early January, and drilling should be completed by mid-February. Donnycreek also holds a 50% interest in this well. 

As of October, Donnycreek also has a 75% working interest in 136.5 gross sections at Wapiti (in Montney) and a 40% working interest in 33 gross sections at Chicken (south of Wapiti). Donneycreek is an operator in both.

The bottom line: Donnycreek has an amazing land package that insulates it against any drop on condensate price. And we're talking about holdings that are already paying off and have long-term value. It's not prospective.

Here are the quick facts for Donnycreek:

•    Shares were up 25% to $2.49 on 1.5 million volume as of 19 December, after Perpetual Energy sold over 20,000 acres for $75 million in close proximity to Donnycreek's holdings
•    Market Cap 58.54 (not so good)
•    Shares 23.51 million
•    In October, the company closed a $29 million private placement
•    A nice, decade-long drilling history
•    They own the best condensate in North America
•    They're drilling in areas with proven reserves
•    They own the sweetest, largest chunk of land

Possible risks:

•    The market cap is small, yes, and it's a small company
•    A lot of the $29 million it raised will have to fund some pretty expensive horizontal drilling 

But so far, investors like this one. There's been some pretty impressive fund-raising, and land acquisition has been accomplished cleverly-by good management. Most significantly, though, the land it owns has increased its value in a very short time thanks to the drilling success of its first well. Investors are predicting more wins in subsequent wells. (At least Calgary billionaire Clay Riddell thinks so-he has a 10% interest in Donnycreek-and he's not on the company's board, either.)