This week’s events show it’s becoming a bad time to be a generalist. Buyers of large-cap energy stocks have had their wallets handed to them over the last couple of weeks.
But that might signal an opportunity in the making—a return to one of the resource sector’s most profitable investing strategies. Small cap stocks. Nimble development companies that could give investors the perfect way to play several of the biggest emerging themes in energy.
That includes many of the opportunities we’ve been talking about in these pages. India’s coal demand hitting super-critical levels. American exports of natural gas liquids taking the petro-chemical world by storm. The emerging profitability of light oil plays outside of North America, in far-flung places like Africa and Asia.
Up until now, there’s been little incentive for energy investors to look at the small-cap end of the stock spectrum. Over the last several months, stock buyers have done just fine with large cap companies—which had been offering the most stable ways to play energy markets.
Until all that changed a few weeks ago.
Just look at a stock like Exxon (NYSE: XOM). The firm had been riding along with the general updraft in major stock markets—which saw U.S. indices tally record gains of up to 30% during 2013. A lift that helped Exxon gain an eye-catching 20% during the fourth quarter alone.
But Monday’s market correction punctuated a popping of the bubble of sorts for big energy stocks. With Exxon losing 2.3% in one trading session.
That topped off a slide that’s seen the company shed 10% since January 10. Which is not at all surprising—given the wider Dow has dropped 6.5% during the same period.
It would thus appear that the generalist lift big energy stocks enjoyed over the last year is now working against investors. With growing negative sentiment over the wider markets weighing down large-cap energy companies.
So, what’s the solution? Recent trading suggests that a return to small-cap stocks might provide greater upside—and may even offer better protection against losses.
A number of the small-cap energy stocks I’ve been following have not only held their ground the last few weeks—but actually made significant gains. Even as their larger peers tumbled.
The great thing is, many of these companies stand to benefit most from the biggest trends in the energy world. With their tight project focus makes them particularly leveraged to segments of the energy world that are seeing explosive growth.
The Top Play For High-Value International Oil
Just look at the recent performance of two junior international oil developers: DualEx Energy (TSXV: DXE) and Africa Hydrocarbons (TSXV: NFK).
These small caps are jointly exploring one of the most prospective onshore light oil projects globally: the Bouhajla concession in Tunisia, north Africa. Drilling right next to a massive oil field that’s produced over 45 million barrels.
Over the last several weeks—as the wider markets fell—both stocks have been steadily gaining. With DualEx up 10% and Africa Hydrocarbons up 30% since the beginning of the year.
That’s because of growing investor enthusiasm over drilling at the Bouhajla license. The partners are moving to re-complete the first well ever drilled on the property—which was completed in July 2013, but hasn’t yet been tested due to technical setbacks.
If successful, the Bouhajla project fits well with one of the themes we’ve been discussing a lot of late—the growing premium of international oil prices to domestic North American crudes. As I write, Brent crude is selling for $8.50 more per barrel than WTI. That’s a big incentive to look for oil abroad. And Bouhajla is one of the leading places to do it.
The Best Way To Beat Today’s High-Cost Environment
Another junior that’s ramping up is Chelsea Oil & Gas (OTC: COGLF). With a unique strategy that may be the perfect fit for the current oil and gas environment—the farm-out model.
Chelsea holds big acreage positions—to the tune of millions of acres—in some fast-emerging oil and gas plays in Australia. But rather than spending the cash to develop the land themselves, the firm is letting others do it for them.
Like what the company has done in the Copper/Eromanga Basin of South Australia. Where Chelsea has signed up a joint venture partner on its 156,000 acres of licenses—who will pay a minimum $14.3 million to shoot 3D seismic and drill up to five wells.
This farm-out strategy is a great way to beat the high costs that are killing developers in many parts of the world today. Let someone else pay the big bucks for development—while sitting back and taking a free carry.
Chelsea is also getting a free ride on spending by some major companies around its acreage in the Georgina Basin of Northern Australia. The company holds 5 million acres here—surrounded by Total, Statoil and Santos.
Those big players have committed to spending up to $545 million in drilling, ringing Chelsea’s lands. With some of the first wells set to spud within the next few months. The aim is to prove the basin’s hydrocarbon potential using fracking completions—which, if successful, would add big value to Chelsea’s large land position here. At no cost to the company.
First Mover in a Billion-Tonne Coal Basin
Another small-cap stock worth watching is one poised to capitalize on a trend I’ve talked about a lot: India’s rapidly-growing demand for thermal coal.
Despite ravenous demand, there simply aren't a lot of places that can easily ship coal to India. In fact, it really comes down to just two countries: Indonesia and South Africa.
The latter is particularly interesting, given that it holds billions of tonnes of coal resources, that are just now starting to be tapped. By firms like junior mine developer Resource Generation (ASX: RES).
The company holds over 700 million tonnes of coal reserves at its Boikarabelo project. Part of the prolific Waterberg coal fields of northern South Africa. The Waterberg is one of the newest coal basins on Earth being developed—with a massive resource positioned close to South Africa’s well-developed export infrastructure.
Resource Generation is moving to be one of the first companies to production here. Giving it a leg up in selling supply into the world-leading markets of India. Just this month the company announced a binding term sheet for $65 million in infrastructure construction loans from major mining conglomerate Noble Resources—bringing production even closer to reality.
With all of this potential, the company still commands a market cap of only $110 million. Making it a small-cap play that may be perfectly positioned for profits in the current markets.