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Keith Schaefer

Keith Schaefer

Keith is the publisher of the Oil & Gas Investments Bulletin – an investment newsletter that looks at opportunities within the Canadian small cap oil…

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International Junior Oil Stocks: How Investors Can Position Themselves for High-Reward International Plays

Without question, the oil stocks that have made me the biggest profits have been junior oil companies with international plays.

Companies like Xcite Energy, (XEL-TSXv) which went from 62 cents to $6 with a heavy oil play in the North Sea, or TAG Oil developing their New Zealand asset, moving from $2 - $6 a share.

(The one big international stock I missed was TransGlobe, (TGL-TSX) which went from $3.50 - $20 on drilling success in Yemen and Egypt.)

These junior international plays are often orphaned stocks with big, high-impact exploration plays - and if they hit... WHOOSH! The stock can flow upwards like oil gushing out of a well.

But if they miss... OUCH. The investment can be a big win, or a big loss. These international exploration plays are what I call a one-decision stock, or a widows-and-orphans stock (nobody gets out alive) or a binary trade - it's a 1 or a 0.

They have several key differences from the home-grown North American oil plays. If investors know what they are, and how to "game" them, they have a much better opportunity at making a profit - whether the well is a gusher or dry.

Here are the three clear differences that international plays can have:

1. More political risk that warrants a lower valuation...
2. A much bigger prize (bigger well) if they hit... and
3. More risk geologically compared to domestic ones. (I'll explain why below.)

First, though, understand that North American plays are now dominated by shale or "tight" oil plays, like the Bakken or Cardium plays, or the US shale gas plays. In shale oil plays in North America like the Bakken, a really good well might have an IP rate of just over 3000 bopd - but in Canada the best wells are more like 500-600 bopd.

But in countries like Colombia, companies like Petrominerales are often hitting 6,000, 10,000 and 15,000 bopd wells. The value of your investment is obviously going a lot higher with those bigger wells.

And the international arena is full of countries just opening up to new levels of investment in oil and gas. And investors can expect this trend of big new discoveries to continue - onshore and offshore.

North America is a mature enough basin that all the juicy profitable low hanging fruit is gone, and can't compete with those production numbers.

The other factor that gives (successful) international plays much more profit potential has to do with risk and valuation.

Domestic plays have become denominated by the "Resource Play," which is a large acreage of "tight" oil, or is an "unconventional" play that can hold a large number of low risk wells with highly repeatable results.

With 3D seismic and other exploration tools, investors have become accustomed to companies drilling successfully 80%, 90% or 95% of the time.

This safety factor means that companies with domestic plays can extract higher valuations from the market when they get financed - at a higher percentage of the company's Net Asset Value, or NAV. So not only is the upside capped on domestic plays by small IP rates, the starting point is higher due to less risk.

So the potential profit window is smaller on domestic plays.

My experience is that most domestic plays get financed between 0.7 - 1.25x NAV.  However, international plays can get financed as low as 0.2 NAV - 0.5 NAV, particularly if they are "orphaned" stocks.

What does that term mean?  It means the company has no active "sponsorship" in the market; no brokerage firm or controlling shareholder is actively promoting the company. Also, keep in mind that most retail investors greatly under-appreciate the importance of good sponsorship in a stock.

I will often buy stocks just because the most important investment banker in Calgary or Toronto is firmly behind the company. Besides premium assets, sponsorship creates premium valuations more than anything in the market - This is a very important point for retail investors to understand.

And without it, stocks are orphaned, and can trade at big discounts. And there are often a lot of international plays that are orphaned.  TAG Oil was orphaned from 15 cents all the way up until GMP raised them $17 million at $2.50 in 2010.  Xcite Energy was orphaned for a long time; no brokerage firm was actively telling the rest of the street - "this is our deal, we financed it, and it's going to be a big winner."

And there is truly a very simple way to discover, and play, these high profit potential stocks. If you're serious about making money in this highly profitable - but higher risk - sector, it will only mean a little bit of sleuthing.

Below I will explain how I do it, and how you can play them to maximize the opportunity for capital gains.

Lastly, I would say these opportunities are likely to become more difficult to find.  That's because after the financial crash of 2008, the oil patch - like everybody else on earth - reduced risk and stopped spending money.  These types of high risk international plays were obviously the first to get canned from exploration budgets.  Enough risk appetite has returned to the market that these high impact international plays are now attracting a lot more mainstream attention sooner than before, and getting in REAL cheap, like I did with Xcite, will be more difficult.

But as long as the international play in your sights is not a recognized resource play, then it should still be trading at a good enough discount to NAV to provide some excellent upside potential.

If they hit.

Now - How do you find - and play - the junior oil exploration stocks that can be 10-baggers?

As I said, all these exploration plays are international - and the big winners often come from orphaned stocks that get financed at a very low valuation.

Here's how I find these companies, and how I invest in them.

1. My investment philosophy is to have the biggest "deal flow" I can get; create a big hopper of ideas and keep it full.  So that means I have accounts with a lot of smaller, regional brokerage houses that cover the junior international exploration companies. In Canada this means securities firms like (alphabetically), Cormark Securities, Haywood, Jennings Capital, Union Securities and Wellington West among others.

Some of the national firms cover a few international juniors (Canaccord Capital, GMP Securities, Macquarie Capital), but these junior companies often don't raise a lot of money before their first big success, so it's tough for the larger brokerage companies to make any money covering them.

Whatever firm you're with, have them email you their morning letter and specifically an energy letter if they have it. (I get 8 each day, and get some of my best investment ideas from them.)

In the U.S. the analysts tend to be more myopic and don't do near the small cap international coverage that the Canadians do. In fact, it's not unusual for US-based teams with international projects to list on the Toronto Stock Exchange first.

These companies often get orphaned as the investment bankers in Toronto and Calgary don't know the management that well, and they fall through the cracks - unless management can raise their own money or has a remarkable track record in exploration.

2. Another free and easy way is to sign up for the daily emails from some of the trade magazines - I read the daily email from Rigzone.com - I find that the best one. I also get the daily email from platts.com and upstreamonline.com, and and I also pay for The Daily Oil Bulletin in Canada.

3. I also have Google Alerts to track some very talented energy writers, including Allen Brooks' Musings from the Oil Patch: http://energy-musings.com

4. I also create Alerts for specific areas, like "offshore West Africa" or "North Sea oil."

5. Every six months there is an investment conference of junior oil and gas companies in Calgary hosted by SEPAC - the Small Explorers and Producers Association of Canada (www.sepac.ca) that is worth attending.

6. And if you do all these things, guess what will happen? You will create the single most important and powerful profit center of your investing career - your network of friends and contacts.

They send you research. They share talks they've had with other people. They may know of a junior company that has just assembled a big land package right beside a big new discovery in Timbuktu or Nowhere - and they're doing a cheap financing.

OK, so now you are slowly building your information flow and have a list of several exploration stocks you're following.  Which ones to buy?

Like any other energy investment, you want to check out management, find out how much production they have, how big their land position is, and whether or not their production is nearby.  You want to know the cash balance, and the share structure, and how transparent or corrupt the country is.

I want to find a big play that is getting financed now, but won't get spudded for several weeks or months. I want to put my money in when The Big Money comes in.  I may have been watching the company for months, or longer, but I wait for The Money to come in. (I also call this the BIBA Machine - Brokers, Investment Bankers and Analysts.)

Getting the timing right is very important to me on these high-risk, high-reward international plays.

One thing I don't want to do is be too early to the play.  Perhaps management is waiting for permits of some kind - the politics and bureaucracy in many countries is very slow.  Or maybe the hot property is in a legal dispute.  Or there is some negative attribute ("hair on the deal," it's called) that is keeping The Money away.  Without The Money, the chances are much less that the stock can build a speculative premium close to drilling.  The Money promotes the stock with management.

And that is key.  I like to make my investment several weeks before results are due on the well.  That gives management time to promote the stock to analysts, who can get their reports out to their clients.  Hopefully management can spend a lot of time doing investor presentations to institutions and other investors to create some excitement around the play.  Who organizes most of those presentations? The Money.

I want this "excitement" to cause the stock to go up so I can choose to sell enough stock to cover the cost of my investment and ride for free on the results.  If the timeline from investment to results is too short, I might not get that opportunity.

High risk, high reward. But these are the plays - for the risk-tolerant investor - that can be 10-baggers over short periods of time.

By. Keith Schaefer

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