When Low Hanging Fruit Doesn’t Satisfy the Hunger
By Michael Brush
March 16, 2006
Back when oil was cheap – say $10 a barrel – energy companies could afford
to be cavalier, extracting surprisingly small amounts of crude from an
energy field before moving on.
To grab the proverbial “low hanging fruit,” they’d use a relatively simple
technique of drilling a deep hole into a reserve base. The natural
underground pressure – seeking an escape -- pushed crude towards the well
hole where it could be removed.
With this approach, oil companies would typically grab only 10%-15% of a
given reserve, pack up and move on to more easy pickings.
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But now, with oil above $50 a barrel, we are circling back to take another
look at these “abandoned” energy fields – applying advanced technology to
extract an additional 50% or so of the initial reserve base.
Insiders have recently been buying shares at one tiny Texas-based company at
the forefront of this effort. And if you look at the long-term potential of
Cano Petroleum (CFW), you can imagine why insiders are still buying at
current levels, nearly twice where the stock was a year ago.
Based on its reserve base – excluding likely acquisitions – there is a
plausible case that this $7 stock will rise to the low- to mid-$20 range in
a few years, offering a triple to anyone who buys now.
Enhancing returns
Cano uses two techniques that extract a lot more energy out of “abandoned”
fields. The first is called water flooding. Cano injects water into an
energy field and applies lots of pressure to force the water and crude
towards a well hole, where the crude is then brought up to the surface. The
crude is separated out. Then the water gets re-injected. This technique can
bring up another 10% to 30% of a reserve base.
The next step is called alkaline-surfactant-polymer (ASP) flooding. Here,
those three substances are injected along with water to pull up another 15%
to 25% of a reserve base. The surfactant cleans oil off the rock – like soap
cuts grease in a frying pan. The polymer helps spread the mix through more
of the rock. And the alkaline keeps the rock from absorbing the surfactant.
These more sophisticated – and more costly – methods of taking oil out of
the ground are known as “enhanced oil recovery” in the industry.
“We provide the capital and the technology needed to bring more oil out of
the rocks,” says Cano chief executive Jeffrey Johnson. “We are a technology
play in mature oil fields. We figure out how to shake a little more off the
rock in the ground.”
Probable upside
Cano’s current assets include six mature fields located in Texas and
Oklahoma. That adds up to “proved reserves” of about 40 million barrels of
oil equivalent (BOE). Take out the debt and work through the math, and that
gives Cano shares a theoretical value of about $11.25.
The big potential upside in the stock comes when you factor in the “probable
reserves” of 105 million BOE in Cano’s fields. That works out to about $48
per share. If you cut that in half to account for the risk that not all of
this estimated oil reserve is coming up, you get a potential stock price of
$24 per share over the next few years.
True, these are only “probable” reserves, behind the price target. But Cano
is in the business of converting probable reserves into the real thing with
its enhanced oil recovery. So its estimates carry some weight. “We pay a
fair value for what is proved, and we pay nothing for the upside of the
probable. And through technology we move the probable to proved,” says
Johnson.
Improbable risk
But what if China stops growing, peace suddenly breaks out in the Middle
East and the price of oil plummets? That could put the kind of work Cano
does on hold. But it’s not a likely scenario.
Amir Arif, a Friedman Billings Ramsey energy analyst who has made several
astute calls in other columns of mine over the years
(http://moneycentral.msn.com/content/P137301.asp), believes steady demand
from fast-growing countries like China and India – along with geopolitical
risk – will soon start pushing oil prices upwards again. These factors also
suggest oil won’t decline in a big way, any time soon.
Besides, oil would have to fall back down below $25 a barrel for Cano’s
technology to be too costly to use. What’s more, the company has three years
worth of hedges that pay off when oil drops below $60 per barrel this year,
and below $55 per barrel over the next two years.
The bottom line: Cano takes its name from Spanish explorer Juan Sebastián
del Cano who successfully took over an expedition after the death of its
leader, Magellan. The story gives this company’s name a nice ring,
considering the kind of work it does. And unless oil goes back down to the
$20 range and stays there, Cano is unlikely to meet the fate of its
namesake, who died crossing the Pacific in his very next outing. Meanwhile,
Cano shares have been weak over the past few days because grass fires in
Texas partially shut down one field. The sell off gives you the chance to
buy below the lowest levels where insiders most recently bought, or $7. I’d
take advantage of the discount because this disaster is a one time event
that doesn’t really affect the long-term story behind this company.
Disclaimer
At the time of publication, Michael Brush did not own or control shares in
any of the companies listed in this column. Mr. Brush is an independent
columnist for this web site.
For more on Insiders Corner disclosure, see the disclosure section in About
Insiders Corner: http://www.investorideas.com/insiderscorner/.
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InvestorIdeas is not affiliated or compensated by the companies mentioned in
this article.
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