To profit in the current oil and gas space, investors have to move down the food chain to find “unusual bargains,” says Randall Abramson, CEO and portfolio manager with Toronto-based Trapeze Asset Management. Abramson expects global demand to return oil to $75–85/barrel inside 12 months, which means you won’t have to wait long to see those bargains rise with the tide. In this interview with The Energy Report, Abramson discusses several bargains in the junior oil and gas space, as well as a handful of serviceable service names.
The Energy Report: In a previous interview, you said that Trapeze Asset Management uses its valuation model from a bottom-up perspective to tell you where to find individual bargains, and from a top-down perspective to tell you whether markets or sectors are overvalued, undervalued or fairly valued. What is that model telling you about today’s oil and gas space?
Randall Abramson: Overall, the U.S. stock market appears to be smack on its fair market value and, unusually, has held there for about a year. In fact, we have had the least amount of volatility in the first six months of 2015 than, apparently, in any first six-month period in history.
That said, with oil and gas prices having dropped so far from this point last year, the industry appears to be trading at a 20% discount. Some of the quality names are only bargains assuming higher oil and gas prices, which is reasonable given that oil is trading below the average cost of production—and way below where it ought to, since it normally trades at a premium to the cost of production. Some of the smaller names have traded way off, and they represent unusual bargains even at today’s oil prices. Those names appear particularly attractive.
TER: Do you see Iran flooding an already flooded market with crude after the recent landmark nuclear deal?
RA: We don’t. Based on the readings we’ve done, we think there’s only a few hundred thousand barrels per day that Iran could add to the system. Total Iranian production today is roughly 2.8 million barrels a day (2.8 MMbbl/d). It could possibly get to about 3.2 MMbbl/d, but it’s not going to be all that meaningful to the overall picture, in our view, given ever-growing demand and declining or flatlining supplies around the world.
TER: What did you make of the recent American Petroleum Institute (API) crude inventory numbers?
RA: The numbers in the U.S. mask the reality. They show big inventory growth, but it’s somewhat based on a model. Our readings show there are some potential inaccuracies, because U.S. demand seems to be growing smartly, yet the U.S. Department of Energy’s production figures are model-based and likely overstated. U.S. production has likely flatlined. We expect to see the inventories wane in the months ahead. Already, only 19 MMbbl have been added this year, since May, versus 24 MMbbl normally.
Global oil inventories are more important to the oil market and are more in line. That’s because, in the global market, we haven’t seen the oversupply issues that we’ve seen in the States. Global demand for oil has grown even faster than the most bullish prognosticators have predicted.
TER: What is the current drill rig count in the U.S.? How does that influence your view on near-term and medium-term oil and gas prices?
RA: We’re down to about 870 rigs in the U.S. That’s less than half of the peak. That tells us that, even if we are more efficient today, there are fewer people finding oil and gas. The decline rate, particularly in the shales, where most of the growth has come from, is huge, especially in the early stages. While we have yet to see major declines in U.S. production, it’s inevitable that production is going to be flat or down for the foreseeable future, unless we have a massive recovery in the oil price. Even still, I doubt that most boards would approve drilling projects unless they are highly robust because of the glut-less decline in the oil price in the absence of a recession.
TER: How long do you expect the price decline to last?