Tag Archives: utilities

TransCanada – It’s Not The End Of The World, Rather A Buying Opportunity

The president has finally rejected TransCanada’s Keystone XL pipeline. The decision seems more political than economical, but it is bad for TransCanada which has already spent $2.4 billion on the project. Although the market has been focusing on the future of Keystone XL, TransCanada has other projects in its pipeline that could fuel its growth in the coming years. Energy East could be the biggest growth driver in the long term, but the management has laid emphasis on a number of small projects. Earlier this month, the Obama administration finally rejected TransCanada Corp. (NYSE: TRP )’s Keystone XL pipeline on the grounds that the project was not in U.S. national interest and could reflect poorly on the country’s global leadership in protecting the environment. The decision, which was widely anticipated, finally concludes TransCanada’s seven-year efforts in getting an approval for the 830,000 barrels a day pipeline from the current administration. The decision seems more political than economical. It is difficult to imagine how a 1,179-mile pipeline spread over six states which would have mostly carried crude from Canada’s oil sands, but also up to 100,000 barrels a day of North Dakota oil, to Gulf Coast refineries would not lead towards meaningful economic benefits for the U.S. and Canada. Besides, the State Department’s environmental review , released in Jan. 2014, had already stated that the construction of the pipeline will not have any substantial negative impact on the climate. On the contrary, the rejection could increase the Canadian oil sands producers’ reliance on rail for delivering the crude to the U.S., which is far more carbon-intensive than the pipeline. Nonetheless, the decision is bad for TransCanada which has already spent C$2.4 billion on the project. A significant chunk of the expenditure could be written off as non-cash pretax charges in the coming quarters. The investment which related to the physical pipeline and equipment, however, can be utilized on other projects. As I have discussed previously , TransCanada has several options on its table following the rejection. The company can seek remedies under the energy chapter of the North American Free Trade Agreement, construct a rail loop that would connect U.S. and Canadian pipelines, or simply wait until a new U.S. president arrives in 2017 and then file another application. However, it is also important to note that the rejection is not the end of the world for TransCanada. Although the company’s stock declined 5.2% on the day of the rejection and has failed to completely recover completely since, I believe this could be an interesting buying opportunity. Although Mr. Market has been largely focusing on the future of Keystone XL, TransCanada has several other projects in its pipeline that could fuel earnings and cash flow growth in the coming years. This includes the giant Energy East pipeline which is bigger than Keystone XL in terms of investment, capacity and impact on the bottom line. Energy East, which comes with a price tag of more than C$12 billion as opposed to Keystone XL’s C$8 billion, will be able to ship up to 1.1 million barrels of crude per day from Alberta to Eastern Canada. Once Energy East becomes fully operational by 2020, it can lift TransCanada’s annual earnings (EBITDA) by C$1.8 billion. Keystone XL, on the other hand, was supposed to generate annual earnings of C$1 billion. Overall, excluding Energy East and Keystone XL, TransCanada has a backlog of C$15 billion of commercially secured major projects that can lift its annual earnings by more than C$1 billion in the long-term, according to my rough estimate. Energy East pipeline What’s even more interesting is that during the recently held investor day (Nov. 17), TransCanada emphasized that in addition to the major projects, it also has a C$13 billion backlog of eleven smaller projects, none of which require investment of more than C$1.4 billion, which will drive its growth over the next two years. Some of these projects, such as the Houston lateral and terminal, Topolobampo, Mazatlan and Canadian Mainline, will begin to contribute to earnings in 2016 while some of the bigger ones with capital cost of at least C$1 billion each, such as the liquids pipelines Grand Rapids and Northern Courier, will fuel earnings growth beyond 2016. Overall, the small and large projects are forecasted to drive 8% to 14% increase in annual earnings through the end of the decade. This will lead towards an average of 8% to 10% increase in dividends in each year through 2020. That’s higher than the CAGR of around 7% witnessed over the last fifteen years. Thanks to the recent drop following Keystone XL’s rejection, the stock is already offering an attractive yield of around 5%, which is higher than the industry’s average of 3.2%, according to data from Thomson Reuters. I believe the recent weakness could be an opportunity to buy this pipeline stock and earn strong returns in the long-run.

Future Growth Opportunities For Duke Energy After Piedmont Acquisition

Duke Energy expands its reach from the electric utility industry into the natural gas business. Increases Duke Energy’s stake in very profitable Atlantic Coast Pipeline while tripling gas customers. Expect to see increased EPS for Duke Energy. By Matt De Jesus I have a strong buy recommendation for Duke Energy (NYSE: DUK ) after its acquisition of Piedmont Natural Gas. Duke Energy acquired Piedmont for $4.9 billion, and will also assume around $1.8 billion of its debt, representing an enterprise value of close to $6.7 billion for Piedmont. Duke Energy paid a 40% control premium on the acquisition, paying out Piedmont shareholders $60 in cash for each share outstanding. Reasons they paid this high premium are related to the possible synergies related to the deal. This acquisition is a good deal for Duke Energy, as they try to grow in the utilities industry and possibly expand nation wide. Duke Energy is the largest electric power holding company is the country, and is headquartered in Charlotte, N.C. Before acquiring Piedmont, Duke Energy was known for producing electricity, and not a big name in the gas industry. However, with the electricity industry showing signs of stagnant growth, Duke Energy wanted a piece of Piedmont Natural Gas for a couple of reasons. First, the natural gas industry is growing, whereas the electricity industry is not. Utilities are going through a period right now where natural growth is slow, so companies, like Duke Energy, must grow through acquisitions. The natural gas market, according to Wall Street analysts, is bullish right now, so everyone is trying to get into the gas business, adding significance to Piedmont’s acquisition. They will receive all of Piedmont’s existing customers, thus tripling its number of natural gas customers from 500,000 to 1.5 million. Also, with Duke’s established brand and stake across the southeast, I expect these numbers to grow further. The second reason Duke Energy acquired Piedmont was because of the Atlantic Coast Pipeline. Now owning Piedmont, Duke Energy increases its stake in the $5 billion Atlantic Coast Pipeline to 50%. More importantly, because of the state regulations on Piedmont’s fuel delivery incorporated with the pipeline, the acquisition provides Duke Energy with a steady and predictable profit, which is very important in the utility industry. Much of a utility companies growth is based on a rate base, which is the value of property on which a public utility is permitted to earn a specified rate of return. So, utility companies make money off returns on investments in property for the company. This is why the regulated returns on the Atlantic Coast Pipeline are so important, as they are consistent and profitable. Third, the move is in line with the company’s possible plans to grow throughout the U.S. and not just stay in the Carolina, southeast area. By establishing itself in the gas industry, Duke is scaling itself for the long-term next step in its growth, which may be to take the company nationwide. This move would not be any time in the near future, as Duke must first establish itself in the gas industry. Some may question Duke Energy’s paying such a high control premium to buy out Piedmont, but in the long run, this is a great deal for the company. The deal enhances Duke’s forecast EPS rate of 4% to 6%. To give some perspective, Piedmont’s rate base and EBITDA have been rising annually at about 9%. Duke’s stock price is currently at $67.32, and has been down recently because of the debt involved with the deal and slowed growth in the electric utility industry. The 52-week low on the stock is $67.07, with the high being $89.97. This deal, in the end, will be good for Duke, and it’s investors because it will enhance EPS. The stake in the Atlantic Coast Pipeline is very integral to this, and will provide regulated profit for the company even when the market for electricity is down. Also, the market for natural gas is bullish, and with a big company like Duke Energy providing natural gas, investors will reap the benefits of the profits Duke will make from Piedmont. We’ll see Duke Energy grow in these next months/year, but it will take some time before we see the major benefits from this deal.

Karoon Gas – Give Me $1.00, I’ll Give You $1.20 And 2 Significant Oil Discoveries

Summary Karoon is a depressed stock trading 20% below cash backing due to a low oil price, and several major shareholders exiting the stock. A major selloff has resulted in Karoon being significantly undervalued. Provides fantastic long term exposure to a rising oil price with 85 mmbbls of 2C reserves from 2 recent oil discoveries. Karoon Gas is currently in the process of buying back up to 10% of stock on issue. Overview Karoon Gas (ASX: KAR, OTCPK:KRNGF , OTC:KRNGY ) is an Australia-headquartered oil and gas company with exploration opportunities focused in North-West Australia, Peru, and Brazil. With a set of great oil prospects, and no major gas prospects, they should consider changing their name to Karoon Oil. Of all the sell-offs in the oil and gas sector, this one has intrigued me the most. On a market cap of AU$450 (US$319) Million at the current share price, they sit on cash of AU$550 (US$390) Million. This cash came from their recent sale of their Browse Basin permits to Origin for the following: An upfront payment of US$600 Million (Received) A deferred cash payment of US$75 Million payable on FID A deferred cash payment of US$75 Million payable on first production A deferred cash payment of US$5 Million for every 100 BCFe of independently certified 2P reserves exceeding 3.25 TCFe Reimbursement of the costs associated with drilling its 40% held Pharos-1 well. (Received) So why are they trading so low? Apart from the oil price, I think it is primarily due to these 3 factors: Several major investors have exited the stock over the last year. IOOF Holdings, Future Fund Board of Guardians, and Paradise Investment Management all ceased to be substantial holders, selling out a major portion of the stock. The company has some corporate governance issues. There are concerns that family members of the chairman Bob Hosking are appointed on key positions at the company, as pointed out by the activist hedge fund manager Pegasus. The majority of shareholders may or may not agree with this, and I myself have questions regarding it, but none of the three candidates that Pegasus put up for election were voted in. A lot of Australian companies have corporate governance issues, and activist investment is much lower than in the US. Like any market risk, this is a risk that must be weighed against the benefits. Speculators pushed the price up to obscene levels, and then pushed the price back down in fear Despite these issues, Karoon has a great track record of increasing the long-term value of shareholders when you normalize for the boom and bust cycle. Past speculation during the boom had driven the share price as high as $12.10 – it currently sits at $1.81 at the time of writing. Karoon is, at present, up over 950% from 2004 and has managed to unlock plenty of cash for the exploration and appraisal of their major Brazil operation in the Santos Basin. (click to enlarge) ( Google Finance ) Offshore Brazil (Two Significant Oil Discoveries) The map below shows the Kangaroo and Echidna resource as well as the Bilby oil discovery dating back to 2014. (click to enlarge) ( Source – Karoon Annual Report 2015) Kangaroo went through further appraisal in 2014, production testing at rates that signaled a single vertical well could flow 6,000-8,000 bopd from a net pay of 135 meters ( Source ). It needs to be noted that Kangaroo 2 also had two side tracks as part of the appraisal that indicate that this may be a complex reservoir which would enhance the cost and difficulty of production. Despite the complexity, it remains a significant find that has a great chance of commerciality. Echidna followed up the Kangaroo discovery with a 103 meter net oil column and a facility constrained flow test 4650 bopd, further enhancing the chance of a commercial discovery for the region. (click to enlarge) ( Source ) From an operational perspective , Karoon is looking at a variety of options for producing the Echidna and Kangaroo discoveries that are less than 50km apart. The lowest capital cost method includes a Floating Production Storage and Offloading Vessel (FPSO) producing roughly 20,000 barrels of oil per day (bopd), then expanding that to 50,000 – 70,000 bopd once the field has been proven. Discussions for the development of Kangaroo have also involved Petrobras for an integrated oil hub in the region, which could be economic as low as $43/bbl according to Citigroup ( Source ). The same article also denotes the drop in costs which could make the project economic at even lower prices “Because it’s a distressed market now worldwide, we are looking at redeployed assets, for example, a redeployed FPSO [floating production storage and offloading vessel]. The labor market is getting cheaper, the labor is getting cheaper; we see there’s a lot of cost savings for us.” One of the primary reasons for investing in Karoon is that there is almost no value attributed to the Kangaroo and Echidna discoveries. After writing off Karoon’s AU$105 (US$76) million tax liability against its cash reserves, the 2C reserves equate to a value of AU$0.41 (US$0.29) /bbl. However, investors must keep in mind that production isn’t likely oncoming until 2018 at the earliest while Karoon moves through engineering and approvals, and this may hold the share price back for the medium term. Offshore Peru and Offshore Australia After all this, Karoon still has more to offer. A possibility of more major discoveries exists offshore Peru and Australia. Nearly 27000 square kilometers of permits sit on the acreage outside of Brazil, with significant long-term potential for Karoon. They have a habit of bringing in joint venture partners to free carry them through the initial drilling stages to minimize the capital outlay from Karoon. These are likely to sit for several years during the current supply glut, however, they provide some great upside for an oil recovery. (click to enlarge) (Karoon Annual Report 2015) Share Buyback One of my favorite things to see a company do is an all-cash share buyback – specifically when their share price is trading at an all-time low. Karoon has bought back 9.4 million shares at $3.27 over the last 12 months as well as announcing plans to buy back a further 25 million shares. That comprises up to 10% of the company’s ordinary shares on issue and will further expose investors to the upside of an oil price recovery in 2-3 years. On top of all that, Karoon has a significant amount of built up exploration expense of $AU485 Million that can be written off against future cash flows. Risks and Uncertainties Karoon is in the early stages of several significant oil discoveries. There are plenty of issues that need to be sorted out, and a significant amount of cash that needs to be spent to bring these oil fields into production. Production is not likely to begin for several years, and the oil price currently sits at levels that would make these projects uneconomic. Most investors would agree that the current supply glut will not extend out to 2018, however, it is possible and poses a significant risk as Karoon spends more on the appraisal process. Karoon also has no source of cash flow, and Origins deferred payments are unlikely in the current environment. Conclusion Having several major investors exit the stock over the last 18 months has left the share price in the doldrums. While Citigroup has calculated a combined development for Kangaroo and Echidna would be economic as low as $43, I would not expect the project to go ahead unless oil moved well into the 60’s – unless the resource is found to be much larger than current estimates. There is plenty of unrealized value in this stock with hardly any value attributed to the Kangaroo and Echidna discoveries, and no value to the significant amount of exploration expense that Karoon can write off against future cash flow. Karoon’s cash reserves can be used to develop these discoveries and increase shareholder value at the same time the share buyback is increasing investors oil exposure per share. As for the remaining Australian/Peruvian blocks, Karoon will likely delay drilling as much as possible to preserve cash for the Kangaroo and Echidna discoveries. Overall, there is a significant amount of risk around Karoon going forward. They are in the early stages of appraising these reservoirs while the oil price has crashed. However, a crashed oil price means cheaper drilling, completions, procurement, and construction. Karoon would not be likely to produce oil until 2018 at the earliest, and there is plenty of time for the oil price to recover in that time period. As the Financial Review quoted from an RBC Capital Markets report “Whilst high risk, this is a freebie and success would open a significant new oil play.” I love Karoon as an asymmetric bet on an oil recovery, and I can confidently see an upside of well over 100% in the next 3-5 years in the event that the oil price recovers. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.