January 15, 2010 - 3:12pm EST by
2010 2011
Price: 14.33 EPS N/A N/A
Shares Out. (in M): 137 P/E N/A N/A
Market Cap (in $M): 1,963 P/FCF N/A N/A
Net Debt (in $M): 500 EBIT 0 0
TEV ($): 2,463 TEV/EBIT N/A N/A

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 NAL Oil and Gas 

While the Williston basin Bakken play has garnered a lot of well-earned attention in the US, Canada his its own Bakken-style play developing too; namely, The Cardium, in Alberta. The Cardium extends about 1000 miles north from the US border, through West Central Alberta and into NE British Columbia.  As with other such plays, the Cardium has long been known to contain an immense amount of OOIP.  It has been conventionally drilled on for decades, but much of the OOIP was unexploitable with the technologies of the time. Approximately 10-12% of the OOIP was recovered. Now, as with the Bakken, the development, refinement and implementation of horizontal drilling and multi-stage fracking has unlocked the potential of the field. The sweet spot of the play appears to be the Garrington to Pembina area. An excerpt description from the Alberta Geologic Survey -a good source for those interested in the details of the geology--( describes it as follows.

 The Cardium Formation is of significant geological interest for two principal reasons: 1) it represents a complex stratotectonic pulse that alternated between sandy and muddy stages during the period of maximum inundation of the Mesozoic North American foreland basin, and 2) it possesses a colossal hydrocarbon storage capacity, manifest in a series of stratigraphic traps, the largest of which is the supergiant Pembina Field (Fig. 23.2) (Nielsen and Porter, 1984; Krause et al., 1987a, b).

 The Cardium produces light sweet crude(48 API). Additionally, the only water in the play is from some previous attempts at waterflooding, so, unlike some frac plays, there are no groundwater contamination issues. Due to previous exploitation, the Cardium has much processing and takeaway infrastructure already in place, which leaves more money available for drilling. Cardium wells are drilled to total vertical depths of 2000 meters plus 1000 meters of horizontal distance with ten oil-based fracs per hz well. The cost to drill and complete hz Cardium wells is approximately $3-3.2million per well. It appears that slickwater fracs may work just as well as oil-based fracs and could lower costs by $400K per well. Reserves per well are150-200Mboe. 

NAL, which has a dominant land position in the Garrington area, was one of the first to apply the multi-stage horizontal fracking to the Cardium . NAL has moved aggressively to grow their Cardium land holdings via acquisition, acquiring Alberta Clipper Energy, Spearpoint Energy, and Breaker Resources. NAL's Cardium profile includes 275 (179 net) horizontal Cardium opportunities across 150 gross (100 net) sections of land.  NAL is cashed up, having recently sold a $115million convert, leaving them with $234million in bank lines. Additionally, NAL has a strategic alliance with deep-pocketed Manulife, Canada's largest insurance company. Manulife typically takes a 40-50% stake in NAL's acquisitions. Moreover, the trust has approximately $550million of safe harbor (ability to grow pre-2011) and will continue to actively look at buying opportunities before the 2011 trust conversion deadline. NAL yields 7.9% on a conservative payout ratio of 58%.

 There are many other players in the Cardium, and many exceptional drill results are coming out almost daily. Vero Energy issued an update this week reporting a well at "West Pembina and flowed over 1,500 bbls/d of oil during the first 3 days recovering all completion fluids and over the past 2 days, the well has flowed at 650 bbls/day".  West Energy has shown great promise. Berens Energy was just bought out by PetroBakken at a 33% premium. Drilling in the Cardium is expected to rapidly escalate in 2011 and NAL is seen as the best "pure play" on the Cardium.

 NAL is expected to report latest results on Jan20th, and I believe this could be a catalyst for the stock. 

Additionally, while proving out the unbooked potential of the Cardium will be the primary driver of value in NAL, I believe there will be another overlooked source of value for NAL, and, indeed many of the Trusts. 

As any long term investor in the Canadian Trusts is painfully aware, the Trusts will be forced to convert to Corporations in 2011. Payouts will then be characterized as dividends and retained earnings taxed. This "Halloween Massacre" change in the law caused all the trusts to re-rate lower and caused most foreign (ie, US) investors to abandon the trusts. 

However, there are two dynamics which have the potential to alter the common perception of  post-2011 trust value. First, many trusts have huge tax loss pools which will shield them from paying taxes for many many years, meaning they can hold distributions constant.  NAL has $1.2B in tax pools and may have more with any 2010 acquisitions. They also generate them with ongoing drilling and exploration expenses. But a larger dynamic, for Canadian investors, is that the trust payouts are considered interest payments for tax purposes and are thus 100% taxable. Dividend payouts are given better tax treatment and are worth about 40% more in a Canadian taxable account. Thus, for a trust with a sustainable low-payout-ratio, large tax pools, and a growing reserve base, the value to a Canadian investor should increase as should the stock price. As more and more investors, stung by commons stock volatility, seek yield vehicles outside of tax-deferred accounts, I think companies like NAL will benefit.



Short term: Jan 20th Investor update

Long term: Recognition of dividend maintenance and increased after-tax value of the dividend

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