An Unconventional Energy Player in the Driver’s Seat

Our energy bets are bruised and battered, and it’s easy to see why.

By Michael Brush
Exclusively for InvestorIdeas.com
January 11, 2006

Investors had big bet on energy stocks, but now that crude oil has fallen 9% this year and 30% since last summer, hedge funds are heading for the exits.

Is there any end in sight?

It may be just around the corner. The eerily warm weather in much of the U.S. is about to "turn on a dime," predicts AccuWeather.com forecaster Joe Bastardi.

"Those who think that this winter is going to remain mild are in for a shock," he says. "A week from now, we'll start seeing truly cold air across much of the country, and we expect this change to last.” By the end of the month, people in the Northeast will be shoveling out their driveways, and today’s mild weather “will be a distant memory," he says.

I wouldn’t be surprised. A sharp reversal in the second half of winter can be common when an El Nino pattern causes unusually warm weather in the first half – the case right now.

The arrival of cold winter weather to the environs of a good portion of the world’s energy traders in New York will likely reverse the negative psychology towards the sector – and put a bid under our energy stocks.

Besides a change in the weather, these factors should support higher energy prices:

Strong global growth and demand from countries like China and India.
Tensions in the Middle East -- which have moved off the front pages but haven’t gone away.
Underlying shortages of natural gas in Northern America where prices are higher compared to a few years back because all the easy reserves have been exploited.
We’ve even seen a little insider buying in this pullback. Insiders recently bought at Weatherford International Ltd. (WFT) click here). Aubrey McClendon and other top execs at Chesapeake Energy (CHK) were recently buying (click here). There were also buyers in late December at Abraxas Petroleum (ABP) (click here).

Panhandle Royalty

Here’s another energy stock where a savvy director recently stepped up to buy: Panhandle Royalty (PHX). This is a micro-cap natural gas company with solid holdings in two of the hottest natural gas plays around: the Fayetteville Shale in Arkansas and the Woodford Shale in Oklahoma.

The buyer was Robert Robotti, a money manager at Robotti & Company Advisors. Specializing in small-cap names, his firm has beaten the market consistently over years. On January 8, Robotti bought $291,000 worth of Panhandle Royalty stock. That took his position up to 576,000 shares, according to Insiderscore.com, or 6.8% of the company’s shares outstanding.

Cooperative beginnings

While most energy companies have to lease land, take on most of the investment risk and giving up a big part of the profits as well, Panhandle Royalty is on the other side of this equation.

It owns big swaths of energy-rich land in Oklahoma, New Mexico, Texas and some other states, thanks in part to its humble origins as an energy cooperative eight decades ago.

The company was founded in the Oklahoma Panhandle in 1926 as the Panhandle Cooperative Royalty Company. For years it functioned as a co-op based on a simple principle. Any single individual in that area at the time might own land with rich energy reserves. But it wasn’t a sure thing. Given the uncertainty, wouldn’t it be better for lots of landholders to pool their land and then share equally in any finds?

A lot of people thought so, and the co-op was born. It converted into a company in 1979, and it still holds 260,000 acres in energy-rich regions.

It holds “unconventional resource plays,” meaning the energy is tougher to get out. It’s usually done through horizontal wells. But a little math – and speculation – shows the potentially huge amount of energy Panhandle Royalty controls in these unconventional plays, which now get a lot more attention because natural gas prices have gone up so much.

Fayetteville and Woodford

Let’s take Panhandle Royalty’s 9,000 acres in the Fayetteville Shale in Arkansas first. Panhandle Royalty has leased out the land for a $2 million fee and an 18.75% royalty. It will also take a “working interest” in some wells that will cost some capital and yield a 5% or so revenue share.

But here’s the key question: How much natural gas lies beneath Panhandle Royalty’s land? One way to guess is to look at what other energy companies are finding. Southwestern Energy (SWN) and other players there are reporting two to three billion cubic feet of gas (BCF) per well.

Panhandle Royalty’s 9,000 acres could have about 80 wells, or 160 BCF of gas. If that’s right, Panhandle Royalty’s 18.75% share would work out to about 30 BCF of natural gas. That’s nearly double its current 34 BCF of proven reserves.

The potential for Panhandle Royalty’s 10,000 acres in the Woodford Shale in Oklahoma is even greater. Based on production numbers from Newfield Exploration (NFX) – and assuming Panhandle Royalty’s holdings are equally productive – Panhandle could have 240 BCF worth of gas. That’s seven times its proven reserves of 34 BCF.

“The opportunities are dramatic, given the company’s small size,” says Robotti. That would explain why Robotti recently took his already-large position in this company up another notch, at around $18 a share.

Panhandle Royalty also has 2,600 acres in the Woodford Shale in West Texas, and 7,300 acres in Wolfcamp in Chaves County, New Mexico.

The bottom line: It will take years to prove out the above scenarios, and they are no certain bet. But if they work out this stock could go up dramatically. Anyone buying Panhandle Royalty in this recent pullback should be willing to wait several years for that to happen.

Disclaimer
At the time of publication, Michael Brush had long exposure to Weatherford International, Southwest Energy, and Chesapeake Energy. 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/. InvestorI deas.com Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp . InvestorIdeas is not affiliated or compensated by the companies mentioned in this article.