Terra Energy – Unlocking Value from an Asset Rich Junior

The following guest post is by Peter Norris, a fellow investor in the oil and gas sector who presents a high risk/high reward investment idea.

Terra Energy TT.TO 0.335 [-0.005] is a Western Canadian Oil & Gas Exploration and Production Company which has entered into a strategic initiative to realize shareholder value. The Company is asset rich with undeveloped land of 400,000 acres in Alberta and British Columbia, 134,000 net acres of Montney lands in British Columbia.  Current production is 5,500 boe/d. Conservative estimates put the break-up value far above the Company’s current $130 million enterprise value, as concern over Terra’s debt load and the extremely negative natural gas pricing environment have undermined the share price.

TSX Symbol “TT”

• Shares Outstanding 101.7 MM
• Market Capitalization (@ $0.34/share) $34.6MM
• Net Debt $94.7 MM on a credit line of $94MM
• Enterprise Value (fd) $130 MM
• Operational
• Q1‐12 Average Daily Production (boe/d) 5,564
• Proved Plus Probable Reserves (mmboe) 33.9
• Q1‐12 Production Mix (oil/liquids/gas) 9%/8%/83%

Trading at a recent price of $0.34/share, a conservative sum of the parts estimate could see the Company liquidated at a value of $1.50 per share (see table at the end of the report). The June 2012 sale of Progress Energy (a Montney focused Canadian natural gas producer) to Petronas was done at a metric which would value Terra’s contingent natural gas resource in the Montney in excess of $500 million alone. The most significant risk is the inability of Terra management to execute a sufficient dollar amount of asset sales in the current negative macro & commodity price environment. Terra is  asset rich but current natural gas pricing has placed the Company in an untenable position of not producing enough cash flow to ensure it can remain a going concern. The Company is also facing land expiries in certain areas that make it paramount that deals be reached in order to harvest some value from these assets.

An impressive land base for a junior!

Value Catalysts

Currently, Terra is marketing 3 asset packages. All packages contain attractive assets & the process is very advanced. Unfortunately, the marketing of these assets comes at a time when natural gas prices have hit decade lows & access to capital to many in the energy space is limited. If management is unable to realize value in the next few months, Terra would make an excellent hostile takeover target (insiders only own 25% of the shares outstanding) for a strategic or financial buyer with the financial ability to develop these assets to their full potential.  As well, the corporation’s lenders have given Terra until August 31^st to make progress although this could very well be further extended:

In agreement with a syndicate of lenders, including Canadian Imperial Bank of Commerce and ATB Financial, Terra Energy Corp. will extend its current banking facility through to Aug. 31, 2012. The terms of the facility require that an annual review take place by June 29, 2012. The facility has been extended through to Aug. 31, 2012, to allow for the advancement of marketing processes that have been initiated by the company in relation to various packages of assets. Terra and its advisers continue to market three major asset packages actively, including certain of the company’s undeveloped lands in west-central Alberta and the company’s Alberta Peace River Arch assets. Proceeds from the sale of these asset packages will be used to reduce debt and strengthen the company’s balance sheet. In addition, efforts by the company are continuing in relation to the marketing of the company’s unconventional Montney assets, located in British Columbia, consisting of more than 130,000 net acres of Montney mineral rights, including the search for a potential joint venture partner or an outright sale.

1. British Columbia Montney Natural Gas

The most significant asset package is over 101,000 net acres of liquids rich natural gas in the heart of the British Columbia Montney play. Reserve evaluators have assigned net gas in place estimates of 11.9 trillion cubic feet (for perspective, all Canadian natural gas production per year is only 6.4 tcf). The last four Montney deals conducted in 2010 & 2011 have been transacted at an average acreage value of $24,300 per acre, due to interest from Asian buyers for West Coast LNG facilities (in my Montney valuation I use $500/acre despite Terra’s location amidst these transactions). Terra’s horizontal Montney well had one of the highest test rates at 13 million cubic feet per day.  Terra highlighted at the 2011 AGM that land value alone would exceed $300MM at a per acre valuation of $3,000. For further perspective, land acreage sales in other major North American NG resource plays have been as follows: Horn River (BC) $4,649; Marcellus (Pennsylvania) $6,318; Eagle Ford (Texas) $12,811 – source Macquarie Tristone/ Scotia Waterous. (See table at end of report).

http://www.macquarie.com/dafiles/Internet/mgl/com/macquarietristone/current-mandates/Terra-Energy-Corp-BC-Montney/terrabc_om.pdf

B.C. Montney – Scotia Waterous & Macquarie Capital Markets

• The Montney is one of the best unconventional gas plays in all of North America
• Land base is in the heart of the B.C. Montney Fairway and is a world class asset
• Over 130,000 net acres of Montney

2. Alberta Production & Undeveloped Land Package

Alberta Peace River Arch Package – AltaCorp Capital

• Production of approximately 1,000 boe/d (36% oil and liquids and 64% natural gas)
• P+P reserves of 3,854 mboe
• Before tax NPV 10% of P+P reserves of approximately $60 MM
• Over 83,000 net acres of undeveloped land

3. Alberta Undeveloped Land Package

The Duvernay land position in this package would be of most interest to potential buyers. Terra’s Duvernay falls within the “condensate & oil window” of the Duvernay. Duvernay land sale prices averaged $580/acre in 2011 and over $1.4 billion has been spent acquiring over 1 million acres in this play since 2009 (CIBC, Macquarie). To be conservative, I have valued all of this land at only $100/acre despite Terra owning rights to multiple zones in addition to the Duvernay.

Alberta Undeveloped Lands Package – Macquarie Capital Markets

• Approximately 219 net sections (140,000+ net acres)
• Approximately 84 net prospective sections (~53,000 net acres) of Duvernay rights
• Primary targets include: Duvernay, Montney and Beaverhill Lake to Dunvegan
• Non‐core and have no production or reserves attributed to them

http://www.macquarie.com/dafiles/Internet/mgl/com/macquarietristone/current-mandates/Terra-Energy-Corp/terra_om.pdf

Other Assets

Terra has not placed a substantial amount of undeveloped acreage or production into any marketing package at the current time. This includes additional undeveloped land in British Columbia and northern Alberta and the Company’s significant dry NG production, pipelines and facilities in the area surrounding Fort St. John B.C. As well, the Company has significant tax assets which would be attractive to a purchaser:

“At December 31, 2011, Terra Energy had estimated income tax deductions of approximately $239 million available to reduce future taxable income.“

Upside to Liquidation Approach

Terra has tremendous upside beyond that implied by this liquidation value model. Significant improvement in natural gas fundamentals combined with asset sales to reduce or eliminate financial risk would result in a major re-rating of this Company’s valuation. Using Montney deal metrics from 2010 & 2011 on land alone would value Terra’s concentrated land position in this area in excess of $2 billion. The June 28^th acquisition of Montney player Progress Energy by Petronas also highlights the potential value of Terra’s 11.9 Tcf net gas resource – Cormark (below) assigns valuation of $3.5 billion to the Progress Montney 25 tcf.

We believe a more relevant transaction metric is based on Progress’ contingent resource in the North Montney project, which we calculate at $0.14/Mcf. The breakdown of this calculation is as follows:

Progress’ current production capability of 50,000 BOE/d (current production of 45,000 BOE/d  plus 5,000 BOE/d shut-in) at a value of $40,000 per producing BOE equates to a value of $2.0 billion. The $5.5 billion deal value less the $2.0 billion assigned to the producing assets equates to a residual value of $3.5 billion assigned to the contingent resource that Petronas is inherently acquiring.

Adding together GLJ’s contingent resource assessment of 8 Tcf for the great Town area (22% of Progress’ North Montney lands), Petronas’ 15 Tcf contingent assessment of the JV lands at a 50% WI and approximately 10 Tcf on the remaining 78% of Progress’ non-JV Montney lands equates to a total contingent resource of 25 Tcf. Therefore, the contingent resource value of $3.5 billion for 25 Tcf of gas equates to a resource metric of $0.14/Mcf for the North Montney lands. 

This was a guest post by Peter Norris from Boeckh Investments.

Disclaimer: the information presented above is only for informative purposes. It is in no way an encouragement to buy or sell the aforementioned securities.

Disclosure: Both the Author & Boeckh Investments own shares of Terra Energy.

[Mich] I do NOT own shares in Terra Energy.

Do you think TT is a value trap, an outright sinking ship or an opportunity for a quick flip given the attractive Montney assets  for sale in BC?