Encore Oil Presentation: Update And Analysis

21st May '10 by marben100

39 comments 15403 reads

Introduction

Encore Oil (LON:EO.) is a UK North Sea focussed E&P company. After a successful discovery and disposal of the Breagh field, it is cash rich and now seeks to appraise and monetise its remaining assets before returning value to its investors.

Encore recently held a meeting for private investors. I applaud the company for arranging this and thank Alan Booth, Encore’s CEO, and Yvonne Fraser for their time and effort. The presentation given to PIs has been published on Encore’s website and I refer to slides from the presentation in my commentary below.

Executive Summary

The detailed discussion & analysis which follows will show that Encore at its current share price below 17p represents an attractive risk/reward for the investor. The “Analysis” section below shows that a “worst case” scenario leads to a return of at least 15p of value to the investor (i.e. downside of 2p on a two-year view), with possible additional upside of 30p+.

Some investors may have formed a negative impression from the presentation given by Encore, simply because there IS considerable uncertainty about the direction the company will take, which depends on near-term drilling results. Alan Booth was also at pains to stress the difficult environment that North Sea operators face at present. However, these negative factors do not negate the excellent risk/reward that I believe Encore offers and that risk/reward fully accounts for them.

In the sections that follow I explain:

My understanding of the purpose of the meeting
The dilemma Encore faces in putting its case across to investors
My understanding of Encore’s strategy
The impact of current North Sea market conditions on Encore’s strategy
Details of how I believe Encore will proceed
Implementation of Encore’s share buyback programme
Encore’s track record and that of its management
An analysis & valuation of the company

Purpose of the Meeting

Encore has had to adapt its strategy to meet changing market circumstances, as I shall explain below. This has caused some confusion amongst investors. The purpose of the meeting was to highlight for investors how the market environment was impacting Encore’s decision making and likely outcomes.

Encore’s Dilemma

It is difficult for Encore to explain its situation to investors without disclosing market sensitive information or generating expectations that may not be met. I felt that Alan Booth was scrupulous in not doing so and also in not speculating in…

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About the Author

Marben100

Premium Member

I am a full-time private investor... with a little trading on the side (generally small-scale arbitrage in specialist niches). Previously, I spent 24 years in the IT industry, 13 of those running my own IT services firm. I invested as a "hobby" for 20 years before turning it into a full-time occupation in 2004. I really enjoy the "research" side of investing, finding out about varied businesses and industries and learning what makes them tick. Since going "full-time" I have learnt an awful lot from some very erudite investors & professionals who are kind enough to share their expertise in electronc forums such as this. I can now count a number of them as my friends, having had the opportunity to meet them in the real world, as well as this virtual one! I try to pay back the debt I owe by sharing what I've learnt and I always value constructive criticism to correct my errors and misapprehensions! I am a Director of ShareSoc, the UK organisation for individual shareholders. See below for details. more »

39 comments

marben100

5th Jun '10

Sorry davjo, but there are some factual inaccuracies in your post.

Firstly, I did not buy the day before the annoucement. My last purchase (which was only a modest addition to my overall holding) was on 25th May.

Secondly, in my book, a "speculative trade" is one that carries considerable risk. The whole point of my original article is that my assessment of the risk was that it was pretty small, on a two year+ view (not a short-term view), due to the cash tangible asset backing and my view that management could be trusted to ultimately return that cash to shareholders - or to use it prudently to generate greater returns. Also in my book, an explo or production licence is a much riskier asset than cash, because it depends on guesses (albeit informed ones ;0)) about what future costs will be, how the field will perform in the fullness of time, what the future oil price will be, taxation of oil revenues etc etc.

Hence, in my book Encore, at its current price, now carries MORE not less risk that it did before - especially in current markets - which appear quite capable of assigning silly values to assets, and especially as the DST has not yet been carried out.

Yes, if Catcher had been a duster I would have held - and if the SP had reacted badly and fallen below 15p I'd have added... because I'd be very confident that my 15p was safe (again, on a two year+ view) and, most important, Catcher was thought to be the hors d'oeuvre to the main course of Cladhan - which I still hope to be the case, but that IS speculative.

Investment Philosophy

I recently read a highly recced post on TMF seeming to suggest that investment was largely a matter of luck, that there was little point putting effort into investment analysis and that one should adopt an approach assuming "I know nothing". I don't know whether the post was intended to be tongue in cheek (I suspect it was) - though most respondents seemed to take it seriously. That post is entertaining & thought provoking nonsense.... but contains a grain of truth.

That grain of truth is that luck DOES play a part in investing and that my experience tells me that investing is not a black and white, cut and dried matter. Rather it is all about probabilities, expectation values... and capital preservation. [as well as many other things, like good information, solid research and quality company managements ;0)]

Encore as an Illustration

Now let's consider Encore as an example of this phiosophy at work. Let's suppose my overall portfolio is £100,000 and let's suppose I'd decided to invest 15% in Encore, prior to the Catcher result @ 17p. My maximum likely risk on a two year view is 2p x 88235 shares = £1,765 (1.7% of my notional porty)... and the maximum reward (if Catcher & Cladhan came off) is... very large ;0) [I put it at 30p+ per share in my article = £26.5K gain. As I pointed out, that is a very attractive risk/reward.

Now consider where we are now - well, the prospects for reward are certainly better, and my 88235 shares are now worth £24.7K @ 28p each out of my total portfolio which now stands at £109.7K = 22.5%. If one has any concerns about capital preservation, that is too much to have invested in any single equity, IMO. That alone is a reason to topslice. Naturally, that's an issue that will depend on each investor's personal circumstances - e.g. if you have substantial assets outside your equity portfolio and/or are a long way from retirement, you might be prepared to take bigger risks.

How does the risk/reward stand now, however? Well, the potential reward certainly looks better: Catcher looks extremely promising and the sidetracks may show it to be larger than the upper end 50mmbbls assigned to the currently drilled portion of the reservoir. We still have the "main course" of Cladhan to come, in the near future. Maybe 40p+ from here - but, as previously, that IS a speculative figure, most certainly NOT a nailed on certainty.

Risk

Well we've looked at the sparkling rewards, which are clearly attracting you, but how about the other side of the equation, the risks? We still have the cash & Egdon tangible asset backing (but cash will be a little lower after the cost of sidetracking, which may or may not be successful). So 15p-ish still remains "nailed on". Clearly Cladhan may or may not come good (more on that in a moment). Doesn't Catcher "guarantee" the current SP? No, it most certainly does not. As I pointed out originally, there are many factors that can go wrong and there is absolutely no guarantee it is worth 10p-ish. Yes, there appears to be a strong likelihood that it will ultimately yield at least that much but no guarantee whatsoever.

In a "worst case scenario" it is conceivable (but highly unlikely) that it is worth nothing. Being more realistic, 4p would represent a pretty bad outcome. So, it is hard to imagine that Encore shares, on a two year plus view, could be worth less than 19p now. So how much of my capital am I risking, if I didn't sell? Instead of £1,765, at the current share price, I am now risking 9p x 88235 = £7,941 or 7% of my entire, improved, portfolio - a much larger figure.

Cladhan and Mr Market

The market's assessment of Cladhan provides a further illustration of why it is sensible to moderate risk and preserve capital/cash to take advantage of opportunities. Up until the Catcher discovery, Mr Market appeared to be giving Cladhan very little value - maybe 1-2p per share at best. Yet Cladhan was already a good light oil discovery. It has every chance of being larger than Catcher. A lower bound had been put on the reservoir but due to the lack of oil-water contact, there is (almost) no upper bound!

Well if Mr Market can be that daft about a discovery with excellent prospects, who knows what he may do when the initial excitement about Catcher wears off? He may give me the opportunity to buy some of the shares I sold back at a price where my downside risk is much lower. ;0) [but I'm not counting on it]

How I Got Here

What led me to this investment approach? Simply that I have invested in a lot of "dead certs" in my time. Some of them have generated great returns but some have turned out not to be as certain as I had believed. I will freely admit that I am not as expert an oil investor as you. That's where SteveClarke's philospohy, as expounded in Beans' post DOES come in. It is easy to be lulled into the trap of thinking that you know more than you actually do (no matter how expert you are). "Black Swans" DO happen more often than most think. I am now cautious and try to balance my risks.

This philosophy has served me very well, especially during the the recent market turmoil, by ensuring that I spread my risk amongst quite a number of promising investments. I am pleased to say that I remain 8% up this year in my main SIPP portfolio, despite the FTSE all-share being 5% down - with Encore making a healthy contribution to that gain (as well as Ceres Power Hldgs (LON:CWR) , LO-Q (LON:LOQ) and Medusa Mining (LON:MML) amongst others). A significant part of that gain has been due to taking advantage of market volatility, buying when I believe stocks have become cheap and selling when either they are not, or they have grown to become too large a proportion of my porty.

Thank you Mr Booth and the team at Encore.

Regards,

Mark

nigelpm

6th Jun '10

Great post Mark!

The fascinating thing for me about Encore is that at 15p it really was as good as it gets in equity investing in that downside risk (barring director fraud) was pretty much zero. And this isn't hindsight - it was posted quite clearly at the time.

but not many were that interested, even people who frequent these boards who I'd argue are in the upper echelons of private investors. Why was that?

The risk has risen hugely as you assert above but BB posters (check ADVFN) and other commentators are all over it - a strange psychology and indicative of a clearly quite irrational market that favours reward dramatically over capital preservation.

These situations don't come around often but I'll be doing my damnedest to seek them out! ;-)

flyingbull

7th Jun '10

but not many were that interested [nigelpm]
There were 4 people out of c.40 who nominated Encore to win the June >20% Up Competition. That is 10% of the entries. Extrapolating this 10% into wider oil stock investment community, then I'd suspect there were quite a lot of private investors who were punting Encore to be successful on Catcher...but may not be too vocal about it....due to disappointment of gas storage in the past.

In many ways, I agree with both Dave and Mark, if that is possible! :-) It would be interesting to see how the share price moves over the next few days. "Take profit (some at least)" win or "top up" win??? Most likely, a "hold" win??? I have no idea how the share price is going to pan out this week. Nonetheless, it'd be interested to watch.

fb

repobear

7th Jun '10

Hi fb,

I took some money off the Encore table because the risks of the price going down from 28p a fair bit, are a lot more than when the shares were 16p.

If you read back on ADVFN it won't take long to conclude that the slightest disappointment with Catcher and the price will be hit very hard. There have been months of calling AB all the names under the sun, when to my mind he has steered a pretty good path, both before and after the huge gas storage disappointment. Cladhan was hardly ever mentioned and now people can't stop talking about it. The potential for Catcher is being trumpeted in every post etc etc. It reminds me of some of the weak football teams I played in when there was a surge of optimism after we scored a goal, but all too often this was quickly blown away and the team got beat as usual..

I wouldn't be surprised to see EO. sink a little over the days until the test results are announced. Things look a lot more positive on Catcher, but other than that nothing has changed. The upside from here looks good if things go well but if the Catcher tests disappoint, and they might yet, than the buy back may not yet be over.

My holding is still pretty substantial and its fingers crossed.

repobear

emptyend

7th Jun '10

not many were that interested, even people who frequent these boards who I'd argue are in the upper echelons of private investors. Why was that?

If you mean to include me in this, you may have noticed that I have been much more restrained than previously when commenting on peer companies (and partners) in general. This doesn't necessarily indicate a lack of interest - though, from a private investor standpoint, the fact that EO is AIM listed has always been a negative for me (due to ISA eligibility).

I'd also observe that there have been plenty of other situations where limited downside in theory (due to cash or whatever) hasn't proved to be the same as limited downside in practice.

rgds

flyingbull

7th Jun '10

Hi RP,

There have been months of calling AB all the names under the sun....

That sounds funny to me. Unfortunately/fortunately I have not been paying any attention to Advfn for a long time; so I guess I have missed out on the fun! :-)

fb

repobear

7th Jun '10

I'd also observe that there have been plenty of other situations where limited downside in theory (due to cash or whatever) hasn't proved to be the same as limited downside in practice.

Hi ee,

Encore was in my mind far less likely to be affected by this for the following reasons.

i) the buy back programme;

ii) a clear well financed near term drilling plan to realise the value of most of the assets;

iii)the focussed nature of the assets; and

iv) the track record of AB and his team, in finding oil and gas, and monetising these assets, in the region where they are currently drilling.

The value of Encore, always looked like it would be a large proportion of the cash, plus whatever value was realised from drilling the assets. Those companies operating in various regions, with less focus on high impact potential drilling, and higher management costs/company value and less of a track record, are unlikely to be treated equally by the market. This treatment will include some cynicism of where that cash pile is heading for in the fullness of time and whether wells will ever get drilled without further cash calls/dilution of existing investors.

repobear

marben100

7th Jun '10

Just one small point to note. Whilst it is certaintly true to say there is nothing to stop a company trading below cash and, indeed Encore has done so on occassion, it is important to distinguish between companies that have indicated that they intend to conserve their cash and return it to investors in due course vs companies that intend to use their cash in higher risk explo ventures. Encore was free carried on Catcher (but won't be for the sidetracks) and does not expect to have to spend more than £2m on Cladhan., if unsuccessful.

I have always made it clear that Encore's risk appeared low, on a 2 year+ view. I do not equate risk with volatility (which academics and economists do) but with the likelihood of an ultimate loss of capital. In addition, Encore afforded the protection of having the buyback programme in place, which should have prevented the price crashing too far, outside closed periods.

In investing and trading in Encore (I did and will do both), I never attempted to make predictions about what the market might do on a short-term basis but simply added to my holding when the stock appeared cheap and sold when the element of risk increased. A simply strategy which generated some nice profits along the way, before the big gain in the core investment + trading positions when the Catcher result came in.

Of course that big gain hammered home a point you have often made, ee. Rather than trying to be too cute it can be dangerous to be out of a stock that you hope/expect to make big gains at some point. You can never be sure exactly when and how suddenly those gains can come. No chart could have predicted an 80% gain within hours after months of trading in a pretty narrow range.

Best,

Mark

emptyend

7th Jun '10

Of course that big gain hammered home a point you have often made, ee. Rather than trying to be too cute it can be dangerous to be out of a stock that you hope/expect to make big gains at some point. You can never be sure exactly when and how suddenly those gains can come. No chart could have predicted an 80% gain within hours after months of trading in a pretty narrow range.

True - not the first time this has happened in recent months/weeks either....though I'm still waiting for it in the stocks I own ;-/

GBP, for example, currently trades at about 80% of net cash - though of course there is no buy-back programme there (other than the ad-hoc one being operated by the CEO ;-))..... and no clear prospect of near-term drilling either.

johnnylite

7th Jun '10

On the risk side of the risk / reward equation, i have a question about what happens now with regard to the immediate risks... we are currently doing the DST but what are the possible results of this? Obviously a stonking flow rate would be fine but what are the chances of a poor result? Assuming no technical problems (eg SIA gumming up) then what is the likelihood of a decent flow given what we know now? Is this another 90% chance like the Esmond GS drill? If so then let's hope lightning does not strike twice!

Assuming this is successful, does the success with this well de-risk the Eastern part of the structure too? Would 50% COS be unreasonable for the side-track?

Looking further ahead, can anyone interpret anything from the Seismic squiggles in the last presentation to hazard a guess on how many other prospects are in the rest of the block(s)?

Thanks for any help.

JL

repobear

7th Jun '10

Hi JL,

This might help.

http://www.hydrocarbonassets.com/pdf.php?id=85&PHPSESSID=ea3e7c8c8bbe3dd5756626ecc73049ff

Thanks to bobby2 on ADvFN.

Presumably the higher recovery rate for lighter oil means greater potential across the block. If Catcher East comes in then the 200mbl figure will be substantially raised again, it being in a different source rock. Whether it's a 50% chance I'd doubt but I've seen 31CoS quoted for the original Catcher well on 11-31mbo. The latter is now 25-50mbo.

The original STOIP figures quoted here were 76m for Catcher and 474m across the whole block. Given the length of the column, these figures should now be higher, perhaps much higher.

repobear

davjo

7th Jun '10

G'day Mark

Just coming back to this briefly. I wasn’t criticising your trade, which was obviously an excellent one, just querying the logic behind what you describe as a strategic sale of a purchase made days beforehand...possibly what fb alluded to when he agreed with both standpoints ;-)

For me, I'm not working as hard as you trying to make day to day profits. I'm in for the longer term, backing my assessment of the assets/management and looking to them to time my exit for me. That's always been my prime objective apart from occasional short term speculative trades, of the sort I thought I'd recognised you had made!

REO100

3rd Jul '10

Just a quick note on Cladhan, Sterling Resources the operator have indicated the rig J.W. McLean should be available mid-July for drilling. I asked if they could indicate on potential size - analyst estimates for original oil in place range from a low of 100 to a high of 300 million barrels - hope that might help, I think it will add to current sentiment, whichever metrics are used for valuation, EO.'s share 16.6%. Back to the football !

Reo

repobear

4th Jul '10

A bit more 'hype' and some interesting background, courtesy of ADVFN posters

http://business.scotsman.com/business/The-discovery-of-significant-new.6399198.jp

http://www.heraldscotland.com/business/corporate-sme/the-big-boys-don-t-do-oil-exploration-any-more-they-hold-us-to-ransom-with-their-infrastructure-1.1039044

It's even reached the Sun, so the 'hype' must be hype;-)

http://www.thesun.co.uk/sol/homepage/news/money/city/244711/Sun-City-Market-report-All-the-latest-business-news.html

The thread on Advfn is decent and one poster in particular is worth a read. Like from here

http://www.advfn.com/cmn/fbb/thread.php3?id=11488916&from=28869

More detail here

http://www.hydrocarbonassets.com/pdf.php?id=85&PHPSESSID=ea3e7c8c8bbe3dd5756626ecc73049ff

and Marben's presentation link

http://www.encoreoil.co.uk/assets_cm/files/PDF/encore_oil_presentation_for_iod_hub_22_april_2010.pdf

I can't understand why Encore receives far less attention than Aminex, here and on TMF. Maybe after looking through some of the above one of the more knowleable people here might care to explain.

repobear

doverbeach

4th Jul '10

Nice colour from the Herald link. Alan Booth was on holiday in Padstow last weeK;

“I jumped on the next flight back,” says Booth, 52. “I was back in town in a couple of hours. We all went down to the pub, basically"

haiderali

4th Jul '10

I can't understand why Encore receives far less attention than Aminex, here and on TMF. Maybe after looking through some of the above one of the more knowleable people here might care to explain.

Could it be that the GS was an unorthodox play on O&G and reading the Herald article it becomes clearer just how surprising the Catcher result has been?

I know the value of meeting management can be double-edged, but in the case of EO., the demeanour, style and the information that Alan Booth provides really does inspire trust and confidence.

I remember at the EGM, him being quite explicit that Catcher/Cladhan etc. could all be total failures.

marben100

4th Jul '10

Is the hype starting to go OTT, or were some of the earlier estimates (esp Premier's) too conservative? From the Herald article:

A second exploration in an adjacent slot to the east proved that the well was three times bigger than originally thought. This means that Catcher contains at least 150 million barrels of recoverable oil, with the potential for double or triple depending on subsequent drilling.

And:

Having seen EnCore’s share price leap 47% on last week’s announcement, the next question for Booth is how far the deposits stretch. This will not be clear until other holes are drilled over the coming months, but some analysts are forecasting 800 million barrels in place (meaning 400 million recoverable).

If even 150mmbbls is realistic (22.5mmbbls WI to Encore), then it looks I was premature slicing a few more towards the close of business of Friday. Never mind, Encore is already proving one of my most profitable investments ever, second only to Extract. Mind you, that's largely due to my original investment in Encore being considerably larger than that in Extract, due to my relative risk perception.

Cheers,

Mark

repobear

4th Jul '10

Mark,

The source for all the press info seems to be AB himself. If you think he's likely to hype it up then you have your answer.

In interviews PMO have confirmed that they don't argue with the 300mbbl oil in place estimate.This has been seen as an interesting change of stance so soon after a RNS, by someone closer to the action than me;-)

After the DNX developments, PMO may come into someone's sights a bit quicker than they might have liked. Playing down Catcher, and the rest of the block, in the hope of buying an aditional slice or two, and operatorship, might turn about to be a risky strategy if Dana gets snapped up at around 17.50. If some buyers are looking at production growth PMO will look very attractive once Dana has gone. Assuming the deal doesn't blow up soonish because the Koreans are being cheapskates again and bid below 15 quid.

It will be interesting to see if PMO are a bit more upbeat if the good news which the house broker expects in the next few days comes through.

http://boards.fool.co.uk/Message.asp?mid=11969715

I bought back my top slice after the original announcement on a dip a few days later. It maybe not too late to change your mind too;-) It's nearly doubled since I did and I am glad I had the nous to tell myself I got it wrong, change my mind and pay an extra couple of pence a share. It's an acid test for me as an investor and one I fail too often.

Nice thread.Thanks.

repobear

marben100

4th Jul '10

Thanks repo. Nope, like you I don't think AB is hype-prone (rather the reverse), so if the article reflects his view, then I do suspect PMO were playing things down for their own purposes.

Just in relative terms though, what does make me cautious is comparing Encore's market cap with Dana's. At 58p, Encore's market cap is ~£168m vs ~£1,260m for Dana at 1400p, i.e. Dana is valued at 7.5x Encore... but Dana produces ~40mboepd and has reserves closer to 10x those expected for Encore's WI in Catcher (admittedly, some of that is gas though).

Of course if Catcher does turn out to be 400mmbbls recoverable or Cladhan turns out to be as good as it might be, then Encore's current price will look very attractive - but that's speculative. OTOH, maybe it's just that Dana's cheap @ the currenr price. ;0)

Never mind, even after all the topslicing/profit taking my holding in Encore remains larger than that in Dana or Soco and all remain meaningful relative to my porty. Good to replenish my cash a bit after running it down to scoop up some bargains elsewhere (Polo Resources Ltd (LON:POL) , Medusa Mining (LON:MML) & Caledon Resources Plc (LON:CDN) mainly) in the latest market downleg.

Cheers,

Mark

doverbeach

4th Jul '10

In interviews PMO have confirmed that they don't argue with the 300mbbl oil in place estimate.

This is confirmed by wht PMO's Exploration Director said to me. Something like "I think we have been more conservative than Encore in our RNS but I am not trying to distance myself from the Encore figures."

I do however wonder if the next week may not be great for the shareprices of the three companies, as people seem to be expecting major news from the current drilling. Whereas it is not intended to add more resrves, just give more information about reservoir structure to aid development planning.

Encore Oil Presentation: Update and Analysis

Introduction

Executive Summary

Purpose of the Meeting

Encore’s Dilemma

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About the Author

Marben100

39 comments

Investment Philosophy

Encore as an Illustration

Risk

Cladhan and Mr Market

How I Got Here

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