Executive Q&A with Katana: Oil, Junior E&Ps, Western Canada and Private Equity

Ross Stewart Campbell (RSC) from The Oil Council: Jess, many thanks for joining us to share your thoughts on today’s markets. Some of our readers might not be familiar with Katana; can you quickly introduce your company and the investments in your portfolio?

Jess Larsen (JH) from Katana: Thanks Ross, Katana is a Calgary based Private Equity Firm. We invest growth capital into junior oil and gas and renewable energy developers. We typically target what we believe are more reliable returns; limited- exploration risk for oil opportunities and non-technology risk for renewables projects. Our other soap box is low-cost production like our high net-back Bakken play in Manitoba that provides our limited partners with ongoing disbursement checks.

RSC: Looking first at the small-cap (junior) oil and gas sector Jess, what is the role of juniors in today’s oil and gas landscape? And how significant a role will they play in determining the future success of the industry as a whole?

JL: Juniors will be responsible for enabling the progression of our industry. Many young engineers at large firms seem too concerned about protecting their bonuses to be willing to really push the envelope or scrounge for every last drop of oil/gas in a property/field. In contrast we often see the best talent leaving those firms to start junior companies, where going the extra mile can not only make them millions personally but also very strong rates of returns for their investors. This form of reward usually seems to win when compared to the modestly bigger bonus
Juniors will always have a significant role to play because they are statistically so much better at finding and proving up new reserve additions than larger producers. For stock prices these larger producers need to replace the oil they pump each year and when they fall short of finding enough reserves the answer is simply to buy up some juniors and top up their [possible] growth reserves.

RSC: Many believe in the potential and strong upside of the junior sector but conversely many also believe that the sector is too risky to be involved in. With this in mind would you say Katana has a greater appetite for risk in your investments, or, that in fact you’re geared up for greater growth potential and higher returns on investment?

JL: Listen, there?s no getting around the fact that many CEOs in this end of the business are total gamblers who want to make their next big bet with your money. Without the right team to verify stories and top-shelf technical talent to confirm reservoir characteristics, it can be very hard to tell the difference between the gamblers and the really great and reliable management teams. That said, so many of the truly great management teams are just not willing to settle for a few hundred thousand a year, riding a desk, when their own track record has proven they can consistently create millions for themselves and others by simply running their own junior company. At Katana we spend a lot of time sorting through the chaff until we find these guys, and it works for us.

RSC: What size of return(s) are Katana typically looking to make from an investment and do you have a standard investment period before executing an exit strategy?

JL: It takes a lot of deal sourcing to find them but between cash flow and sale price we typically want to see a project have a 4x–7x upside over maybe five years or so. With these kinds of goals you can see why we favour low-cost production, such as oil wells that only have $20/bbl in costs instead of some of the giant projects that only have $20/bbl of profit.

RSC: In today’s small-cap companies what qualities and characteristics are you looking for in a future investment? How do you separate the wheat from the chaff? Is management the defining key? And what attracts Katana more: an exploration focus, a development focus, a production focus, or a mixture of assets/plays?

JL: We want experienced developers Ross. Teams that know who is doing what in their area of operation(s) and how they can acquire and improve undervalued assets. Our favourites are management teams that can show they have done this before and that have created an entire new opportunity to do it again. We want to fund a team which has all the details worked out and the last thing they need is the money, those are stories that get our attention.

RSC: Turning the tables somewhat now, with your niche in the marketplace Jess what are companies who approach Katana typically looking for? Is it merely a ‘capital pit-stop’, or, are they looking for management expertise, technical ability, increased operating capacity, or perhaps a new network of future investors?

JL: Mostly it?s just the money until they find out what kind of active partners we are. Once they realize that we?re not “bleacher” type investors and that we?re willing to get into it up to our elbows with them they start to view us more like a real business partner, not “just the investors”. This includes being willing to help source third party capital for JVs, or contribute our technical and legal teams at no cost to them in order to preserve capital for oil producing capex costs.

RSC: Due diligence is key in any transaction Jess. Do juniors make any typical (and therefore avoidable) mistakes when looking to attract and secure private equity partners?

JL: Ross this is something that the industry could use some work on. Many teams disqualify themselves early on by not being committed enough to risk their own dollars and pay for a solid third-party evaluation of their opportunity. Capital sources like Katana are typically looking for something that will be reliably profitable. The oil business has profit, the first breakdown comes in how reliably that management team can execute their plan and come up with the results they are promising. Juniors should put their money where their mouth is and invest more personal capital; proving reliability with third-party reserves verification and recruiting more team members and advisors until they know they have a top 10 sector team. This type of reliability attracts investment. We want to see 100% commitment, unshakable confidence and third-party verification.

RSC: What role should a private equity company ideally play in a management and direction of a small-cap oil and gas company?

JL: We think private equity should be the jet fuel in the small-cap vehicle; more money, more connections, more senior-level strategy.

RSC: When we spoke with Chris McLean [Stonechair Capital] earlier this year we discussed the need for some oil and gas companies to look more internationally for investment and partners as some were perhaps guilty of focussing their efforts too much on local and regional sources of capital/service. Are some companies in Western Canada – where a lot of your investments are based – doing enough to reach out to the international capital community and make themselves known?

JL: Unfortunately not. We have recently started The Energy Entrepreneur (TheEnergyEntrepreneur.com) to be used as a tool for making that connection, but it takes real effort if someone wants results. Many claim their dream is more important to them than anything else but then aren?t willing to pay the price to secure international contacts/expertise and find those experts to ask how it all works. One way would be to go to your New York Assembly this fall where you can meet these kinds of international investors and financiers. These energy capital conferences are a great meeting point to hear real-life stories from veterans and meet advisors [like Managing Directors of large investment banks, consultants, brokers and law firms] who already know people at the capital sources that a junior would want to get introduced to.

RSC: How underexploited is Western Canada is terms of small (but economically viable) oil and gas fields? Would you advise international E&P companies to look more seriously at the region for new E&P plays rather than more exotic E&P opportunities in Africa and Latin America?

JL: There are positives and negatives about everywhere but the positives in Western Canada are quite enviable: access to skilled labour and service companies support, possibly the best public reservoir data of any country in the world, healthy Canadian banking system for sourcing debt and economic stability, a well developed regulatory a environment, and security are all favourites of ours.

RSC: What’s your outlook for the future of oil and gas focussed private equity in 2010/2011? Are we going to see a new wave of investment and the resurgence of their involvement and influence in the industry?

JL: With the prospects of higher prices coming, many more players are already coming to the table. We have had unsolicited calls from large „household name? financial institutions looking to start new fund of funds to get into the profits of this business. A lot of people now realise that even though the recession has [we believe] been and gone, our world is out of cheap and easy oil.

RSC: With the risk of perhaps revisiting previous ground I’d like to ask your opinion on one last topic: entrepreneurism in the oil and gas industry. Are we, as an industry, doing enough to foster – and even champion – entrepreneurs? Are there ways we can look to reward entrepreneurism more?

JL: My personal opinion is that not enough is done for entrepreneurs. They?re the reason we have progress and adaptation and they deserve all the help they can get. On the community citizen side, we hope to inspire some of our peers to copy us by starting The Energy Entrepreneur.com, but there are many more things the rest of us can do; such as run free seminars to give entrepreneurs access to known experts and successful mentors, and have lunch with local politicians to lobby on their behalf. On the business side these individuals are the „soon to be rich?, they?re worth investing in by key service providers (financial, legal, etc) so that they can learn to make the money needed to build new businesses and perhaps in turn hire you later in your career.

RSC: I’ll wrap up Jess by asking your one-word opinion on the future of the following. Bullish, Bearish or Uncertain? The Canadian Economy

JL: Bullish

RSC: Stephen Harper

JL: Uncertain

RSC: Oil over $100 before the end of 2010

JL: Uncertain

RSC: The TSX-V

JL: Bullish

RSC: Oilsands

JL: Bullish

RSC: Thanks for your time Jess.

Katana provides growth and development capital to renewable and traditional energy producers and projects. His career in the energy industry began by building oil and gas pipelines and has progressed beyond the petroleum industry into the hydro electric and other clean energy production companies. His finance background stems from his time in Mergers & Acquisitions with Citigroup and subsequent services provided for Energy Private Equity Groups and Family Offices. For more information on Katana please visit: www.katanaoil.com