Natural Gas Valuations Jump Up with Buyout - Who's Next?

Valuations in the Canadian gas patch took a BIG jump today as Pengrowth Energy Trust (PGF-TSX) bought out junior gas producer Monterey Explorations (MXL-TSX) for its Montney gas play in NorthEast British Columbia. Monterey's stock jumped 80%, up $3.46, to close at $7.74 on 6.3 million shares.

Pengrowth paid well over $200,000 per flowing barrel for a natural gas producer - when the average for junior producers is $55,000 – $70,000 per flowing barrel, according to Canaccord Genuity and BMO Nesbitt Burns recent data. Storm Exploration (SEO-TSX), one of the most respected teams and lowest cost gas producers on the TSX, sold for $69,000 per flowing barrel exactly one month ago.

Now, there were some mitigating reasons for this very high valuation - which I will explain briefly - but it has investors wondering - which junior gas producer is next? With premium buyouts that high, these previously moribund junior gas stocks could have some profit potential for investors this summer.

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There are several junior Montney gas players, including - in alphabetical order – Advantage Energy, Birchcliff Energy, Celtic Energy, Cequence Energy, Cinch Energy, Crew Energy, Crocotta Energy, Delphi Energy, Insignia Energy, Orleans Energy, Painted Pony Explorations, Progress Energy, Rock Energy, Seaview Energy and Terra Energy and Trilogy and Yoho Resources.

One factor driving valuations could be the new focus on the deep (3500 m) Duvernay shale, the bottom formation in the Montney area, which is pervasive yet unexplored. The Duvernay shale is believed to be the source rock for all the prolific oil producing reef structures in the Beaverhill Lake and Leduc formations just above it. Over $450 million was paid for Alberta oil and gas rights last week, and most analysts believe the bulk of it was spent for the Duvernay shale. Many junior gas stocks with Duvernay rights had an uptick last week after the sale.

All this is happening while natural gas prices are still low. Production in the US is still increasing, especially in the Marcellus shale of Pennsylvania, although demand is also up. Many companies still must drill or lose their gas lands regardless of price.

But low gas prices have not impacted mergers & acquisitions in the US. Canadian brokerage house GMP Securities estimates more than $70 billion in transactions in natural gas producers have been completed in the US in the last two years.

In speaking with Calgary CEOs and investment bankers today, nobody understood why Pengrowth paid that much for Monterey. But, while Monterey has only 1,700 boe/d now, it has 20 million mmcf/d (million cubic feet of gas per day production) ready to go into a new 28 mmcf/d facility. The industry converts gas into oil at 6:1, so that 20 mmcf/d=~3,333 boe/d. Pengrowth clearly paid for that, and Pengrowth expects to exit 2010 with 6,000 boe/d on the Monterey lands. At 6,000 boe/d, Pengrowth says the valuation metrics are just under $50,000 per flowing barrel. Pengrowth already owned a big chunk of Monterey, but good for Monterey management for getting that priced in.

And their latest 3 wells AVERAGED 7 mmcf/d on short term IP rates - you do see these bigger numbers, but not often as an average. That's good consistent high rates of production.

Also, Monterey spent the money to acquire the Duvernay rights to its properties. Many analysts are calling the Duvernay the next "Horn River" play, referring to the huge new shale play on the Yukon-BC-Alberta border. Except the Duvernay - if it works - is in the middle of lots of oil and gas infrastructure, like pipelines and suppliers, and doesn't need tens of kilometers of roads built through tough northern bush.

All this is good news for investors in junior and intermediate natural gas stocks, as the industry is clearly saying – build it, and we will come (buy you out).

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