(Idea) Kelt Exploration
We’ve been taking a look at natural gas-weighted E&Ps, with a preference for those that have a meaningful portion of their production in liquids. Our interest stems from our bullish long-term outlook for North American natural gas. For the foreseeable future, the world will consume increasing quantities of gas, and few places in the world possess bountiful natural gas reserves that can be extracted at a lower cost than the U.S. and Canada. As North American natural gas demand increases by 12% with the arrival of LNG export facilities over the next few years, natural gas prices are likely to increase as the marginal cost of extracting such massive volumes ticks higher.
E&Ps with low-cost production weighted toward natural gas will fare well with this bullish macro backdrop. We prefer those that also have meaningful liquids weighting because they possess a built-in financial cushion during those inevitable times when a glutted natural gas market drives prices far below production cost. During those gas market downturns, cash flow from higher-value crude oil and NGLs can significantly reduce the risk of value destruction.
So far, Spartan Delta (SDE:CA) and ARC Resources (ARX:CA) have been the standout investment candidates with both dry gas and liquids exposure. However, Kelt Exploration (KEL:CA) is another name that holds potential.
Kelt Exploration Overview
Kelt Exploration is a C$1.3 billion market cap E&P that generates value through asset acquisitions, exploration, and asset sales. The company is managed conservatively. Its net debt of C$32 million is expected to grow, but nowhere near to a level that puts shareholders at significant risk. It has operated with a low debt balance since 2019, when it paid down long-term debt through asset sales.
Kelt produces approximately 34,000 boe/d, of which 38% is liquids—light oil and NGLs—and 62% is dry gas. Due to historically low natural gas prices, however, its operating income was weighted 90%/10% between liquids and natural gas in the first quarter. These quarterly results point to why we favor a liquids weighting in our natural gas holdings.
Kelt’s shares are 12.8% owned by CEO David J. Wilson, who has been operating oil and gas companies since 1987 and since then has created billions of dollars of value for shareholders. Kelt is his sixth E&P iteration. Wilson’s previous company was Celtic Exploration, which grew by counter-cyclical asset purchases and exploration. Celtic was sold in 2013 for C$3.2 billion to Exxon Mobil (XOM).
Celtic operated in the Montney and Duvernay, so Wilson has extensive experience in the Montney, the currently “hot” play where Kelt operates today. Kelt itself was formed by being spun off from Celtic.
Kelt has also executed value-creating transactions such as its sale of Montney assets in 2017 for C$100 million and again in 2020 for C$510 million.
Today, the company operates in the Alberta and British Columbia Montney, as shown in the map below.
Source: Kelt Exploration May 2024 Investor Presentation.
Kelt has extensive land holdings, which include 375,775 undeveloped acres. It has 339,000 acres in the Montney and recently acquired 87,000 acres in the Charlie Lake region of Pouce Coupe.
As of its 2023 reserve report, proved reserve life stretches 23 years and proved-plus-probable reserve life is 31 years. The company has recently amassed new prospective acreage in the Montney.
Kelt is in growth mode. Management expects to grow liquids production by 26% and natural gas production by 21% year-over-year in 2024. Total production is expected to grow by 23%, one of the highest growth rates among Canadian E&Ps.
In addition to production growth, Kelt is de-risking its undeveloped acreage, which is likely to increase its reserves volumes and value.
The company is currently undergoing processing expansion that management expects will increase production capacity from 38,000 boe/d to 68,000 boe/d over the next two years. These projects will create room to nearly double production growth.
Kelt has distinguished itself with its sophisticated marketing strategy, through which it realizes premium pricing on its natural gas sales. In the first quarter, its gas realizations stood at 130% of prevailing AECO prices. The marketing agreements are shown in the following slide.
Source: Kelt Exploration May 2024 Investor Presentation.
Kelt also generates additional income from its marketing operations. It generated C$4.9 million in the first quarter from marketing activities, which include oil blending operations and natural gas marketing opportunities.
In recent quarters, Kelt’s marketing agreements have enabled it to routinely generate positive net income. Even in the first quarter, with natural gas prices trading in the C$1.00 to C$2.00 per MMBtu range, it reported net income of C$11.8 million despite hedging losses.
Despite Kelt’s impressive net income performance, the company will struggle to generate free cash flow due to its heavy growth capex spending. At today’s commodity prices, nearly all of Kelt’s cash flow is consumed by capex with significant expenditures devoted to midstream infrastructure. These include the construction of processing facilities and pipelines, all of which will accommodate profitable long-term production growth. Development spending will moderate once the infrastructure has been completed. Kelt’s cash flow over the past nine quarters is shown below.
Due to Kelt’s conservative balance sheet, with debt at only 10% cash flow, as well as cash flow generation potential and positive net income at low commodity prices, Kelt offers low risk for shareholders.
That’s not to say the company hasn’t faced challenges. Earlier this year, Kelt experienced outages on infrastructure operated by third parties. The outages caused the company to miss analyst consensus production estimates in the first quarter, during which it reported total volumes of 32,900 boe/d, below consensus expectations of 34,300 boe/d.
Management reported that in March, production had increased to approximately 34,000 boe/d. The first-quarter miss is likely a one-time incident, though third-party outages will remain a risk for production until sufficient Kelt infrastructure is in place later this year. Management expects the infrastructure to be in place by 2025, at which point the company will not be at risk from outside midstream operators.