It’s a tough time to be in the oil business. Thanks to a shortage of transportation infrastructure, North American energy trades at a steep discount to international benchmarks. And until new pipelines or LNG terminals are built, that discount is likely to persist for the foreseeable future.
The simplest way to avoid this problem: invest in companies that sell their production into those premium international markets. Take Vermilion Energy (TSX:VET, NASDAQ:VRML) for example. The company is centered primarily in Europe, Australia, and Canada. Because of its geographic position, Vermilion has less exposure to the discounts plaguing North American producers.
I wanted to learn more about the company. So I sat down with Vermilion Energy President and Chief Executive Officer Lorenzo Donadeo to discuss the latest developments in the industry. Below is the transcript of our conversation; it has been lightly edited for clarity.
Robert Baillieul: Hello Lorenzo. Thank you for taking the time to speak with The Motley Fool community today. Last year Vermilion made two big acquisitions in the Germany and the Netherlands. Clearly you guys clearly like Europe. What makes the continent so much more attractive than say North America or other regions at the moment?
Lorenzo Donadeo: We’ve been in Europe since 1997 and it’s a real core focus for us for a number of reasons.
Firstly, we get premium pricing for all of our products in Europe. For our oil we get Brent pricing which is priced about $10 per barrel above WTI [West Texas Intermediate]. In comparison, North American oil is getting about a $12 to $16 per barrel discount to WTI. In aggregate Vermilion receives about a $22 to $26 per barrel more per for its European production as compared to say North American producers. That’s quite significant.
It’s a similar story on the gas side. We currently receive about $11 per thousand cubic feet compared to say an average of $4 to $5 per thousand cubic feet in North America. Cash flow wise, these higher prices give us premium netbacks that really drives significant incremental cash flow.
The other major reason we find Europe attractive is that it’s a much less competitive environment than North America for an intermediate company of our size. What that means is that for acquisitions there is generally less competition and you can to buy them cheaper.
The same applies on land acquisitions. When you’re just trying to acquire land it’s less competitive. In many cases there’s really no competition so you’re allowed to buy land quite inexpensively.
The other thing is when you buy acquisition internationally you’re generally buying them directly from the majors. The majors are usually selling assets that are at the bottom of their portfolio. They have been undercapitalized and under resourced in terms of people. When you take them over not only can you buy them cheaper but there’s a lot more of what we call low hanging fruit. There’s many things you can do in terms of increasing production.
Baillieul: Why do you think other companies have overlooked these European assets?
Donadeo: I think a lot of North American companies don’t have the expertise to go internationally. And many of the ones that go internationally are typically going for the higher risk ventures that are more in Africa, offshore, etc. Those companies are looking for the home runs.
[In Europe], these sorts of assets that provide good steady growth. They’re not suited for everyone and not everyone has the expertise to operate internationally. You do need a skill set that is different from operating in North America.
Baillieul: You have stressed that in your German acquisition was primarily for conventional natural gas. But are you optimistic overall on the prospects of fracking [hydraulic fracturing] both in Germany and even Europe as a whole? Or are the politics and geology just too difficult.
Donadeo: Right now I’d have to agree that the politics are a bit difficult right now. It seems like there is a lot of public opposition to fracking in general in Europe. There may be areas that aren’t as bad. But generally across the board it’s more difficult.
Over time that will change. In Europe it’s pretty clear is that everyone wants to cut back on nuclear after what happened in Japan a couple of years ago.
Recently in Germany the government announced that they were going to cut back on some of their green energy subsidies. Those green energy options are very expensive and you need government subsidies to make them work and keep power costs at a reasonable level. With the low GDP growth in Europe people are looking to cut back on subsidies in areas like that.
As a result all that is left is really coal and natural gas. Natural gas is by far the best alternative.
Right now there is a lot of opposition. But as people start to see the costs grow and the power bills increase, those views will change over time. It’s not going to happen overnight. But over time as the industry can prove that it can be done safely and they look at the fact that gas is the cleanest, safest, cost effective alternative, I think the politics will come around.
In terms of the geology, there are certainly areas that work from that perspective. In aggregate it’s an opportunity that’s going to develop over time. But over the next three to five years, perhaps sooner, you’ll see a little bit of that activity happen in Europe.
The one thing I want to make clear in terms of our existing operations, our current growth plans are really driven off conventional gas. We don’t really need to frack. But if there is a change in the fracking perspective from the government there’d be a step change in our growth projections going forward.
Baillieul: When I look around a lot of companies in the Canadian oil patch, firms that are diversified internationally tend to run into execution issues. In fact, many geographically diversified firms are spinning off non-core assets and consolidating their operations. Why shouldn’t investors be concerned about the same issues arising at Vermilion?
Donadeo: We look at ourselves at being involved in three core areas; Western Canada, Europe, and Australia. We see ourselves as fairly concentrated for that perspective. If you look at the distances from the Netherlands to France or the Netherlands to Germany, it’s like the distance from southern Ontario to northern Ontario.
Geographically they’re not much different. We share a lot of the same services, the same people, and a lot of the same infrastructure. We’re pretty comfortable. We’ve been operating in these areas for the last 15 or 16 years internationally. And when you look at our track record, we have proven that we can execute and execute well.
The one advantage of being diversified is that you get a diversification of your commodity exposure. As I discussed earlier we’re getting about $26 per barrel more for our oil [in Europe]. And we’re getting, call it, $6 or $7 per thousand cubic feet more for gas. That’s a real benefit of being diversified. It really mitigates the impact of any regional price fluctuations and reduces the overall risk in a company. You’re not just tied to one play.
Look at the people that were tied to the Marcellus dry shale gas play in North America. Five years ago everyone was really excited saying they’re so focused. Then all of a sudden gas prices go out of wack and all of these guys are sidelined and nobody like them anymore.
The diversification story is that if you do it right and you stay focus — which we think we are even though we’re in a number of countries in Europe — we think we can effectively manage that.
Coming up next…
Lorenzo and I discuss his views on the current state of the energy industry and the future of oil prices.