April 1st, 2009

UNE caught my attention lately after having gone up about 200% in short time, without any clear reason for it. I've heard some call it a pump&dump story, mostly because of this thing going around (http://smallcapfortunes.com/uneff/index.html). Well, it's possible that some people wanna put a hype on this company to make quick money, but it doesn't necessarily mean that the company is bad or overvalued.

UNE is a developer of unconventional gas and oil. Today they have a small amount of production and their main activities are in exploration. In the latest financial report (nine months ended september 30, 2008) they showed a total revenue of $658,357, up 350% from last year. Mcap today is about $10M and net cash position is about -$1M, but from what I've seen they have been quite able to raise money.

The 350% increase in revenue is mostly attributable to higher production since gas-prices between the two periods (on average) changed little. So there is definitely a strong growth in the company. The basis of the "hype" for the company is the fact that in total they have almost 2 trillion cf (cubic feet) of natural gas resources. Remember that resources are not reserves, they are merely an estimation based on the large geological structure, whereas reserves are created by lots of drilling. Total reserves are today at about 32 billion cf.

UNE is active in the Appalachian basin and the Western Canadian sedimentary basin. These areas are mainly exploited through unconventional methods that have really just been devloped in recent years and still can be considered cutting edge technology that enables companies like UNE to exploit these shale and tight-sand reservoirs without spending too much money.

Because the operation of installing unconventional wells is a bit tricky, it usually takes a lot of preparations and careful planning before going ahead and installing a well. Therefore in the last three years that he company has been active the development has been going slowly. But as we all can see from the revenue growth, the expansion in productivity can assume quickly. Of course with the financial crisis the activities of the company have been more focused on acheiving higher production and the less developed properties will be put on hold or even sold. It also remains to be seen what happens with the price of natural gas, it has already gone down more than 50% since the top and although it could drop further there still is a long-term shortage of natural gas in North America - that's why unconventional plays came into the picture in the first place.

Besides the pump&dump rumours going around about the recent upswing in the share price, there have at the same time come out two positive news-items. First there was the announcement that a well is being drilled to test a very promising structure in the Appalachian basin (results coming in April). Secondly there was the newly drilled well in Canada that showed flow-rates of 2.3MMcf/day.

To put all this is some perspective: Natural gas is priced in MMbtu (million btu) and one can roughly say that 1000btu is 1cf natural gas. 1 MMbtu today costs about $4, which means that 2 trillion cf of gas is worth ~$8 billion. It would be impossible for UNE to exploit all this gas, but as is mentioned in the "pump&dump"-letter, they might be able to recover 25% - which is still worth a lot. The 2.3MMcf/day well would make UNE $9,200/day - that's $3.4M per year!

As the company now is focusing mostly on ramping up production and putting geological testing/exploration more aside, there could be a good upswing in revenues, even with lower gas prices. The recently drilled well showed very positive results and there is a lot of promise in the other ongoing work, as well. It isn't impossible that the company might not be able to raise more money in the future as things are looking now and the whole thing could be more or less put on hold. But the resource they hold is worth a lot in the long term and should always be of interest, especially with the recent developments in exploting these resources.

To conclude, I can't see how this company is overvalued at only $10M, it might be that I'm underestimating the impact of (potentially) lower gas prices and overestimating the ability of management to ramp up production. But as a long term investment - they have the resources that are just waiting to be developed - and it will be sooner or later (even if it means being bougth out by a larger company).

(Note: I wrote this post a little hastily and forgot to mention that management of UNE sees at least another 30 wells being drilled in the same area as the 2.3MMcf/day well - which once completed could bring revenues of up to - or more - than $100M/year. That's ten times more than the current mcap!!)