Three Global Threats that Keep This Stonecap Analyst Up at Night
Thu, Mar 28, 2013
International Investment Climate
The Energy Report: In your interview last December, you commented on overly optimistic management teams that understate possible country risks. What geopolitical concerns are you watching closely these days?
Amin Haque: The Iran nuclear issue continues to have an impact on global oil prices, although I don’t know which way it will go this year. Second, in Colombia, a peace process negotiation has been going on for some time and I’m following that closely. Third, Nigeria will have an election in about a year and a half. There are quite a few things at stake on the oil and gas front in the meantime.
TER: Another current point of possible concern is this bank situation in Cyprus. Do you think that’s going to have any particular impact on the international investment climate and the companies involved in oil exploration and production (E&P)?
AH: The International Investment Climate is a very broad-based issue. As an international oil and gas analyst, I look at things through a narrow aperture, so I will try to answer from that perspective. We’ve already seen that problems in smaller, on-the-fringe countries in the Eurozone can spread very quickly and shake confidence in the whole euro structure. Cyprus is a small country, but the crisis in its banking sector has subdued the confidence in the zone itself. That may translate into lower economic activities as well as lower petroleum demand in the Eurozone. We have seen a downward pressure on Brent right now. Except for some secondary effects, this may not turn into a full-blown crisis. So a $1 or $2 drop in the Brent prices is where I believe it’s going to stop.
AH: The deal has not closed yet, but only about 5% of the outstanding shares are in the public’s hands, with the remaining 95% held by Oando Plc (OANDO:NSE; OAO:JSE), the parent company. So with a small float and limited trading, I don’t think there is much to say about the impact on the current shareholders. But concurrent with the transaction, the company is raising money and is issuing a large amount of equity. Of course, Oando Plc plans to subscribe a large part of it, but then again, at least half of the total issue would be offered to the public. These would be new shareholders investing in the new Oando Energy Resources. So in a way, it’s almost an IPO.
“The Cyprus crisis may translate into lower economic activities as well as lower petroleum demand in the Eurozone.”
First, this acquisition would offer shareholders a more stable production base. ConocoPhillips is entitled to 20% production from the Nigerian Agip Oil Company Ltd. (NAOC), a subsidiary of Eni SpA (E:NYSE), joint venture, which is a strong base to grow production and cash flow. Second, the acquired asset portfolio contains large and attractive exploration assets, especially in offshore deepwater. There have been a number of large discoveries surrounding these assets. Third, rationalizing or streamlining some of the mainstream assets like the pipelines, the proposed liquefied natural gas project and also the independent power project within the joint venture or within Oando’s portfolio should generate cash that the company can use in its exploration program. I would say that these are the three strong points for investing in this new company.
TER: Why did Conoco decide to get rid of these assets?
AH: It was a stated objective of ConocoPhillips to divest its non-core international assets, which it has been doing for the last two years. At about the same time it got out of Nigeria, it also sold its assets in Algeria. It also divested its Kazakhstan and Russian assets. Like many other super-independents, Conoco sees more opportunities in North America with lower country and headline risks. This divestiture of international assets opens up once-in-a-lifetime opportunities for smaller, independent, international E&Ps.
TER: With all these new shareholders coming in, I guess it’s going to provide more liquidity and maybe make the stock a little bit more attractive to investors.
AH: Yes, absolutely. As attractive as Oando looked before, it was difficult to take a substantial position with only about 5M shares publicly available. Now it will be a much more broad-based shareholding with more liquidity.
TER: Another Nigerian play that you talked about last time was Mart Resources Inc. (MMT:TSX.V). It has restarted production there and has some other things going on. What’s happening with it now?
“Brent price has shown strength and averaged over $110/bbl in 2013.”
AH: Mart lost about 50 days of production in Q4/12 and about 40 days in this quarter. For any oil and gas company, not being able to produce from its single asset for such a long time is bad news. However, Mart has enough cash to pay dividends and complete its 2013 development program, which is going on full swing. It recently shared some news about its 10th well, UMU-10. It also plans to drill three or four wells during the rest of 2013 so that by the time the alternative pipeline is ready, there should be enough production to take advantage of the extra pipeline capacity. So far, things seem to be going well on the development front.
TER: What do you see for upside on the company at this point?
AH: One is higher production from the current field. Second, there’s the plan to drill an exploration well either on the eastern or the western flank of the current field. If it makes a discovery, that would be very encouraging. Third, with increased production, Mart would have a large cash position, which it can use to acquire new assets. We keep hearing about the next marginal field bid round in Nigeria. Mart would be in a good position to take advantage of a new bid round.
TER: Another company you talked about is Greenfields Petroleum Corp. (GNF:TSX.V), and its operations in Azerbaijan. I see in your research you now have a target price of $10/share on the stock compared to around $4/share, where it is now. What gives the company that much upside?
AH: The company has had its operational challenges. It has missed deadlines a number of times. The rigs are now in place and the first well has been drilled, which is encouraging. If Greenfields can ramp up development drilling, it should be able to achieve a respectable production figure by the end of the year. The two-thirds partner in this field is a local Azerbaijani company, whose main business is oil trading. After attaining a respectable level of production, this project could become very attractive for buyers who are looking for sizeable production in that part of the world.
TER: Another company you talked about in December was Touchstone Exploration Inc. (TAB:TSX.V; TCHSF:OTCPK), which is operating in Trinidad and Tobago. It’s drilled about 10 wells since then and seems to have some better performance. Where is the upside on this deal?
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AH: This is one of the lowest-risk international E&P companies in my universe, both in terms of country risk and geological risk. The issue is that the wells are not large producers. At best, you can expect around 100–150 barrels per day (100-150 bbl/d). On the positive side, they are really inexpensive wells that can be drilled for less than $1 million. Also, recompletion of the wells adds about 15–20 bbl/d. You can do the recompletions for about $50,000 ($50K). The issue for this company is funding new wells and maintaining discipline so as to keep costs down. Both the recompleted and new wells sand up fairly quickly, so Touchstone has to take them out of production for a few days, perform workover and put them back to production. The company has tried different technologies to address the sand problem and is now getting better results. It has also started drilling wells in some of its newer blocks. Those are exciting developments.
TER: New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX) had to suspend some drilling, and you’ve decreased your target price on it. What’s happening there?
“I believe this year the market will have more confidence in the E&P companies’ ability to make money at current oil prices.”
AH: Back in January, I wrote a note highlighting some of the challenges the company was facing. At that time, I reduced my target from $3.50 to $2/share and also downgraded my rating from Outperform to Sector Perform. The challenges that I was predicting played out. Also, a $40M acquisition tied up capital and left very little cash to continue its exploration program. When the company confirmed that it was facing challenges, the market reacted violently and the stock went down to about $0.39/share. Despite its challenges, that level of price decline is not justified. The sum of the value of individual assets should be higher than that. That’s why I put my target price to $0.75/share and revised my rating to Outperform. From there, the share price moved up to about $0.60/share.
TER: Are there any other companies you’re following you’d like to talk about?
AH: Parex Resources Inc. (PXT:TSX.V) is a Colombia-focused company. It has been fairly successful in increasing production and reserves. During 2012, it increased production by about 25% and total reserves by about 50%. In that regard, it’s one of the more successful E&P companies in Colombia. But, things slowed down quite a bit in the last year. Production and reserve growth has not been as dramatic as in the prior two years. But, again, the focus has shifted from exploration to delineation and development, which should help production. Also, the new investment in infrastructure, especially in new pipelines, should help the E&P companies by reducing trucking costs.
TER: To conclude, what is the most relevant trend for investors in the oil and gas space?
AH: As much as the domestic companies, especially the Canadian domestic companies, suffered because of oil price differentials, international oil and gas companies have done quite well. Brent price has shown strength and averaged over $110/bbl in 2013. I think cash flow for the international oil and gas companies has been fairly good. That should keep them going, spending more on exploration and development and increasing production and reserves. That keeps me excited and optimistic.
TER: Will that optimism be reflected in the prices of all these companies, both large and small?
AH: The broad market indices have done quite well in the last four months. But I guess investors have been very selective in taking on risk, and they’re still waiting for more signals that the broader economy would do well and oil demand would not weaken. I believe this year the market will have more confidence in the E&P companies’ ability to make money at current oil prices.
TER: Thanks for talking with us today, Amin. We appreciate your input and your updates.
Amin Haque joined the Stonecap Securities’ oil and gas research team in Calgary in October 2011, providing research coverage of international explorers, producers and oilfield service companies. Haque brings 14 years of financial market experience, seven of which have been devoted to equity research analysis. He worked as an analyst both on the buy and the sell sides focusing on energy and other resource sectors. Prior to joining Stonecap, Haque provided independent valuation services to oilfield services, logistics and related companies. Before his career as an analyst in the energy and the resources sector, he worked in risk management for a New York-based global credit card company. He also worked as a management consultant providing consulting services to a variety of U.S. and international financial organizations including Ginnie Mae and the World Bank. Haque is an electrical engineer by training, and holds a Master of Business Administration degree from Georgetown University in Washington, D.C. He is a CFA charterholder.
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1) Zig Lambo conducted this interview for The Energy Report and provides services to The Energy Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report:Mart Resources Inc. and New Zealand Energy Corp. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Amin Haque: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Greenfields Petroleum Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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