06/02/2008 - 22:00

Patient investors win with oil

06/02/2008 - 22:00


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Given the strength of energy markets generally – with the price of crude oil almost doubling in the past 12 months and quadrupling over the past four years – it is remarkable and somewhat counterintuitive to note how poorly many oil and gas producers have

Patient investors win with oil

Given the strength of energy markets generally – with the price of crude oil almost doubling in the past 12 months and quadrupling over the past four years – it is remarkable and somewhat counterintuitive to note how poorly many oil and gas producers have performed on the stock market.

Many oil companies have halved in value during the past two years or so. For instance, Tap Oil fell from a high around $3.20 per share in August 2005 to trade at $1.40 during the second half of 2007. Roc Oil has plummeted from $4.25 in July 2007 to lows of $1.90 in recent days, while Arc Energy has also halved in price during the 30 months.

The list goes on, with the casualties including Petsec, which is now trading at close to one third of its high of 18 months ago, while AED fell precipitously from $11 to $2 per share.

Majors such as Woodside and Santos have not been immune to share price weakness, although their recent form could more easily be put down to overall market conditions.

The reasons for this seemingly anomalous behaviour vary, but centre on poor exploration outcomes and thus perceptions towards medium-term growth and, in some cases, poor project execution and resource downgrades.

Roc Oil has tended to trade with a high level of value for its risk-adjusted exploration appeal. A series of poor exploration and development well outcomes, firstly in Mauritania and then at the newly acquired Zhao Dong project in China, followed by a recent dusters in Angola and China’s Beibu Gulf, have downgraded Roc’s exploration appeal.

In Mauritania, the much-vaunted Chinguetti oilfield has gone from being 123 million barrels with upside to 140mmbls, to now stand at about 35mmbls, with the field massively under-performing its early production expectations.

Reservoirs here are now seen as being highly compartmentalised and further development drilling is required to maximise production. Political turmoil in Mauritania, along with an unexpected bill for $US100 million from the newly, self-installed Mauritanian regime, also dampened enthusiasm for the project and the region, so much so that Woodside has now sold out and is leaving Africa completely.

Roc Oil’s recent oil reserve downgrade in China was met with savage and punitive selling on the market as investors vented their frustration and anger at director of share sales ahead of this announcement. It’s tough being a director when selling shares is almost impossible, but a degree of support and integrity is always appreciated, especially when directors are well paid for their involvement.

Briefcase believes recent selling was irrational and overdone, offering an excellent entrance point to investors who have so far missed out on the Roc story.

Arc Energy has suffered a similar fate at the hands of the drill bit. A series of dusters at its home base, onshore Perth Basin, during 2007 and so far equivocal results from an $18 million dollar exploration program in the Canning Basin have led to its share price being savaged. Takeover bids, first for Mitsui’s offshore production assets, and more recently a doomed attempt to secure Anzon’s 40 per cent of the Basker Manta Gummy oil and gas fields, has also kept investors away.

Meanwhile, Petsec Energy, always appears to be running hard just to stand still, and its production is based on the lower valued natural gas.

Tap Oil has slowed the pace of its exploration, focusing on more material targets in the Philippines, while it’s local oil and gas production levels slowly decline, offering little short-term reason for excitement.

What does all this mean and how do we process this information? Firstly, let’s look at value. Most of these companies are now trading with an enterprise value (EV = market cap plus net debt) to annual operating cash flow generation of about two to three times. So, notionally, these companies are able to generate their entire market value in pre-tax, operating cash flow inside three years, which would appear to offer potential for patient investors.

It must be emphasised that the operating cash flow for these companies is a snapshot in time and revenues will generally fall away as natural field depletion reduces flows over time. But against that, all these companies are sitting on high-quality exploration permits where discovery could add significantly to values currently expressed on the market.

Woodside, which might be considered to be a benchmark, generates about $4 billion a year of pre-tax operating cash flow and currently trades with an EV 8.3 times this cash flow.

Tap Oil, which has net cash of $95 million, now trades on an EV to current operating cash flow of just two times, while Roc is on 2.5 times, Arc is about 2.5 times and Petsec has an EV 3.1 times its current cash flow.

Let’s look at the level of underlying, proven and probable hydrocarbon reserves. Briefcase calculates that Woodside trades with a an EV which represents about $A46/barrel of its proven and probable reserves of value equivalent oil (BOVE). Roc is on $34.5/BOVE by its own recent reserve calculations, and Tap trades on $30/BOVE.

Arc is on a more modest $21.60/BOVE and Petsec is at $29/BOVE. This means that, if I buy Roc Oil, I am effectively paying $34.50 for each barrel of its oil reserves, without allowing any additional value for exploration or development upside.

With oil trading at $100/barrel and considerable added exploration and development appeal, all of these companies start to look appealing, since they are trading at a price close to or below their net present value per barrel of oil reserves, with no value for exploration and development.

In the case of Roc Oil, that company has a large pool of undeveloped hydrocarbons, which are not classified as proven and probable reserves. In the Beibu Gulf, oil resources of between 20 and 60mmbbls have been outlined, in which Roc will have an effective interest of between four and 11mmbls.

Similarly, Roc has a 37.5 per cent interest in about 12mmbbls of oil and 60-100 Bcf of gas in the offshore Perth Basin, and a 60 per cent interest in a large pool of biodegraded shallow oil in Angola, which does not affect the EV/BOVE calculations above. And there are additional pools of oil and gas around the Chinguetti oilfield, which will certainly prove to be commercial as the price of oil rises over time.

Adding these possible and contingent hydrocarbon resources improves Roc apparent value so that it could be said to trade at about $A12.60/BOVE, based on this looser measure of resources, while offering huge exploration upside for ongoing and current drilling in Angola, offshore China, and in the Perth Basin, as well as planned programs elsewhere.


• Peter Strachan is an AFS licensed research provider and author of weekly, subscriber-based newsletter, www.stockanalysis.com.au. The author holds shares in Roc Oil, Arc Energy and Tap Oil.


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