When I buy energy companies, I prefer the ones with proven, un-risked land and significant Proven and Probable (2P) reserves in place as I have pointed out in my article about the Canadian Second Wave Petroleum (SCSZF.PK).
I just want to play it safe. I am not a big fan of the exploration vehicles due to the increased risk they carry. Their land has not been de-risked, their oil potential is unproven and these exploration companies try to predict reservoir sweet spots which is always a challenge in their unexplored acreage. As a result, they can offer both significant rewards and big disappointments along with very dramatic share price corrections after some exploration misses at potentially very high-impact wells.
The downside risk of the explorers
The aforementioned exploration misses along with the big disappointments and the price corrections is not an imaginary scenario. The cases of CGX Energy (CGXEF.PK), Houston American Energy (HUSA) and PetroFrontier (PFRRF.PK) deserve a very close look because they help us understand this high risk of the exploration companies:
1) CGX Energy is a Canadian oil and gas exploration company that holds 25,000 square km (net acreage) on 5 Blocks in the Guyana-Suriname Basin. According to the company, Guyana Suriname Basin is a highly prospective basin with a proven hydrocarbon system. CGX drilled two wells in 2012. The first well, Jaguar-1 well, sampled light oil in two zones, but the well abandoned for safety concerns in July 2012. The second well, the Eagle-1 well, resulted in a dry well. The price has dropped from $1.50 down to 19 cents, the company has run out of cash and new financing is on the horizon to help it survive and drill again.
2) Houston American Energy is another energy company with 737,657 gross acres (178,570 net acres) in Colombia. The story is the same. After some dry holes and some operational problems, Houston failed to find commercially viable oil reserves. As a result, the stock price has dropped from $14 down to 55 cents during the last 10 months. This is a disaster. In October 2012, the company completed one more financing and the drilling activity started again. However, now the price hovers at 55 cents, so the further downside risk may be rather limited.
3) PetroFrontier's shares also plummeted 66% and hit $0.10 few days ago after the company announced that no hydrocarbons were recovered at its Owen-3H well in Australia. The company whose price was at $2 in early 2012 holds 14.1 million acres with an 87% WI in Australia. Heritage Oil (HGOCF.PK) announced a couple of days ago that it increased its stake in this explorer and it owns 17.58% of PetroFrontier now. PetroFrontier's stock rose 46% to 16 cents, but there is a long way to go up to $2 again.
These explorers are priced for perfection
Now that we know with examples the exploration misses, the price corrections and the high risk that the exploration companies carry, let's check 5 explorers which have run a lot lately and maybe it is time for a pause. In my opinion, these companies below are priced for perfection and the investors seem to think that there is zero exploration risk in the horizon for them:
1) Africa Oil (AOIFF.PK): The company holds significant land in Kenya, Ethiopia, Mali and Somalia through its 45% stake in Horn Petroleum Corporation (HPMCF.OB). The company found its first oil in Ngamia -1 well in Kenya in March 2012. Africa Oil has 50% WI and Tullow 50% WI in that well. The rig encountered 100 meters of net light oil pay in the Upper Lokhone Sand Section and an additional 43 meters of potential oil pay in the Lower Lokhone Sandstone section. This was the first oil discovery in Kenya and the stock has risen 300% since then.
Africa Oil's second well, Twiga South-1, was drilled in September 2012 and the rig encountered 30 meters of net oil pay which was below expectations as the stock price has dropped about 25% since then.
In onshore Kenya, the Paipai-1 well in Block 10A was drilled in October and this well is scheduled to be completed in early 2013. In onshore Ethiopia, Africa Oil will drill the Sabisa-1 well by year-end.
According to Reuters, the commercial viability for both the Ngamia-1 well and the Twinga South-1 well has yet to be ascertained, and it would be at least a year before it knows whether its March discovery (Ngamia-1 well) can be extracted and exported.
Africa Oil has not received any good news from Somalia's front either. Horn Petroleum drilled two wells in Somalia in 2012 but it did not find oil in any of them.
So we have a company with a market cap of $1.7B currently and PBV=6 although the commercial viability of its two wells is questionable and it will take about one year to be determined. In addition, the company has zero production, it has negative funds from operations along with losses every quarter. It has also ended Q3 with cash of $55.4M and working capital of $32.0M down from cash of $109.6M and working capital of $90.2M at December 31, 2011.
As the company was about to run out of cash, it announced a financing of $232M (~15% dilution) few days ago to be able to keep funding the very expensive wells of East Africa.
According to regulatory filings, there have been major insiders' dispositions and few insiders' purchases since July 2012.
2) Cobalt International Energy (CIE): Cobalt has a 40% stake on Blocks 9, 20 and 21 offshore Angola and 21.25% WI in Diaba Block in Gabon which is operated by Total (TOT). Diaba covers an area of 3,500 square miles.
West Africa's geological analogue is Brazil, where a lot of oil has been discovered below the thick salt layers present in the subsurface. Tectonically, these two continents were attached before the Atlantic opened up. Brazil's success points to the potential of the African side. However, is this similarity enough?
Rodinia Oil (RDOIF.PK) has also world-class onshore petroleum and natural gas assets in Australia's Officer Basin. As Rodinia notes: "The Officer Basin consists of Neoproterozoic age Cambrian and later aged Paleozoic sediments and was a component of the giant supercontinent known as "Rodinia" which existed 800 - 540 million years ago. The Officer Basin of Australia is geologically analogous to the vast producing fields in Siberia and Oman that are of equivalent Neoproterozoic age. According to the independent resource-evaluation firm, Ryder Scott Company Consultants Ltd. Rodinia's gross lands contain prospective (recoverable) un-risked, undiscovered resources totalling 125.7 billion barrels of oil."
Despite the encouraging oil shows, Rodinia did not find any commercial accumulations of hydrocarbons. As a result, Rodinia is almost broke today and the stock collapsed from $3 in early 2011 down to 5 cents today.
Cobalt is the operator on all three Angolan Blocks (5,600 square miles) and are pre-salt projects. In 2012, it discovered Cameia in Block 21 with a rate of 7,400 boepd. According to the company, the full production well will produce 20,000 boepd. Cobalt will be drilling another test well in Block 9 by year end and it will initiate a 2 rig program that will drill 4-6 Pre-salt wells in 2013.
The company also holds 600K net acres in Gulf Of Mexico. The risky nature of Cobalt's acreage is demonstrated by the following drilling results:
a) As of April 30, 2012, Cobalt had drilled through the interval discovered by the Heidelberg #1 exploratory well and did not encounter commercial hydrocarbons.
b) In February 2012, Cobalt also announced the successful results of its Heidelberg appraisal well, located in Green Canyon block 903 in the deepwater Gulf of Mexico. This appraisal well, operated by Anadarko (APC), encountered approximately 250 net feet of oil pay in high-quality Miocene sands. However, Cobalt has only a 9.375% WI in the Green Canyon 903 Heidelberg block.
c) In June 2012, Cobalt announced that its Ligurian #2 exploratory well on Green Canyon Block 814 in the U.S. Gulf of Mexico had reached objective total depth after having drilled through all of the targeted Miocene formations. The well did not encounter commercial hydrocarbons and operations are underway to plug and abandon the wellbore.
d) Few days ago, It announced an oil discovery at its North Platte prospect (60% WI) on Garden Banks Block 959 in the deepwater Gulf of Mexico.
Cobalt has zero production currently and there is no guarantee that it will find commercially viable oil quantities on its Blocks. In terms of the African Blocks, the corporate presentation also notes that there are "no known technical barriers to commercial development."
The company has also been losing money and it has negative operating cash flows every quarter. As a result, it had to complete a financing in early 2012 to keep drilling and I assume it will have to get one more soon as its cash resources have decreased significantly since Mar 2012. Despite all these, it trades well above its book value (PBV=4.5) currently.
3) WesternZagros (WZGRF.PK): The company operates in Iraqi Kurdistan which is autonomous since 1991 and it is often touted as one of the final frontiers for onshore oil exploration. Kurdistan has also signed deals with foreign majors such as Exxon Mobil (XOM), Chevron (CVX) and Total . The company holds a 40% WI in two Production Sharing Contracts (PSC) with the Government of Kurdistan. The first one is the Garmian and the second one is the Kurdamir contract.
WesternZagros operates in the Garmian contract area of 1780 square km and the Russian Gazprom Neft also holds a 40% WI there. Talisman (TLM) has a 40% WI and is the operator at the Kurdamir contract area of 340 square km. The Government of Kurdistan holds a 20% WI in both PSCs.
The rig found oil at the Oligocene reservoir of the Kurdamir-2 well in July 2012. This boosted the share price which has yielded almost 100% thus far. However, the recent results from Kurdamir-2 well on the Shiranish Formation exhibited non-commercial flow rates in this location. Additionally, the results from the Eocene reservoir of the Kurdamir-2 well resulted in the flow of light, 45 degree API oil at sub-commercial flow rates.
The company's reserves are still Prospective; they are not Proven and Probable (2P). After the two recent failures from Shiranish and Eocene, it seems these Prospective reserves will be revised downwards according to the company.
According to the latest news, Abu Dhabi National Energy Co. (TAQA) said last Friday it had sold its 19.9% share in WesternZagros Resources and this is not a positive development. TAQA had bought these shares at $0.63 per share.
The production from the Sarqala-1 well restarted which is now producing approximately 5,000 bopd. However, the company does not receive 100% of the proceeds. WesternZagros received $39.6 million of gross proceeds for test oil production from the Sarqala-1 extended well test during the nine months ended September 30, 2012. Following the reconciliation with the KRG, the Company's net proceeds for the nine months ended September 30, 2012 were $11.5 million. So the company nets only 29% of the total proceeds from its one producing well so it incurred losses and negative funds from operations for the nine months of 2012.
As there is no increase in production during Q4 2012, I believe the funds from operations will remain negative in Q4 2012.
The company had $114M in working capital as of Q3 2012. However, the capital expenditures estimate for the fourth quarter of 2012, including the requirement for the company to fund 50% of Garmian activities and 60% of Kurdamir activities to be in the range of $30-40M. The estimated well cost is around $20M on average.
WesternZagros has an enterprise value of $466M and it trades above its book value (PBV=1.3). It is currently working on the drilling of the expensive Hasira, Baram, Upper Bakhtiari and Kurdamir wells in 2013 that have an estimated cost per well around $25M on average. If the drilling results are not satisfactory again, then a financing may be on the horizon.
4) ShaMaran Petroleum (SHASF.PK): ShaMaran is a Kurdistan-based exploration company with one project in Kurdistan, the Atrush project (26.8% WI).
ShaMaran, through its wholly owned subsidiary, ShaMaran Ventures B.V., has a 33.5% stake in GEP (General Exploration Partners) which is a party to the Atrush Block Production Sharing Contract and currently holds an 80% WI. Marathon Petroleum KDV B.V., a wholly-owned subsidiary of Marathon Oil Corporation (MRO), holds a 20% interest in the Atrush block.
GEP is a joint venture between privately-held Aspect Energy, which owns a 66.5% interest in GEP, with the remainder held by ShaMaran.
According to the latest news, Abu Dhabi National Energy Co (TAQA) bought Aspect's stake in Atrush oil block via joint-venture firm General Exploration Partners (GEP). So now the Atrush Block is owned by Marathon (20% WI), ShaMaran (26.8% WI) and TAQA (53.2% WI).
GEP said in Sep 2012 that Atrush-2 well had flowed a combined flow rate of 42,200 bbl/d. This propelled ShaMaran's share price which has yielded more than 100% thus far. The decline rate of this well remains unknown as of today but it was declared a commercial discovery which was submitted in Nov 2012.
There is also the Atrush- 1 discovery well which was drilled last year was completed in Nov 2012. The well is now ready to be connected to production facilities and put on stream as a future producer.
The company reported net income of nil and a net loss of $26.2M for the three and nine months ended September 30, 2012 (2011: net losses of $2.8M and $3.3M). The cash balance of the company was $43.3M as at September 30, 2012 (December 31, 2011: $49.1M).
As the first production revenue will show up in Q1 2013, the funds from operations will remain negative in Q4 2012 eroding further the stockholder equity. Despite all these, the company has an EV=$365M currently and it trades well above its book value (PBV=3.6).
ShaMaran plans to spud the AT-3 appraisal well by the end of 2012. According to regulatory filings, the Chairman of the Board sold almost 800,000 shares at 49 cents in September 2012.
5) Kosmos Energy (KOS): This is another oil explorer in Africa and South America. The company has assets offshore Ghana, as well as exploration licenses offshore Mauritania, Morocco and Suriname, and onshore Cameroon. Kosmos production comes from the Jubilee oil field in the Tano Basin of Ghana. According to the company, additional large developments will be coming onstream soon. Despite early successes in Ghana, there have not yet been any discoveries of similar size elsewhere in the region, even though some discoveries have been made in Sierra Leone and Liberia.
The gross average production from Jubilee is 70-80,000 bopd in 2012 and Kosmos has 18% WI. YE12 exit rate is anticipated to be higher than 90,000 bopd. In late 2012, Kosmos targets its first well in offshore Cameroon where it holds a 100% WI. It also anticipates the results from its onshore well in Cameroon in early 2013.
The company has $1B long-term debt. It has also been losing money in 2012 and it has quite unstable operating cash flows which go from positive to negative every quarter. Even the quarterly positive ones are not big enough lately and the DCF annualized ratio is higher than 5.
As a result, both the stockholder equity and the cash resources have dropped significantly since early 2012. In addition, the market estimate is that Kosmos will lose money in 2013 too. Despite all these, it trades well above its book value (PBV=5) currently.
The market looks comfortable with the current valuations of the 5 companies above. I personally do not feel comfortable with them and it seems to me that these companies are priced into perfection currently. I think the investors have to see the existence of economically recoverable hydrocarbons to commit new money into these companies. We need to bear in mind that things can change rapidly to the worse if some potentially high impact wells prove to be goat pastures.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CGXEF.PK over the next 72 hours.