HRT Participacoes Has An Asymmetric Risk/Reward Profile - Part 3

Feb.12.13 | About: HRT Participacoes (HRTPY)

HRT Participacoes (OTC:HRTPY) is not a stock for everyone. It has a high risk/very high reward profile. Below I will argue that the risk of losing all of your money is outweighed by the opportunity to make multiples on your money, but again, this is not an investment for everyone. In order to keep things simple, this article will only focus on Murombe and Moosehead, which are by far the two largest Namibian oil prospects and will be drilled this year with the contracted Marianas semi-submersible rig.

Click to enlarge images.

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As you can see from the chart above, the chance of success for Murombe and Moosehead is 23% and 25%, respectively. You will also note that the Pmean for Murombe and Moosehead is 4 billion and 3 billion barrels of oil equivalent, respectively. The company has stated that the P10 for Murombe and Moosehead is 10.7 billion and 5.5 billion barrels of oil equivalent, respectively.

Valuation of an Oil Discovery at Murombe or Moosehead

Assuming the value of a barrel of oil in the ground equals $7:

Murombe Pmean = 4 billion bbls x $7/bbl x 86% ownership / 590 shares = $40.81
Murombe P10 = 10.7 billion bbls x $7/bbl x 86% ownership / 590 share = $109.32
Moosehead Pmean = 3 billion bbls x $7/bbl x 86% ownership / 590 shares = $30.61
Moosehead P10 = 5.5 billion bbls x $7/bbl x 86% ownership / 590 share = $56.12

Chances of Realizing Value From Murombe or Moosehead

Assumptions:

  • A gas discovery is worth nothing
  • If successful, the chance that the discovery is oil is 50%. These are oil prospects so the chance of a gas discovery is less than 50%, but I don't know how much less so I am going to conservatively assume 50%
  • If successful, the chance of at least Pmean = 40% (the chance of finding at least the mean value is less than the 50% chance of the median value)
  • If successful, the chance of at least P10 = 10%

Chance that both wells fail = .77 x .75 = 58%
Chance that at least one well is a success = 1 - .58 = 42%
Chance that at least one well is an oil success = 21%
Murombe Pmean = .23 x .5 x .4 = 4.6%
Moosehead Pmean = .25 x .5 x .4 = 5%
Murombe P10 = .23 x .5 x .1 = 1.15%
Moosehead P10 = .25 x .5 x .1 = 1.25%

Conclusion

There is a 9% chance that either Murombe or Moosehead will be worth at least $30/share in value. Using these odds and the current share price of $1, the Kelly Formula Calculator says to bet 5% of your bankroll. But wait, there's more! There is a 2% chance of HRT being worth at least $55/share. Furthermore, Murombe provides a 1% chance of at least $100/share in value. Below I have plotted these points. Notice that there is a 79% chance of no payout and a fat tail for the other 21% of outcomes.

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The Kelly Formula Calculator assumes an all or nothing bet. While there is a chance that you may lose all of your money with HRT, I argued in Part 2 that the chance of losing all of your money is much less than 100%. (Also, you can read Part 1 here.)

Disclosure: I am long OTC:HRTPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. I do not work in the petroleum industry and there is a risk that there is an error in my analysis.