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Harvest Natural Resources, Inc. (NYSE:HNR)

Q4 2008 Earnings Call Transcript

March 5, 2009 11:00 am ET

Executives

Keith Head – VP, General Counsel and Corporate Secretary

James Edmiston – President & CEO

Steve Haynes – VP, CFO and Treasurer

Analysts

Bill Frazier – Greenhill Capital

Michael Bodino – SMH Capital

Mike Sikvolo [ph] – Matlin Patterson

Operator

Good morning, and welcome to the Harvest Natural Resources earnings conference call for fourth quarter and year end 2008. As a reminder, this conference is being recorded. I will now turn the call over to the Vice President And General Counsel for Harvest Natural Resources, Mr. Keith Head. Please go ahead, sir.

Keith Head

Thank you. Good morning, and welcome to Harvest Natural Resources 2008 fourth quarter and year-end results conference call.

This morning our press release was broadcast through the company's fax and email list. If you would like to be on one of those lists or you did not receive yours due to a technical difficulty, please call our office at 281-899-5700. In a few hours, a replay of today's call will be available in the Investor Relations portion of our web site at www.harvestnr.com. Additionally a telephonic replay will be available this afternoon by dialing 719-457-0820.

This conference call will contain various forward-looking statements and information including management's expectations regarding financial, operating and other results. These statements are based on management's beliefs as well as assumptions made by and information currently available to management. Although the company believes that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to have been correct.

Actual results may differ materially from the company's expectations due to changes in operating performance, project or drilling schedules, oil and gas prices as well as other technical, political and economic factors. Additional detailed information concerning a number of factors that could cause actual results to differ materially from today's information is readily available in the company's SEC filings under the heading risk factors.

The SEC permits oil and gas companies to disclose in their filings with the SEC, only proved reserves that the company has demonstrate by actual production or conclusive formation tests to the economically and legally producible under existing economic and operating conditions. We may use certain terms on this call such as resource potential, probable reserves, possible reserves, prospective resources and similar terms which the SEC's guidelines generally prohibit us from including in our filings. Investors are urged to consider closely the disclosure in our form 10k, which is available from the SEC or on our web site.

At this time, I would like to turn the call over to James Edmiston, Harvest Natural Resources' President and Chief Executive Officer.

James Edmiston

Thanks, Keith and thank you for joining us today. Hopefully you've had a chance to review the earnings release. I'm going to run down the progress of Petrodelta and our exploration programs and then Steve will discuss our fourth quarter and year-end financial results. After that, I'm going to take a few moments to discuss current environment, and our plans for 2009, and at the end we'll open up for any questions that you might have.

Let's start with Petrodelta. Operationally, Petrodelta delivered 1.6 million barrels of oil or 17,000 barrels of oil a day to PDVSA during the fourth quarter compared with 1.2 million barrels or 13,100 barrels per day in the same period one year ago, an increase of about one-third year-on-year. Sequentially production was up only slightly from the third quarter owing to the OPEC related production caps imposed on the business. Again, sequentially, production by month for the fourth quarter was 17,100 barrels per day for October, 16,400 barrels per day for November and 17,400 barrels per day for December, approximately.

During the fourth quarter, 1.6 billion cubic feet of gas or 18 million cubic feet of gas per day were delivered to PDVSA compared to 3.3 billion cubic feet of gas or 36 million cubic feet of gas per day in the same period one year ago. For the year ending December 31, Petrodelta delivered 5.5 million barrels of oil or 15,000 barrels of oil per day to PDVSA compared with 5.4 million barrels of oil or 14.7 – 14,700 barrels per day for the year 2007.

You remember that our drilling program commenced in April of 2008. So while production was just above flat year-on-year, production increased by 42%, from April when the drilling commenced through year-end. Gas delivered to PDVSA for the 12 month ended December 31st, was 10.7 bcf of gas or 29 million cubic feet of gas per day, compared to 13.5 billion cubic feet of gas or 37 million cubic feet of gas per day for the same period last year.

Now let's move from the production results to the drilling program. Currently Petrodelta has three rigs running, two in the Uracoa field and one in the Temblador field and we expect to be down to two rigs in the coming weeks. In the last call, while I pointed out the drilling time improvements that had been captured through the third quarter, I also communicated Petrodelta’s near term goal was to average less than 25 days drilling complete with costs below $2.5 million per well.

And although Petrodelta continued to have some struggles, especially with one rig in particular, they made some outstanding progress in drilling efficiency otherwise. Overall, Petrodelta drilled and completed 11 wells at an average of 25 days and costs of $2.9 million per well over the period. However, several wells have been drilled in less than 20 days, and the last Temblador well set a new record in drilling and complete time of only 15 days; more on that well later.

The importance of those improvements are two fold. First, the improved performance in drilling time allows more wells to be drilled annually per rig, which translates to improved production growth rate. Secondly, the improvements translate to lower capital cost per well, and therefore improved economics. The second point related to costs should improve even further as we begin to see lower service in commodity costs associated with the drilling program.

Also in the last call, I discussed that with a precipitous drop in oil prices that you would likely see Petrodelta accelerate the focus on appraisal and development of the new fields, namely Temblador, Isleño and El Salto. So far, Petrodelta has drilled two wells back to back in Temblador and is currently drilling a third. As you may have read in the press release, the results so far have been outstanding. The first well PT-62 was drilled and completed in 24 days with about 8 days of trouble time. The well was turned to production on February 9th and continues to produce around 2,000 barrels a day with less than 10% water cut.

The second well, PT 63 was drilled and completed in only 4.6 days, which is their new record. The well was turned to production March 3 and is producing 2,600 barrels of oil per day virtually water free. For the engineers among you, each of those wells are being pumped with electric submersible pumps and only about 200-PSI drawdown. That indicates these truly are world class reservoirs with very high conductivity. At current prices and cost, these two wells achieved an internal rate of return well in excess of 100%.

In summary, from an operation standpoint, Petrodelta increased production 34%, from December 2007 to December 2008 with only one rig running for two-thirds of the year. Currently, Petrodelta is being allowed to produce around 20,000 barrels of oil per day, 64% above production levels prior to commencement of the drilling program. Along with the increase in production levels to date, and given that the backlog of workovers and well remediation is down, we should expect to see significant improvement in unit operating costs, primarily driven by higher production levels and a fairly high percentage of fixed costs.

We believe that even at today's prices, Petrodelta will generate substantial cash from operations with which it can fully fund its continuing capital program. As long as Petrodelta can deliver the kind of results it has of late, I believe that shareholders will be pleased to reinvest cash from operations at high levels into further expanding its operation and further expanding the new fields across the asset base. Hopefully by mid year, we'll have something to say about initial appraisal drilling at the Isleño fields and the El Salto fields as a follow on to the Temblador success to date

Now let me turn to our exploration program. You'll note that our fourth quarter results included exploration charges of $7.4 million, and dry hold costs of $10.8 million. We will start with Budong in Indonesia. Work on our 1.4 million acre Budong PSC located onshore west Sulawesi, Indonesia, is progressing. As you may recall, we will fund 100% of the first $17 million of the program to earn our 47% interest. Acquisition and processing of the 650-kilometer seismic sheet is complete, and interpretation is underway. After completing the interpretation, we expect to drill at least two wells beginning in the second half of 2009.

We spent about $7.7 million on the block through year end 2008 and we expect to spend up to $8.1 million in 2009 associated with late year drilling of the first of two back to back exploratory wells. In Gabon, Harvest operated 680,000 acres Dussafu PSC is also progressing. As you may remember, in September we closed the purchase of an additional 16.66% working interest, bringing our total working interest to 66.7%.

We are reprocessing 1,076 square kilometers of existing 3-D data covering the pre-existing, undeveloped Gamba discoveries on the block. Additionally, we completed the acquisition of 650 kilometers of 2-D seismic. Both data sets are currently being interpreted and we remain on schedule to mature the exploration potential of this block to drilling decisions sometime next year. We have spent about $5.4 million on the block and through year end 2008, and we expect to spend $2.2 million in 2009 in order to reach a drill/no drill decision point.

In the US, we'll start with the Gulf Coast AMI. In January, we reported the results of the Hunter No. 1 well in Louisiana recorded the dry hole cost in Q4. Our West Bay project near Galveston Texas, we've begun interpretation of re-processed proprietary 3-D seismic data set and we expect to complete the interpretation phase sometime in the second quarter. We've also submitted the required applications with the Corps of Engineers to clear the way for our drilling in West Bay. This permitting process will be the critical path item in the process and will likely defer initial drilling into early 2010.

As a reminder, the West Bay project is planned to test a thick section of normal and over pressured Frio and Vicksburg sands on the flank of an untested salt structure. Harvest’s partners control 100% of the acreage over the prospect. We spent about $5.4 million on the project in 2008, and plan to spend only about a half million in 2009 assuming the well is deferred to 2010.

In the Rockies, on our Antelope project, we made substantial progress on our lease acquisition program. As pointed out in the press release today, we plan to spud a deep gas test in the Uintah Basin of Utah to test multiple horizons for both oil and gas. We have a large concentrated acreage position on the prospect, which we continue to build upon. Assuming the permitting and procurement process proceeds normally, we plan to spud the well sometime in the second quarter.

We've spent about $8.4 million on the projects since inception through year end 2008, and plan to spend as much as $18 million on the project in 2009. I look forward to sharing more about this project with you in the near future as we complete the land acquisition phase. While Harvest has invested almost two years and a considerable amount of money into the project, it is still exploration, and carries what one would consider normal exploration risk. However, the risk reward profile is such that if we are successful, this project could easily be a game changer long-term for Harvest.

With that now I would like the turn the call over to Steve to discuss fourth quarter and 2008 year end financial results in detail.

Steve Haynes

Thanks, James, and good morning everyone. Our form 10-K will be file later today, and will be posted on our web site at www.harvestnr.com.

First I will provide the 2008 financial results of Harvest. Harvest incurred a net loss for the 2008 fourth quarter of $19.7 million, or $0.60 per diluted share, compared with earnings of $68.1 million, or $1.86 per diluted share for the same period one year ago. Our fourth quarter 2008 results include $7.4 million of exploration expense, primarily related to the purchase and reprocessing seismic for US operations and acquisition and processing of seismic for Indonesia and Gabon operations. We have also incurred $10.8 million of dry hole costs for drilling of the Harvest Hunter Number One exploration well, which was plugged and abandoned in January 2009. For the year ending December 31, 2008, we incurred a net loss of $24.3 million, or $0.71 per diluted share compared with earnings of $60.1 million, or $1.59 per diluted share for the same period one year ago.

Now I would like to talk about Petrodelta’s financial results. Petrodelta's fourth quarter earnings prepared under International Financial Reporting Standards, IFRS, were $24.3 million, or $7.8 million net to 32% interest. After adjustments to conform with US GAAP, our 32% share Petrodelta’s earnings was $9.9 million. Petrodelta results of operations are summarized in note seven of our form 10-K, and are also attached to our press release.

Petrodelta’s earnings for the 12 month ending December 31, 2008, prepared under IFRS were $121.2 million or $38.8 million net to our 32% interest. After adjustments to conform with US GAAP, our 32% share of Petrodelta’s earnings was $28.7 million. The GAAP adjustments that are made to adjust the Petrodelta net income to Harvest are as follows

First, add back the deferred tax benefits on non-monetary assets as calculated by Petrodelta. Two, amortize the excess bases between Harvest carrying value of Petrodelta investments prior to the conversion and the value assigned by CVP to the Petrodelta assets at conversion; the amortization has been calculated using current production over three key reserves at the day of conversion.

Three, reverse the deflation expense under IFRS reported by Petrodelta and record completion expense based on US GAAP and SEC requirements. Four, add back to reserve for the accrued interest on certain invoices billed to CVP, which were recorded in the third quarter of 2008. This is a nonrecurring item.

Now I would like to go through the Petrodelta income statement in more detail to provide clarity of the operating and financial results reported by Petrodelta under IFRS. For the fourth quarter of 2008, the world market price for quality of oil produced by Petrodelta averaged approximately $46.57 per barrel, or 70% of West Texas Intermediate. Due to the drop in crude oil price, there was no reduction to the price per barrel for the windfall profits tax in the fourth quarter of 2008.

In December 2008, Petrodelta received communications from PDVSA’s affiliate, CVP, that revenue should appear as the gross amount on the financial statement; therefore, Petrodelta reclassified the wind fall profits tax paid during the year out of oil revenue and recorded this expense on a separate line item. The wind fall profits tax is deductible for Venezuela income tax. Finally, the natural gas price was contractually fixed at $1.54 per thousand cubic feet.

The fourth quarter operating expenses were $13.5 million, and workover expenses $10.9 million. Operating expenses per barrel of oil equivalent net to Petrodelta after paying the 30% income royalty was $9.86. To be clear, we are dividing 100% of the cost by 70% of the production volume for these unit cost numbers.

General and administrative expenses were $12 million or $8.35 per barrel of oil equivalent net to Petrodelta. Taxes other than income were credit of $10.6 million or $7.78 per barrel of oil equivalent to Petrodelta. This credit is an adjustment which relates to a liability for science and technology fund obligation that is now recorded at the PDVSA level. Total cash costs, including operating G&A, taxes other than own income, were $18.39 per barrel of oil equivalent, about $10.82 excluding workover expense.

Now let's recap dividends paid from Petrodelta during 2008. During 2008, Harvest received a cash dividend of $58 million from its 32% owned Venezuelan affiliate Petrodelta. The dividend represents Harvest’s 32% share of Petrodelta’s $181 million of net income as reported under IFRS for the period of April 2006 through December 2007. Also Harvest received an advance dividend from Petrodelta on October 29th, 2008, of $16.6 million, which represents Harvest's 32% share of Petrodelta's $51.9 million of net income as reported under IFRS for the six month ended June 30th, 2008.

I would like to spend a moment and address the Petrodelta reserve at December 31, 2008. At December 31, 2008, Harvest 32% interest in Petrodelta proved reserves was $43.3 million BOE consisting of 34.2 million barrels of oil and 54.2 bcf of natural gas. Approximately 79% of the company's proved reserves were oil and had an after tax present value discount at 10% of $111.4 million. This provides 19 years of projected production. Harvest's probable and possible reserves under FCE/WCC [ph] reserves definition were independently estimated at 33.5 million BOE and 37.9 million BOE respectively, representing a large multiyear inventory of drilling locations. The company did not incur any impairment for the related charges in the 2008 or changes in the 2008 proved reserves from the previous year.

I would now like to bring you up to date on our stock repurchase programs. Regarding 2007 share repurchase program, we have completed the purchase of 50 million – of approximately 4.6 million shares of common stock. In July 2008, our board authorized the purchase of another $20 million of Harvest common stock outstanding. We have purchased approximately 1.2 million shares, under this plan costing about $12.2 million. Common stock outstanding as of February 27, 2009, was approximately 32.9 million shares.

Now let's review our cash position. At the end of December, we had $97.2 million of cash or $2.95 per share. We have no restricted cash or debt, due to the repayment of the Bolivar denominated debt in July 2008.

This concludes my comments, I will turn the call back over to James for his closing remarks.

James Edmiston

Thanks, Steve. Let me make a few comments and then we are going to open it up for questions. First thing, I want to communicate clearly that the board management of Harvest are keenly aware of the recent performance of our stock. Many of our shareholders have been with the company since the present board took over. What was then a solvency problem began the first turn-around of the company. You all know the story, the trajectory of the recovery from those dark days in 2001 reached a peak in the second half of 2004, and as a new employee of Harvest at that time, I had to admit that the first six months was a lot of fun.

That fun was replaced with a very difficult period due to policy changes in Venezuela that would last almost three years. Throughout that period, the board management focused on two things. First, that we would find a way to reposition Harvest in Venezuela, that would not only maintain the shareholder value that had been built over those years, but would also provide a foundation for future growth and cash flow.

Secondly, we recognized that it would take time for the equity markets to come to appreciate the outstanding value potential that our new Venezuela business could provide, and that in the interim period, and given our asset concentration within Venezuela only, the market would likely deeply discount our stock relative to the underlying asset value until confidence could be restored. On that basis, we moved ahead with a plan to diversify our asset base over time. During that period, we paid off all of our debt, amassed a solid cash cushion, and we began to put an organization together to support an organic growth strategy.

So why organic and why exploration? For us the logic was fairly simple. We felt confident that we could build significant value in Venezuela and match that level over time. We knew the fields and we knew the assets. We felt that if all else fails, the shareholders would realize significant value over time as the Venezuela story unfolds and significant resources are converted to reserves. But we also felt that no matter how successful we are in Venezuela in the near term, credit markets may actually be closed to us. Drawing down cash reserves to make an acquisition in a rapidly rising price environment wasn't a viable option.

We believe we would have ended up with a portfolio that was about 90% Venezuela and 10% something else and possibly with very little cash. So, we started to put together the most critical piece to exploration success, the technical and organizational capability to explore. Further, we committed to a strategy that ensures that we explore for material projects only in proven petroleum systems, no frontier work, and finally the targets must be viable at low oil and gas prices.

The point of recounting the story of how we got here is to say this; the current upheaval in commodity markets, credit markets and the equity markets doesn't really change much, relative to our strategy. Oil and gas prices have fallen too hard [ph]; quite frankly, our love of our Venezuelan assets is due in part to their significant cost advantage. Look at the numbers, there is a reason why Harvest did not have huge write-offs associated with the price decline. Further, we believe that our exploration portfolio in general remains viable at prices below current levels.

Secondly, on the credit markets, liquidity in the credit markets have been a point of focus since 2001 for Harvest. That's why we insist on a high degree of operational control in order to better manage our outflows and that's also why we try to maintain a pristine balance sheet. As for the equity markets, we continue to be deeply discounted due to our Venezuela concentration as we expected we would be. The imposition of the OPEC cuts had a significantly negative affect on the stock. However, at least recently, the pricing would tend to indicate that we are being priced along with the long list of small cap E&Ps with deep near term financial risk. In fact, we recently traded at a discount for cash.

Like many of you, I must admit that I find that frustrating; however, our reaction to that frustration is simply to effectively execute the plan we've put in place. At some point, our outstanding asset base and operational performance in Venezuela will be rewarded in the market, and we will expose our shareholders to significant new resources and value through our exploration program over the next two years, and do so efficiently and within our cash means. The fact that we will be able to execute our exploration program in a lower service cost environment is a blessing, and we have no plans to defer the program hoping for a better day.

So, with that, let's open the lines for discussion.

Question-and-Answer-Session

Operator

Thank you very much. (Operator instructions). We will take our first question from Bill Frazier with Greenhill Capital.

Bill Frazier – Greenhill Capital

Good morning, gentlemen.

James Edmiston

Good morning.

Bill Frazier – Greenhill Capital

I listened with interest to your last comment. And given that we are trading at basically cash per share, and the last well was a dry one at $10 million, we can't drill too many wells like that. Would it make more sense to buy proved reserves in this depressed price environment and get some growth that way, and may be that might attract some interest in the stock?

James Edmiston

Bill, you certainly make a good point, and it's one that we considered both at a management and board level. In the asset side of the market right now, to be quite honest, what we are seeing is really tier two and tier three type assets. There is a lot of companies that are in trouble, struggling with liquidity, and obviously the first thing they are going to put up for sale are the non-core type assets and they're non-core for a reason. So we haven't – while we monitor that side of the market very, very closely, we haven't seen anything that would provide us with the type of base and the objectives that we have which is to actually create significant diversification from Venezuela.

We simply don't have the cash balance to invest in tier two, tier three type assets at this point in time and to look the market or anybody else in the face and say we've created significant diversification in the portfolio and therefore lowered portfolio political risk. But we continue to look at the market, the asset side of the market. And if and when an opportunity presents itself, we would certainly be open to it but it's got to fit that strategy.

Bill Frazier – Greenhill Capital

Okay, fair enough. The capital budget for 2009, have you put numbers on that yet?

James Edmiston

I think we said that we would be spending – ex-Petrodelta, we are looking at about $38 million in – primarily on the exploration projects. And the big chunks of that would be drilling the Antelope well – the well in the Uintah Basin, would also be kicking off the two wells exploration program in Indonesia on the Budong block. Those are the major items.

Bill Frazier – Greenhill Capital

Do you have partners in Indonesia or are you…

James Edmiston

We do, we do. We have a partner that I believe 52%, and we are 47%. We have people basically involved in the well planning and interpretation, et cetera. Our partner company will actually operate through the exploratory phase and in case it is successful, Harvest is set to take over as operator for the development phase and production phase.

Bill Frazier – Greenhill Capital

Have you folks suspended your share buyback plan to preserve the purchase cash?

James Edmiston

Pardon me?

Bill Frazier – Greenhill Capital

Have you guys suspended your buy back plan or are you still buying back shares?

James Edmiston

The buy back – the authorization is still in place. By way of explanation, you can appreciate that there are periods of time that we can buy stock and periods of time that we can't buy stock, both influenced by SEC rules as well as our own internal governance policies. So basically when you get close to year end, you are out of the market. Until we release results, you are pretty much out of the market and so on and so forth. So that authorization remains in place and we will – certainly the remainder of that buy back is a potential use of cash going forward.

Bill Frazier – Greenhill Capital

That's all I have. Thank you, guys.

James Edmiston

You're welcome.

Operator

We'll move now to Michael Bodino with SMH Capital.

Michael Bodino – SMH Capital

Good morning, guys.

James Edmiston

Good morning.

Michael Bodino – SMH Capital

I have a few questions. Could you give us a little recap on Fusion Geophysical and how it's performing and what its prospects look for 2009?

James Edmiston

Yes. Again, let's go back, Michael, to why we got involved in Fusion. You got back to some of the comments I made earlier that in order to implement a growth strategy we needed to put together the organizational capabilities to actually do it and to do it at a high level. We didn't feel that we would get excellent exploration results with average technical capability. So rather than to internally try to build from scratch all of that capability, we chose to invest in Fusion to provide a wide range of geoscience services at a very, very high level across the company.

Their most recent results were affected by essentially a merger. Fusion's subsidiary that controls most of its technology and technical businesses were merged with a company called 3DGeo. That's a spinout of the Stanford Exploration Group. They're fairly well known in the industry and again, very much on the high end of geophysical interpretation software, well known for reverse time migration, those type things. Officially it was an acquisition type merger where Fusion is the surviving company, and the shareholders of 3DGeo merged in and became shareholders of that Fusion subsidiary. A big chunk of the loss reported by Fusion for the year '08 is associated with losses incurred in that merger. I think on the Fusion based business, they did generate positive cash last year.

Now, I think in the near term as far as prospects at Fusion, other than again, strategically what they provide for us, which doesn't show up in our balance sheet or theirs, times are tough in the industry for all those service companies, and they are certainly going through a rationalization process internally to fit the market, that they going to be operating in in this environment. I think they are expecting a higher percentage of their work to be internationally focused where larger scale projects haven't slowed down to the extent that the work that they've done in the US has. But we expect they will right size their business, live within their cash means. And as a major revenue stream, we expect later this year for them to roll out their integrated geophysics package and software sales to win and supplement the service work.

Michael Bodino – SMH Capital

Okay, great. That's a great update on that. Question on Venezuela and the drilling, I know you are going down on two rigs, just curious relative to the quotas and what you are currently producing, what do you need to keep running to maintain flat production there and then how much do you want to do – work do you want to do down there this year to do things like going out there and developing Temblador and some of these newer fields?

James Edmiston

Good question, Michael. I think, and I'm not going to tell you that we've sharpened our pencils to look at the numbers, but I think the math would be pretty simple. If I can drill a few more of those Temblador wells like the last two, one rig would be more than enough to maintain flat production. I'm just not sure that all of them are going to meet with that level of success. However, we haven't drilled dry holes. But the point is, a very small – at a 20,000-barrel a day level, the amount of rig activity required to hold flat is probably no more than one rig, and I would be surprised if it was even one rig for a full year.

The production caps, I mean the reality of production caps is Venezuela is a strong advocate of OPEC and certainly the policy they put in place since I've been working around them show very strict compliance with what they've agreed to. Now how they manage their OPEC balances within the large portfolio of not only their own operations but these mixed companies, they do that on a very fluid basis. And I think they go through the year and they're looking at capital spending across that entire basin and they are then applying those production caps to the individual businesses, and those individual businesses including Petrodelta are expected to comply with those, and in fact we do and we will continue to do so.

I think while I've – I certainly can't predict what the numbers are going to look like, but what I can say is that in Venezuela, like in every place I know of around the world in our business right now, there has been a pull back in capital spending. And when that happens, one expects a natural decline to set in in all the fields like every field in the world has a natural decline.

The important part about that to us, and to Petrodelta in particular, is Petrodelta has a cost advantage in Venezuela, and quite frankly worldwide. If you'll look at the F&D numbers, and you look at directionally, where the operating costs are headed, as the denominator, the barrels per day increase, I think as you start to allocate in any portfolio, A, where to invest capital, and B, where those caps would be meted out, I would expect them to allocate based on profit, and the state's interest, and so I think in that regard Petrodelta is very, very well positioned.

The second part of your question as far as the new fields, there is – you take a look at Temblador, we just drilled two wells back to back, producing a couple of thousand barrels a day each. We're not pulling, they're not being pulled very hard, and yet you look at the reserve ledger for Temblador field. As an example, I think, the entire proved oil reserves that's booked for that's around 12 million barrels gross, and that's gross to the 100% Petrodelta.

You start looking at the numbers and you see that the businesses improved, has moved Temblador production from, let's say, 500 barrels per day a year ago to 6,500 barrels per day today. And you go – I'm betting that that number, that 12 million barrels of reserves on Temblador, probably is going to increase. So I think that while you have the cap in place, it doesn't make a lot of sense for us to build up huge excess capacity of above what we can produce. We think there is much better value in converting contingent resources and possible and probable reserves into proved reserves and not defer further the appraisal work on the known – the huge known accumulations out there.

So I expect in the first half, in addition to continuing drilling in Temblador, I believe Petrodelta has plans in the first half to spud their first wells in Isleño and El Salto, and I think that's an outstanding use of money. Further, I think at these levels of production now the business generates strong cash from operations and it can easily manage that type of a drilling program. So at this point I couldn’t be – I would love to produce unconstrained, but that's not the issue, but I'm pleased with the direction where Petrodelta is headed.

Michael Bodino – SMH Capital

My last question, I'll let somebody else jump in here. Relative to the 20,000 barrel a day allocation, are you'll giving any time line of how long that is in place or does – or do you just get periodic calls saying you are now at – you are back to 16 or you need to gear back to – you're up to 24, how does that work?

James Edmiston

Obviously, I don't get a call. I get the information passed on secondhand. But the president at the business level gets a call from PDVSA that most surely emanates from the ministry. And, they give them the information that they can. I think they try to give them, okay, a month out, two months out. However, on a day, if they get a phone call that says you need to reduce your rates to X, they go to the field and reduce their rates to X. And quite frankly, for Petrodelta, it's not very difficult to do that. It really amounts to speeding down – or slowing down the speed on the electric submergible pumps. So it's not terribly – it's not a huge interruption to a point. But quite frankly the dialog around production allocation or allocation of the OPEC cuts, I think is an ongoing dialog.

Michael Bodino – SMH Capital

I lied, I am going to ask a little bit more. Given the 20,000-barrel a day allowance, can you give us a little bit better feel for what first quarter volumes are shaping up to look like on average with January and February behind us already?

James Edmiston

I think I have – let me shuffle a bit of paper. I think I have January, February around here somewhere. It's clearly going to be an up tick to what you saw in the fourth quarter. Let me see. I think in January we averaged around 17.5. These are approximations.

Michael Bodino – SMH Capital

Sure.

James Edmiston

In February, we averaged around 18.6.

Michael Bodino – SMH Capital

Okay, very good. I'm going to jump back in queue, let somebody else ask a couple of questions, thank you.

James Edmiston

Thank you, Michael.

Operator

(Operator instructions). We will move next to Pandl Zachariah [ph] with Matlin Patterson.

Mike Sikvolo – Matlin Patterson

Hi, it's Mike Sikvolo [ph] from Matlin Patterson.

James Edmiston

How are you?

Mike Sikvolo – Matlin Patterson

Good, Jim. How is it going?

James Edmiston

Good.

Mike Sikvolo – Matlin Patterson

Got a couple of quick questions. We're just looking at, the stock is starting to trade at or – at times below cash, and wouldn't it make sense in this kind of environment to curtail some of the capital expenditures in new exploration and just buy back some stock?

James Edmiston

Again, I will say that we considered it. Keep in mind, we've pulled probably fairly close to 20% of the stock off the market in the last year or so. And to be quite frank, sitting here today, if you ask my opinion I would much rather have $60 million in my pocket versus that. We stand by the decision. We think the stock was under valued then, we clearly think it's undervalued now. Having said that, obviously, times have changed a bit. But buying back stock, the authorization remains in place, it remains an option for use of cash for us.

Let me answer your second question about deferring growth program at the expense of – in order to do something else. The significant amount even of our G&A and of our activity inside the company is associated with that growth program. To slow down that strategy when we are able to fund it and it also has an associated carrying cost of that program, almost suggests to me a bleed-out strategy. We have more than enough cash to execute on that program today and this year and next year, quite frankly, in a measured way, and by doing so expose the shareholders to significant material additions – potential additions to reserves and growth for years to come.

I can certainly say in the success case, of many of those prospects that we are looking at, in the success case, the financial and value impact to the shareholders far exceeds what we can do with another $10 million in cash buy backs. But having said that, we have concentrated ownership in the stock through about – through taking 20% of it off the market over the past year, and that option remains open. But, for now, we are going to move forward with the growth program that we’ve put in place, and that's about all I have to say on it.

Mike Sikvolo – Matlin Patterson

Great. We're just trying to figure out if there is additional down side risk in the stock. We think it's massively mispriced, it's very cheap. Every time we have a dry hole or we have some kind of exploration failure in this environment, it's going to get reflected on a greater downside risk, so from our point of view, just from kind of risk management point of view, we would kind of like to see some capital being preserved and probably returned to shareholders.

James Edmiston

But again you’ve got probably between the technical and operational people associated with those programs, you got upwards of, let's say, $7 million to $10 million a year dedicated to doing that. And so the savings from deferral of those programs, I don't think is what you or others might think it would be. And to let go of those people would basically impact that growth portfolio for years down the road, so you are not going to do that. But again, we remain open to those uses of cash. The board and I and the management team talk about it at every board meeting. I'm just trying to express where we are on that.

I want to address a second part of it. We are a bit of an odd company in this earnings cycle in that you didn't see us take big write downs. Clearly we don't have equity line or credit line re-determinations hitting us because we have none. Yet, statistically, we are not being priced relative to a fall from a 52-week low in the group of severe financial stress, but we are not terribly far off of it. But I would – if the company is being valued at cash equivalent, I think some of that is a bit coincidental. I think the real issue we need to focus on, what we focus on in terms of how we view the value of the company is on the Venezuelan asset plus cash.

And clearly I think by any measure, the Venezuelan asset is grossly under valued and for a number of reasons, and some of which we’ve already touched on. But from an asset basis, pull – if you do nothing but you pull the Petrodelta statement out from under Harvest and look at the kind of cash from operations it generates, and the exposure to known reserves in place, I don't think anybody can legitimately justify the type of inferred values and I'm talking about inferred by current enterprise value, that that thing trades for. It certainly is a huge disconnect in my view from what the asset market would be for Venezuela.

Mike Sikvolo – Matlin Patterson

Is there a way for us to monetize the asset? Is there some kind of structure we can use or some kind of financial engineering so we can monetize any of that asset?

James Edmiston

We are always open to that. But I mean, let's consider what the normal thing would do. The normal thing would be to go out and borrow money against it, right? And the credit market obviously is in a bit of shambles right now. You seen the yield, the yields on the high yield market what those look like. I don't think it would be questionable, even though it would probably infer a huge – a much bigger valuation than what we have, it's not something that I desire to go out and borrow money at 20 something percent equivalent, in order to prove a point about the Venezuela valuation.

But there is no question, we’ve looked at that – we’ve looked at that often, the possibility to monetize the piece. But for all practical purposes, since OPEC quit riding cover on Venezuela a couple of years ago, it is very, very difficult getting the kind of conventional type debt against it. But without question, and I can assure you that we are always looking at the opportunity to do things that can more fairly reflect what we believe the value in Venezuela is.

Mike Sikvolo – Matlin Patterson

Great. Thanks for the answer, and I'm glad that somebody at the firm is looking at the stock price too, because there is significant mispricing in the market relative to the value underlying the assets.

James Edmiston

I absolutely agree with you. Thank you.

Operator

(Operator instructions). With no further questions, I would like to turn the presentation back over to Mr. James Edmiston for any closing or additional remarks.

James Edmiston

Well, again, thanks to all of you for joining us. I hope we answered your questions. I hope we are starting to get to the point where we can express pretty clearly in numbers the value build that is available to us in Venezuela. If you extrapolate the operating numbers that we are currently experiencing versus what was last year, if you look at the operating – unit operating cost going down, you'll see, I believe a decent expansion of cash from operations versus the fourth quarter, and you will see the ability to maintain a fairly high reinvestment rate of capital program in Venezuela that will certainly move probable and possible reserves into the proved category and build value at an asset basis from that standpoint.

I think equally we are extremely excited inside the company to begin to test the growth prospects that we have been working very hard over for the last couple of years. And again, I can't guarantee success on anyone individually or on the portfolio as a whole. What I do feel very strongly about is this program is going to expose the shareholders not only to the loss of the dry hole, but it's going to expose the shareholders to significant material resources, exploration resources, that could have a very large impact on our company going forward. So with that, I look forward to talking more about that in Q2, and further updates on Venezuela. Thanks.

Operator

This does conclude today's Harvest Natural Resources conference call. We thank you all for your participation, and everyone have a great day.

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Source: Harvest Natural Resources, Inc. Q4 2008 Earnings Call Transcript
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