The following is excerpted from The Energy Report's March 19th article:
With more than 25 years in the business, Malone Mitchell, chairman of TransAtlantic Petroleum Corp., has not only endured but also prospered through seven downturns, turning assets he bought in the 1998 down cycle into billions. His secret? A dynamic business plan. In an industry that provides constant, if changing opportunities, a business plan that adapts along with the market—every three to five years—makes for a great business, according to Malone. In this exclusive interview with The Energy Report, he discusses the business service modifications that enabled TransAtlantic to corner some select foreign markets, likens operating in Morocco and Turkey to operating in Texas, defines what he calls a ‘friendly hostile bid’ and explains why he’s been waiting 23 years for this situation.
The Energy Report: Can we start with your macro overview?
Malone Mitchell: Sure. I started in the business 25 years ago and have seen seven downturns and six upturns, and that’s one of the great things about the industry—it provides a constantly changing opportunity to do business. If you tried to execute the same business strategy for 25 years, you’d be disappointed. So long as you’re willing to change every three to five years, it’s a great business. The business obviously made a very radical change starting last summer. Where once anybody could get any amount of money to develop any prospect and virtually any play anywhere that would pay off economically, now the market is pretty selective.
We had anticipated—certainly not the day—but we had anticipated that things were getting a little frothy just because we’ve seen these cycles before. I had pulled about a billion dollars out of some former energy investments and actually chose to go international with our company.
From a macro standpoint, the thing I’ve come to find out over and over, when everybody says it’s going to be great, it’s about to go the other way; and when everybody says it’s going to be horrible forever, it’s about to turn and get better. I am pessimistic with regard to the price of natural gas in the United States. I think it’s a shale play. . .it’s like the laws of physics have changed and, if you weren’t cognizant of the change in the law of physics, you’re going to be hurt by it. I am optimistic with regard to natural gas prospects we see internationally, in Europe or the European consumer basins, where they’re dependent upon Russia for their supply. I think that there continues to be a pretty strong-arm control of prices that will take quite some time to moderate. Unlike natural gas, which you find anywhere you drill and is normally found at deeper depths, I think there is a much more finite supply of oil, so I believe that we’re probably going to see a recovery in the price of oil.
Generally, I think we may see a recovery in the price of oil as early as the second half of 2010. Having studied economics, not oil and gas, in college, I tend to believe that we’ll solve these economic crises the same way every prior require society has, by debasing our currency, by inflating our way out of it. I think we’re going to see higher oil prices and fairly high gas prices.
TER: You say you see it going higher. Do you see it going lower here? Do you see a possibility of it going to $25?
MM: We’ve hedged virtually all of our product. I do see the possibility of it going lower. Investment is falling at such a rapid rate. I read pretty avidly every day, but it’s hard for me to get a handle on exactly where all of our economies are going to bottom out at and how low consumption will drop.
I’ve got a lot better sense of the supply side of the equation than I have the demand side of the equation and that’s probably the new variable. So I can tell you that supply is going to be impacted dramatically in everything but United States natural gas. I just cannot tell you how rapidly it’ll go down. That being said, I have hedged virtually all of our production for the years 2009 and 2010, and I have hedged all of our natural gas production domestically in the United States through 2012.
TER: Where do you see opportunities? It sounds like you’re looking internationally.
MM: ...We started looking about a year and a half to two years ago more seriously at the international market. For the last 20 years, we’ve seen prospects come to us that, typically, had a number of things in common. There had been a few wells drilled by a large oil company 20 years ago that had what would be considered by U.S. standards very good oil and gas shows, but that had not led to full-scale development by the large company. At that time, we didn’t have the capital, the people or attention to devote to following those prospects.
In the mid-1990s, we did work in South Africa and in Canada, but were probably still a little thinly capitalized to be able to develop those opportunities. About a year and a half ago, we started reviewing prospects internationally because we thought competition, for land both within and outside of the shale plays of the U.S., had become very fractionalized and it’s very difficult to put together a meaningful acreage position on something that we thought was going to allow us to have substantial reserves. So, in the process of doing that, we started studying a number of foreign countries and foreign prospects and wound up taking a majority stockholder position in Transatlantic Petroleum Corp. In doing so, we found an existing management group, which had largely come out of Arco and had managed its Mediterranean area.
When BP (BP) acquired Arco, BP decided to divest virtually all of its onshore properties other than the Bolivian asset, so they left behind a team of land people, geologists and engineers who were knowledgeable on all these field areas where Atlantic Richfield had been exploring for years. What we found in that company was the beginnings of a decent acreage base, but very insignificant capital to be able to develop anything. They were really just looking to farm out properties.
In the process of working with them, we’d been looking at expanded opportunities with other companies. We recently made what I would call a ‘friendly hostile bid’ for Incremental Petroleum Ltd., which is listed on the Australian Exchange. I believe we’ll be successful at acquiring over 90%, and then cash merge the balance within the next two months into TransAtlantic; we work in joint ventures with a number of other companies. One of the companies I’ve been very impressed with is Sterling Resources Ltd..
They have the largest gas discovery in probably the last 10 years, in the North Sea, that they’re developing. They have large gas resources in the Romanian Black Sea they’re developing. They struck me as being very competent people. We reached an arrangement with them to jointly develop a 1.6 million acre block that they had in Romania. I think I’m one of their five largest shareholders now.
We are also in the process of negotiating with a number of other companies. We could name a number of companies, but I think because we’re in negotiation, it might verge on insider trading.
TER: We don’t want to do that. What are other areas?
MM: We’re focusing on areas that allow licensing, which means you can own your reserves rather than production sharing agreements, that have stable to moderate governments. We do not look in the ex-USSR areas. I have also done a lot of business, for a lot of years, in China and have partners in India. I just do not feel that those countries represent an opportunity for us on reserves.
Currently we’re active in Morocco, Romania and Turkey, and we’re actively looking at assets in Tunisia, Italy, the Netherlands and Bulgaria, and in addition to companies and properties in those areas. The thing that we felt would make a difference in all these countries is to bring our own service equipment. We had mobilized our own drilling rigs and a substantial amount of other equipment to these countries and we think that that will enable us to reduce costs considerably.
We just acquired the second largest oil field in Turkey. It’s been developed on a density basis of about 5% of what any comparable field and comparable reservoir would in the U.S., so we’ll have the opportunity to see if our deeds can match our words.
TER: Malone, of all of these countries that you’re looking at, are you looking at oil or natural gas or a combination?
MM: In Turkey and all of these countries, you’re receiving $12 an MMBTU for natural gas. I look at gas prospects that are proximate to good markets and good pipeline systems that have two- to three-month payout in Turkey and Romania. I look at oil properties that, when you look at just the amount of oil that’s been recovered out of the last wells drilled in the field, you just can’t find that in the U.S. anymore.
We continually see fairly low-tech completions and stimulations that produce results that just can’t be done in the U.S. Most of these countries don’t have any stimulation equipment within the entire country. In fact, today we decided to go ahead and add the acidizing as a service that we would provide in the country of Morocco in our service company for both ourselves in other companies, and there is literally no one doing that in the entire country. If you want to acidize a well, you call Europe and you get something shipped out of Europe with a mobilization charge that’s in the hundreds of thousands of Euros.
TER: Are there other public companies that are developing in Morocco?
MM: Yeah, there are two companies that are operating—a company named Circle Petroleum. Circle has recently drilled some very successful gas wells in Morocco. All of these, I think, are mostly AIM-listed companies. Another company that’s active over here that we have relations with, and that seem to have a very good program, is Cabre.
Our company in Romania will probably be the most active operator in the country next to the State Oil Company. In Morocco, we will be more active than the State Oil Company. The difference is you come over here to any one of these countries—Romania or Turkey—both of these countries offer relatively the same amount of promising geology as the state of Texas. In Texas, there are areas that you don’t drill; the geology’s not suitable. Both of these countries have roughly the same amount of promising geology.
During the last upswing in Texas, there were over 800 drilling rigs running. In either Turkey or Romania, you may have no more than 10 rigs capable of drilling at any one time. The level of development here is comparable to the Permian Basin in Texas in 1938. The shallow giants have been found but they’ve not been thoroughly developed. The separate fault blocks that would be great fields in the U.S., but modest fields internationally, have not been defined by seismic and most of the deeper plays have never been drilled.
In Romania, it’s very common to see wells that are only 3,000 or 4,000 feet deep; but when you shoot 3D across it, you see phenomenal structures that are 6,000–9,000 feet deep. In Turkey, there are only 40 or 50 oil wells in the entire country that have penetrated below the cretaceous formation.
I might mention some other companies from a service company standpoint, really the only companies that you see over here are Schlumberger (SLB), Weatherford (WFT), Baker Hughes Inc. (BHI) and Halliburton (HAL), so we think there’s an absolute opportunity for smaller service companies to make inroads into these countries and have very, very good profit margins relative to what we see in the U.S. because the competition is just so slim.
TER: Are you familiar with a company called the FX Energy Inc. (FXEN) in Poland?
MM: Sure. We had looked at FX and done some studies. One of the things I became cognizant of is that the cost of reserves, the cost of production for foreign companies, was much less expensive as just an investing shareholder rather than domestic companies. We did research on FX, invested in that, as well as BPZ Energy Inc. (BPEZ), another company that just stuck out in our research.
BPZ operates primarily out of Peru. Both FX and BPZ stuck out as the anomalies on our research about foreign companies that seemed to have outsized reserves relative to their market caps. We have targeted companies that we thought we brought more to the table from an operational standpoint.
TER: Domestically, where do you see the price of oil trading as we go through ’09 –’10? Can you give me a price point range?
MM: Yeah. Based on contango (a condition in which distant delivery prices for futures exceed spot prices, often due to the costs of storing and insuring the underlying commodity), we’re locked in as a company. We’re locked in with kind of floors at $40 and if you look at it on a contango basis, our ford strip on our crude oil leaves us taking very little capital investment risk that isn’t covered by an average $50 price we’re receiving for crude oil. I am all for it dropping. If it dropped to $20 tomorrow, it would delight me because I have capital and I don’t really have any debt, so it would put me in an even stronger ownership position. As far as a viewpoint of where that price is going, I guess if I had to—based on everything I know—I would have to say we’re going to be range bound here between $30 and $40; and, beginning in probably the middle of 2010, we’re going to see very rapid inflation in the country that is going to lead us to a much higher price with no greater purchasing power. But to the degree that we’ve invested in assets that reflect inflation, which crude oil reserves do, I think that’s a good thing.
MM: As an investor looking at oil and gas companies now, I go back to a pretty simple rule. When you only start with $500 and you only ever have $22,000 paid in capital, what is really important is how long it takes you to pay out the well, what’s your cash flow, what’s your real true free cash flow? I think that’s a point anybody looking at oil and gas companies or oil and gas projects today should be looking at. I think we built up over the course of time, from the ‘80s until mid-2008, where people were buying oil and gas properties and companies based on reserve ads and based on finding costs that were distorted by full cost accounting methods, and I think now all of that’s blown away and we’re really back to more of Warren Buffet “what’s the free cash flow?”— the basis of this industry. I have never, in the cycles I’ve been through, seen rigs laid down at the pace they’re being laid down.
TER: I know, it’s unbelievable.
MM: I’ve got large banks coming to me every week, basically saying these are the public companies we’re dealing in and these are the companies you’re dealing in. They’re going to have no credit and we’re going to take this cash flow. Who do you want to do a deal with? And, unfortunately, my view of credit is somewhat limited in the fact that I think you’ll only know you have credit when you get it, so we’re kind of looking at the cash we have a little more judiciously than we would have a year ago.