The Kurdistan region of Iraq is a geological extension of the world’s richest petroleum fairway, which extends from Saudi Arabia to Syria. It is estimated to have around 45 billion barrels of oil reserves making it sixth largest in the world, mostly recently discovered (even excluding Kirkuk and Mosul which are essentially controlled by the federal government). Due to geo-political conflicts, the resources in Kurdistan have been essentially untapped. Upon the overthrow of Saddam Hussein’s regime in Iraq, however, Kurdistan began to open itself to foreign investment (the tapping of the Kurdistan keg). Currently about 25 companies have been granted the Profits Sharing Contracts (PSC) from the Kurdistan Regional Government (KRG). Some of the publicly traded companies are listed below.
Chart 1 PSC Blocks in Kurdistan
Source: WZR company presentation.
Companies that have made discoveries and/or are producing
- Addax Petroleum Corporation (OTC:ADXTF): Addax has a 45% working interest in Taq Taq, a currently producing oil field, and another 26.67% interest in the Sangaw North PSC. Starting June 1st, 2009, Addax began exporting oil from Taq Taq, a historic event for Kurdistan.
- DNO: DNO entered into a PSC with the KRG as early as 2004. It has a 55% working interest in the producing Tawke field. Just like Addax, DNO was also granted permission to export oil from its Kurdistan oilfield.
- Heritage Oil (OTCPK:HTGLF): The company announced a major oil discovery in early May 2009 with an estimated oil-in-place of 2.3-4.2 billion barrels.
Pre-production: Large International E&P Companies
- Talisman Energy (NYSE:TLM)
- Niko Resources (OTCPK:NKRSF)
- OMV Aktiengesellschaft (OTCPK:OMVKY)
- MOL Magyar Olaj-es Gazipari NyRt (OTCPK:MGYOY)
- TNK-BP (TNBP, listed in Russia)
- Reliance Industries (500325, listed in India)
Pre-production: Junior E&P Companies
- Gulf Keystone (GKP LN or GUKYF)
- Sterling Energy (SEY LN)
- HKN Inc. (HKN)
- WesternZagros (WZR CN or WZGRF)
- Vast Exploration (VST CN or VSTFF)
Investment Theme I: M&A
M&A activities involving Kurdistan-related E&P companies have been heating up over the past several weeks. After a rumored bidding war among Chinese, Korean and Indian companies, Addax was acquired by Sinopec (NYSE:SHI) on June 13th with a price tag of around $8.5 billion (including debt), implying a $6.3/boe or CAD 7.3/boe (3P). On June 9th, Heritage Oil announced its acquisition of Turkish oil company Genel for $5.5 billion. Genel is the working partner of both Addax and DNO in Kurdistan. Last time we heard any meaningful M&A news about Kurdistan assets was back in 2Q07 when DNO received and subsequently rejected an unsolicited offer ($700 million) for its Kurdistan assets from an unidentified international oil company. Based on DNO’s reserve data as of 2Q07, the offer represented a valuation of $7.3/boe or CAD 8.3/boe (3P).
The biggest X factor in Kurdistan is actually China. Recently, China has been very vocal regarding its concerns of the safety of the US dollar and its holdings of US treasuries. There are a lot of signs that China is channeling its gigantic foreign currency reserves into commodities through overseas acquisitions.
China has a decent track record of acquiring assets in South America, Africa and the Middle East where political sensitivity is less of a barrier than in the developed countries such as Australia. Additionally, after China was outmaneuvered and walked away from Rio Tinto (RTP) deal, China was left with a $19 billion additional war chest for overseas acquisitions (assuming the money is still earmarked for the original purpose). China is no stranger to Iraqi oilfields: China National Petroleum Company (NASDAQ:CHNR) set its foot on Iraq in 1997 and has just signed a development service contract of Al-Ahdab oilfield. Kurdistan oil assets could be an ideal target for China though it has shied away from them to avoid offending Baghdad. Sinopec’s aquisition of Addax provides anecdotal evidence of a possible strategy shift. Besides Addax, Niko Resources could also make an ideal acquisition target for Chinese oil companies. NKO has a market cap of CAD 3.8 billion, large enough to be on China’s radar screen, and a portfolio of assets primarily located in the developing countries where China seems to have a diplomatic edge.
Investment Theme II: Kurdistan Pure Plays
There are only two Kurdistan pure plays in the Kurdistan universe: WesternZagros and its “mini” neighbor Vast Exploration. They share many of the same attractive investment characteristics.
Highly attractive risk/reward profile. We believe that the fair value of WZR (click here for valuation details) is conservatively about C$3.60, or roughly 2.5X its current price. There are many cheap lottery tickets in the E&P universe, but what makes this one unique is its high likelihood of success. It is hard to make a forecast of VST’s NAV due to the earlier stage in its exploration efforts. However, NKO, one of the larger E&P companies in Canada with a market cap of CAD 3.6 billion, is not only VST’s business partner (36% working interest) in the PSC block, but also VST’s largest shareholder (17% ownership). Combining both, NKO’s actual working interest in the block is over 42% (36%+36%*17%). Therefore, buying VST stock is essentially buying a call option on NKO’s Kurdistan business or the eventual consolidation into NKO.
High scarcity value. Kurdistan holds one of the world’s most coveted oil fields, which up until recently was off limits, protected from foreign ownership. WZR and VST were among the first movers, and because they took large risks as foreign investors at such an early stage, their potential reward is sky high.
Kurdistan is actually safe. Kurdistan is no tropical island for the long distance traveler, but it is arguably a true “security oasis” within the war-battered Iraq, and it is ranked “secure” by the US military. Over 20 E&P companies have been operating in the region over the past several years with no major interruptions, which makes this a safe haven among prospective untapped oil reservoirs. Click here for detailed blog on geo-political issues in Kurdistan region.
“Elephant” potential. An “elephant” oil field is one whose recoverable reserves are at least 100 million barrels. According to the well respected oil and gas consultancy Sproule and Associates, as of March 31, 2009, WZR’s exploration block has P90 prospective resources of 1.6 billion barrels. P90, for those unfamiliar with the industry jargon, refers to reserves that have a 90% certainty of actually being produced. WZR’s find, if “proved” would count among the 100 largest producing oil fields in the world. VST’s block is bordering both the WesternZagros block and the Heritage Oil block, which are considered among the 2 most promising blocks in Kurdistan (and in the world for that matter). Heritage Oil announced a major oil discovery in its Miran West-1 well early May with estimated oil-in-place of between 2.3 to 4.2 billion barrels. In early February 2009, VST started a seismic acquisition program for a minimum of 350 km of 2D seismic data. The process will take 4-5 months, and at its conclusion, VST will be able to generate an initial reserve estimate for its block – this creates potentially very market moving news flow this summer.
Terrific takeout potential. WZR, although well capitalized for a “junior” oil exploration company, with $130 million in cash and no debt, is extremely unlikely to remain independent long term. Its exploration partner, Talisman Energy, with $8 billion of revenue and a $16 billion market cap, is better suited to take on this elephant, and may wish to increase its stake by acquiring WZR itself. Other large oil companies who either have been waiting on the sidelines due to lack of a clear regulatory framework or who already have small stakes, are undoubtedly eying WZR’s prized oil fields hungrily. NKO is VST’s exploration partner and its largest shareholder. The likelihood that NKO eventually acquires VST in whole is arguably quite high, which provides another very direct catalyst.
Disclaimer: The author is long WesternZagros and Vast Exploration.