Seeking Alpha
Value, special situations, long only
Profile| Send Message|
( followers)  

Brazil's HRT Participacoes em Petroleo S.A. (OTC:HRTPY) is a high risk oil and gas exploration company with no debt, but no production either. I consider part 1 and part 3 of this series of articles to be out of date, but part 2, which is focused on HRT's Solimoes assets, is still valid.

In order to keep this article simple, I am ignoring their assets in the Solimoes Basin and their pending acquisition in the Polvo Field. Furthermore, I will assume that the Baobab, Murombe, and Moosehead prospects being drilled offshore Namibia this year are the only prospects that matter. I expect results for Baobab to be released in July, results for Murombe in August, and results for Moosehead in October.

Independent third party reserve engineers, DeGoyler & MacNoughton, have made the following assessments of HRT's Namibian prospects:

(click to enlarge)

The above chart shows the chance of success for Baobab as 26%, Murombe as 23.5%, and Moosehead as 25%. Crunching the math, I calculate a 58% chance that one of these prospects will be a success. However, the chance of success does not distinguish between a gas discovery and an oil discovery. I will assume a gas discovery is worthless and below I will estimate the chance of an oil success.

The 20-May-2013 press release of the Wingat results is misleading in that it indicates that the oil generating source rocks found can charge the Murombe prospect. However, slide 27 of HRT's 5-Jun-2013 presentation, shown below, clearly shows that these source rocks can charge the Baobab prospect, but not the Murombe prospect (oil migrates up, not down).

(click to enlarge)

Based on the Wingat results, I believe that the chance of success for Baobab is now greater than 26% and that the chance of finding gas is almost zero. Therefore, I believe that I am not aggressive in assuming that the chance of an oil success at Baobab is 26%. Furthermore, I will conservatively assume that if the Murombe and/or Moosehead oil prospects are successful, then the chance of a gas discovery is 50%. In other words, I am assuming that the chance of an oil success at Murombe is 11.8% and the chance of an oil success at Moosehead is 12.5%.

Other Assumptions:

  • All 3 prospects are independent
  • The intrinsic value of a barrel of oil in the ground is $7/bbl
  • If successful, the chance of finding at least the P50 volume is 50%
  • If successful, the chance of finding at least the P10 volume is 10%
  • Baobab is the same size as Wingat (I don't have specific numbers for Baobab, but it looks slightly larger on above chart)

Probabilities:

Chance of oil success = 1 - ((1 - .26) x (1 - .118) x (1 - .125)) = 43%

Chance of Baobab P50 oil success = 26% x 0.5 = 13%

Chance of Murombe P50 oil success = 11.8% x 0.5 = 6%

Chance of Moosehead P50 oil success = 12.5% x 0.5 = 6%

Chance of Baobab, Murombe, or Moosehead P50 oil success = 23%

Chance of Murombe P10 oil success = 11.8% x 0.1 = 1%

Intrinsic Value:

PROSPECTP50P10
Baobab772 mmbo*2112 mmbo*
Murombe2877 mmbo**7818 mmbo**
Moosehead1512 mmbo**5500 mmbo***

* Assumed Baobab possible volumes equal to D&M Wingat estimation

** DeGoyler & MacNoughton estimation

***HRT estimation

Baobab P50 oil success = 772 mmbo x $7/bbl x 86% ownership / 657 fully diluted shares = $7/share

Murombe P50 oil success = 2877 mmbo x $7/bbl x 86% ownership / 657 FD shares = $26/share

Murombe P10 oil success = 7818 mmbo x $7/bbl x 86% ownership / 657 FD shares = $71/share

Before DeGoyler & MacNaughton provided the P50 and P10 values, HRT claimed that the P10 volume for Murombe was 10.7 billion barrels which works out to $98/share. Since this is not impossible I decided to include it as the maximum possible intrinsic value on the graph below:

(click to enlarge)

Conclusion:

Using the assumptions in this article:

The chance of failure is higher than the chance of an oil success. There is a high chance of losing all of your investment.

There is a 23% chance of an intrinsic value of at least $7 per share before year end. The Kelly Criterion recommends wagering 17% of your bankroll based on this data point and the current share price of $0.535. But wait, there's more! When you make this Kelly Criterion wager you get the following fat tail too:

6% chance of an intrinsic value of at least $26 per share before year end.

1% chance of an intrinsic value of at least $71 per share before year end.

If HRT's estimated P10 value of 10.7 billion barrels for Murombe were to be achieved, then the intrinsic value per share would be $98 per share before year end.

Note: This article only addresses exploration risks. Other risks (i.e. political, environmental, etc.) have been ignored. A Macondo style blowout will turn this stock into a zero. Don't bet more than you are willing to lose!

Source: HRT Participacoes Has An Asymmetric Risk/Reward Profile - Part 4