We think that most if not all possible positive news is already priced into Houston American Energy's (NYSEMKT:HUSA) share price. This is a short candidate...Click to enlarge
While its share price has exploded, we wonder whether it is setting itself up for a major disappointment. The stock price has basically increased ten-fold over the last year. The main driver seems to be the promise of their newly acquired Columbian properties (and due to recent liberalization, Columbia is indeed a hot new oil exploration prospect). Adjacent to one of these (the CPO-4 block), two wells (Candililla 1&2) produced rather great results, and the stock price subsequently began to take off. However, we think the shares are priced for perfection and anything less could trigger a substantial sell-off.
2) What Do They Do?
Houston American Energy Corp. engages in the exploration, development, and production of natural gas, crude oil, and condensate. It primarily focuses on properties located in the US onshore Gulf Coast Region, principally Texas and Louisiana, as well as focuses on the development of concessions in the South American country of Colombia. The company was founded in 1981 and is based in Houston, Texas. [6, see below under sources]
The Columbian properties are by far the most important among the Company's collection of reserves, and because they were recently acquired (late last year), the excitement is a rather new phenomenon.
The Company has 30,890,772 shares outstanding[3p2]. With a recent 2.89M shares issue in a private placement, this gives the Company 33.78M shares. The $19+ share price gives HUSA a market cap of $660M.
Total oil and gas revenues decreased 23.6%, to $8,116,275 in 2009 (from $10,622,050 in 2008), but this is rather insignificant. The 15 cents of profits per share estimated for this year (up from a loss of 2 cents in 2009) can't underpin the valuation either, that must be in the assets. 
At December 31, 2009, HUSA had a cash balance of $14,010,637 and working capital of $16,365,490 compared to a cash balance of $9,910,694 and working capital of $10,536,834 at December 31, 2008. The increase in working capital during the period was primarily attributable to the receipt of $12,763,550 (net proceeds) from the sale of common stock in December 2009. This was partially offset by payment of drilling costs, acquisition costs, operating costs in Colombia and dividends. 
David Snow , writes a bull case for HUSA, arguing that it::
...will have $15mm cash, $6-12mm/year free cash flow, no debt, and founded/managed . Free cash flow after Capex is budgeted at $6mm but could be $12mm. Yearend ’10 cash may thus be $15+mm. Cash flow before capex may thus be $24-36mm, or $0.85-1.07/share, putting the stock around a solidly reasonable 8x cash flow. This is also a fair valuation for Colombia before exploratory potentials, as per top of page 1. A small $0.02/share per year dividend is paid.
We're not sure what the basis of these figures from Snow is, according to the annual report :
Operating activities used cash during 2009 totaling $484,677 as compared to $1,452,054 of cash provided by operations during 2008. The decrease in cash flows from operations was primarily a result of a decrease in revenue due to lower commodity prices and the shut-in of Colombian production for part of the year. 
Yahoo lists operating cash flow at $177.5K and leveraged free cash flow at -$3.19M year to date.  But even if Snow is right, since the stock price has more than doubled since he wrote his article in February, what he called "putting the stock around a solidly reasonable 8x cash flow." and a "fair valuation" for Columbian properties seems now quite out of whack.
From the Company website:
The Company was incorporated in April 2001, for the purpose of engaging in oil and gas exploration and production because the Company recognized the opportunity that existed for smaller energy companies to participate in large international projects that held the potential for significant revenues and production. To date, the Company through it's affiliation with Hupecol has been able to maintain a 75% success ratio in its international concessions of Colombia, while keeping an extensive inventory of drilling prospects. Since the Company's inception it has focused on maintaining a low overhead while utilizing the expertise and knowledge of outside consultants and industry partners on an as needed basis. In addition, the Company has maintained a very strong balance sheet in order to take advantage of management's contacts to identify potential acquisition targets as they arise. Generally speaking each of our exploration projects differs in scope and character and consists of one or more types of assets, such as 3-D seismic data, leasehold positions, lease options, working interest in leases, partnership or limited liability company interest or other mineral rights. 
5) What Do They Have?
- North Jade (22.5%) 
- Acadia Parish
- Jim Hogg County
- West Jade
- Profit Island
- North Profit Island
- AMI in Karnes County, Texas
There is a rather insignificant amount gas production going on, and only one well is planned for this year. These properties are not the reason for the excitement in the stock.
5.2) The Llanos Basin, Colombia
From the Company's website:
We hold interest in,
(1) a 232,500 acre tract known as the Cara Cara concession,
(2) the Tambaqui Association Contract covering 4,400 acres in the State of Casanare, Colombia,
(3) two concessions, the Dorotea Contract and the Cabiona Contract, totaling over 137,000 acres,
(4) the Surimena concession covering approximately 69,000 acres,
(5) the Las Garzas concession covering approximately 103,000 acres,
(6) the Leona concession covering approximately 70,343 acres, and
(7) the Camarita concession covering approximately 166,000 acres.
Our interest in each of the described concessions and contracts in Colombia are held through an interest in Hupecol, LLC and affiliated entities. We hold a 12.5% working interest in each of the prospects of Hupecol other than the Cara Cara concession, the Surimena concession and the Tambaqui Association Contract. We hold a 1.6% working interest in the Cara Cara concession, a 6.25% working interest in the Surimena concession and a 12.6% working interest, with an 11.31% net revenue interest, in the Tambaqui Association Contract. 
Note below (6) that some of these have been sold (Cara Cara) and some will be sold in the near future. However, the Company acquired interesting new (participation in) new properties:
5.3) Colombian Farm-Outs and Participations
From the annual report:
In June 2009, we entered into a farmout agreement with Shona Energy Limited pursuant to which we will pay 25% of designated Phase 1 geological and seismic costs relating to the Serrania Contract for Exploration and Production relating to the approximately 110,769 acre Serrania Block in Colombia and for which we will receive a 12.5% interest in the Serrania Contract. 
In September 2009, we elected to participate for our percentage interest (12.5%) in the Los Picachos Technical Evaluation Agreement (the "Los Picachos TEA"). The Los Picachos TEA was entered into in August 2009 by and between the Colombian National Hydrocarbons Agency (the "ANH") and Hupecol Operating Co. LLC and encompasses an 86,235 acre region located to the west and northwest of the Serrania block, which is located in the municipalities of Uribe and La Macarena in the Department of Meta in the Republic of Colombia. As a result of the election to participate, we agreed to pay our proportionate share, or 12.5%, of the acquisition costs and costs for the minimum work program contained in the Los Picachos TEA.
On October 16, 2009, we announced the approval by the ANH of a Farmout Agreement and Joint Operating Agreement with SK Energy Co. LTD., a Korean multinational conglomerate ("SK Energy"), relating to the CPO 4 Contract for Exploration and Production (the "CPO 4 Contract") covering the 345,452 net acre CPO 4 Block located in the Western Llanos Basin in the Republic of Colombia.
Under the Joint Operating Agreement, effective retroactive to May 31, 2009, SK Energy will act as operator of the CPO 4 Block and we agreed to pay 25.0% of all past and future cost related to the CPO 4 block as well as an additional 12.5% of the Seismic Acquisition Costs incurred during the Phase 1 Work Program, for which we will receive a 25.0% interest in the CPO 4 Block. Our share of the past costs was $194,584.
The Phase 1 Work Program consists of reprocessing approximately 400 kilometers of existing 2-D seismic data, the acquisition, processing and interpretation of a 2-D seismic program containing approximately 620 kilometers of data and the drilling of two exploration wells. The Phase 1 Work Program is estimated to be completed by June 1, 2011. Our share of the costs for the entire Phase 1 Work Program are estimated to total approximately $15,000,000.
Subsequent to year-end, in February 2010, we elected to participate for our percentage interest (12.5%) in the Macaya Technical Evaluation Agreement (the "Macaya TEA"). The Macaya TEA was entered into in February 2010 by and between the ANH and Hupecol and encompasses a 195,171 acre region located to the southeast of the Serrania block. As a result of the election to participate, we agreed to pay our proportionate share, or 12.5%, of the acquisition costs and costs for the minimum work program contained in the Macaya TEA.
6) Hupacol Selling
- In June 2008, the Company, through Hupecol Caracara LLC as owner/operator, sold all of the Caracara assets to Cepsa, covering approximately 232,500 acres for USD $920 million. As a result of the sale of the Caracara assets, HUSA received net proceeds of $11.55 mm. 
From the annual report:
In September 2009, we were advised that Hupecol LLC had retained Scotia Waterous for purposes of evaluating a possible transaction (a "Transaction") involving the monetization of five exploration and production contracts covering approximately 413,000 acres comprising the Leona Block, La Cuerva Block, Dorote a Block, Las Garzas Block and Cabiona Block in Colombia. Scotia Waterous has established a process whereby interested parties may evaluate a potential Transaction and has established a due date for proposals of April 6, 2010. We are an investor in Hupecol and our interest in the assets and operations of Hupecol that would be included in any Transaction represent a substantial portion of our assets and operations in Colombia and are our principal revenue producing assets and operations. We intend to closely monitor the nature and progress of the Transaction in order to protect the interests of our company and our shareholders. However, we have no effective ability to alter or prevent a Transaction and are unable to predict whether or not a Transaction will in fact occur or the nature or timing of any such Transaction. Further, we are unable to estimate the actual value that we might derive from any such Transaction and whether any such Transaction will ultimately be beneficial to our company and our shareholders. 
Gain on sale of oil & gas properties. The sale of our Caracara assets resulted in a gain of $7,615,236 during 2008. 
7) What's Left?
After such a sale, only a 6.25% working interest in the Surimena would remain [3p10], apart from the newly acquired participations, the Serrania Block and Los Picachos and the US properties.
8) Recent developments
Drilled 14 wells in Columbia and one domestically in 2009.
From the annual report,
11 wells were drilled on concessions in which we hold a 12.5% working interest, of which 7 were in production at December 31, 2009, and 4 were dry holes. One well was drilled on a concession in which we hold a 6.25% working interest and was a dry hole. 2 wells were drilled on a concession in which we hold a 1.6% working interest and were in production at December 31, 2009. During 2009, we drilled one domestic well, the Wilberts & Sons #1 (Home Run Prospect) which was a dry hole and re-completed one domestic well, the Allar # 1 which was placed into production on May 27, 2009. At December 31, 2009, drilling operations were ongoing in Colombia on one well. 
Our production levels and revenues during 2009, as compared to 2008, were affected by the sale of our Caracara prospect in 2008 and the sharp decline in oil and natural gas prices that began during the second half of 2008 and continued through the third quarter of 2009. As a result of depressed commodity prices, our operator in Colombia temporarily shut-in production from a majority of our Colombian properties and we had no sales in Colombia from February 13, 2009 through April 5, 2009. 
During 2008, the Caracara prospect accounted for approximately 29,954 barrels of oil (net to the Company) produced, or 24% of our oil production, and $3,005,140 of revenues. 
Sale of Common Stock In December 2009, we sold 2,890,000 shares of common stock in a registered direct offering to select institutional investors at $4.68 per share pursuant to which we received net proceeds of approximately $12.8 million. We intend to use the net proceeds of the offering for general working capital purposes, including funding our share of costs of development of properties in which we hold interests in Colombia and in the U.S. 
During 2009, we declared and paid cash dividends to our shareholders of $0.035 per share, or an aggregate of $980,057. 
During 2009, we granted 120,000 stock options to our Chief Financial Officer and 26,665 stock options to our non-employee directors. Our total non-cash compensation expense for 2009 was $1,080,128. 
Depreciation and depletion expense decreased by 67% to $1,900,631 in 2009 from $5,816,691 in 2008. The decrease in depreciation and depletion was due to an increase in reserves due to exploration and development. This resulting increase in our reserves from exploration and development activities lowered our depreciation rate per barrel. 
Impairment Expense. During 2008, we recorded a provision for impairment of oil and gas properties of $5,621,106, most of which was attributable to our South American properties. Impairments related to reduced commodity prices at year end and lower reserve estimates for our Colombian wells, reduced reserve estimates for our U.S. properties as a result of lower commodity prices and lower then expected production volumes, as well as the lack of commercial production on our Caddo Lake prospect. 
9.1) How much are they're going to get for the Huppacol sale?
David Snow argues something like $40-$60M net to HUSA.  We have no idea whether that figure is anywhere near correct (but nor do we have any indications of the contrary).
9.2) How much did they have to pay for the new concessions?
The annual report cites the following relevant figures for 2009:
- acquisition costs $3,411,655
- evaluation costs $2,140,296
- retention costs $47,294
- total $5,599,245 
So it seems they have gotten these properties pretty cheap. These are not all related cost. From the annual report quotes (see under 5.3 above) indications are given about ongoing expenses (pro-rata seismics, drilling costs, etc.), but one thing is for sure, there is a rather significant gap between the market valuation of the company (which, to a large extent derives from the prospects of these new Columbian participations) and those costs.
9.3) How promising are these new concessions?
- CPO 4 Block consists of 345,452 net acres and contains over 100 identified leads or prospects with estimated recoverable reserves of 1 to 4 billion barrels. The Block is located along the highly productive western margin of the Llanos Basin and is adjacent to Apiay field which is estimated to have in excess of 610 million barrels of 25-33 API oil recoverable. On the CPO 4 Block’s Northeast side lies the Corcel Block where well rates of 2,000 to 14,000 barrels of initial production per day have been announced for recent discoveries. In addition, the CPO 4 Block is located nearby oil and gas pipeline infrastructure [3p20]
- The Serrania block adjoins and may be part of a 1 billion bbl field; will be drilled in March or April; and may be worth some $18-36/share, verifyable by drilling by 2Q10 
- This is the Ombu field, which has 122 million barrels of potential recoverable reserves by Netherland Sewell and five wells with production rates from 100 to 400 bbl/d [3p15]
- Initial 2-D data has identified several large prospects located on the Los Picachos TEA similar to those found on the Ombu Block to the south east [3p16]
- The new 25% CPO-4 block is 2.4 miles from a Petrominerales 15,800+ b/d well [Candililla 1]. Announced today; with 3D now, drilling later in '10, and potentials of upward to $67-269/share 
- PMG on 1/3/10 completed a well 2.4 miles from HUSA's block on a related field, Candelilla, and on 2/3/10 announced that it flowed 10,900 b/d of 44-degree gravity crude for the first 30-day average-Prudhoe Bay-size flow rates! Today (2/15/10) PMG announced it now has flowed naturally at 12,400 b/d for its first 45 days! Such a single well would give HUSA $1.50-2.00/share cash flow! Corcel is about 10 miles, and Candelilla 2.4 miles, from HUSA's acreage, along the same fault system. This 12,400 b/d flow came from 71 feet of Mirador pay. 
- On 2/3/10 PMG completed a second well nearby in the Candelilla with 139' of pay: 88' from the Lower Sand 3 (Une) and 51' from the Guadalupe. Today (2/15) PMG announced the well is flowing over 15,800 b/d of 43-degree gravity oil. This well is 2.36 miles from HUSA's acreage. A third PMG well is spudding and results will be due in mid-March. 
- These super-high 14-15,000 b/d flow rates suggest that Candelilla may be an even larger field than Corcel — and very near HUSA. Corcel now produces a total of just 15,600 b/d from 13 wells, or 1,200/well, about 3,000E b/d adjusting for decline curves. The average 14,100 b/d per Candelilla well is thus 4.7x Corcel’s average, with no signs of decline — actually, still rising, suggesting truly monster wells and a large reservoir--and just 2.4 miles away. 
So, the main selling point is that these blocks are close to three promising fields (for an overview see [3p22]), the most prominent are:
HUSA's Serrania block adjoins and may be part of the Ombu field, which we think is in large part of the excitement in the stock price right now
- The Ombu field either has potentially over 1.1 billion barrels of oil according to 10% owner of the field Canacol Energy or 122 million barrels of potentially recoverable oil in place according to Netherland Sewell.[3p15]
- Emerald Energy, 90% owner and operator of the Ombu field recently sold to Sinochem Resources for approximately $836M [3p15]
- There are five wells producing 100-400 bbl/d [3p15]
- Canadian junior Canacol Energy (CNE.V) owns the 10% of Ombu not sold to the Chinese. When it recently raised $20mm via Canacord Adams, a Chicago group invested $14mm. They saw from the seismic that the structure was continuous and extended onto HUSA's block, with as much as half of it on HUSA's block. On this basis they took most of the $13mm equity financing HUSA completed this last December. It's not clear if this would mean another 1B bbls on HUSA's block or half of 1B bbls estimated for the total of both sides of the reservoir. At 500mm - 1B bbls, 12.5% working interest might be 11.25% net revenue interest, or 56-112mm bbls net to HUSA. HUSA believes the oil might be worth $15/bbl in the ground, which would give $25-51/share potential value. Again, risked at HUSA's overall 70% success, this would be $18-36/share-verifyable soon.
As a first approximation, we think it's perhaps wise to stick to the 122MMbbl from the Netherland Sewell estimate. These wells also don't seem overly productive (100-400bbl/d).
More important, we really wonder on what Snow's  assumptions are based considering the supposed $18-$36 value per share of Serrania. That would imply a 1-2x present market cap valuation for the Serrania block. For starters, HUSA only owns 12.5% of the Serrania block, so this would value the block 8-16x the present market cap (or a whopping $4.8-$9.6B!).
Secondly, the Serrania block has yet to prove any presence of carbohydrates, and even if we assume it is as good as the Ombu field we have to keep in mind that 90% of that was sold for $836 (so 100% would be $920M).
So 12.5% of that (as HUSA owns only 12.5% of Serrania) would be $115M, or $3.40 per share, not $18-$36 per share as Snow has it. And keep in mind, Serrania hasn't found anything yet, let alone proven.
- Just above CPO-4 block [3p22]
- Current average production of 20,000Bbl/d from 8 wells drilled since July 2007 [3p22]
- Production from Corcel’s wells have averaged in excess of 5,500 barrels of oil per day for the first thirty days of production declining to approximately 2,000 barrels of oil per day after the first year of production. Production after the first year of production is expected to decline marginally at 5 to 10% per annum. [3p31]
This seems to be the main reason for the excitement. With two recent big hits with the Candililla 1&2 wells producing over 10,000bbl/d and being just 2.4 miles from HUSA's acreage and on the same fault line, hopes are obviously high similar discoveries can be made within their acreage.
We can't help but notice that Snow  goes completely overboard here though. According to him, the 25% of the CPO-4 block HUSA owns could be worth $67-$269 per share (or a market cap for HUSA of $2.2-$9B!).
Petrominerales, the owner of these Candelilla 1&2 wells, presently has a market cap of $3.2B, and they are producing 41,000Bbl/d (HUSA just 1,000Bbl/d). Petrominerales owns 100% of Corcel and the Guatiquila block (where the Candililla 1&2 wells are located), HUSA only 25% of the CPO-4 block.
Even if HUSA would be as successful as Petrominerales, it could only reach roughly 25% of their valuation (or $800M). And we're pretty close to that already, and all that based on wells on adjacent properties.
And to be kind to HUSA, we'll leave out the fact that Petrominerales owns 1.9M acres in Colombia and another 2.6M acres in Peru, apart from the fact that they're already producing over 40,000 barrels a day.
Even if HUSA would discover similar wells like Petrominerales Candililla 1&2, and even if they could produce them and acquire similar a acreage, we would be at least a few financing rounds (and hence further dilution) away from that.
And as of yet, all of this is a mere pipe dream based on some good wells having been discovered on adjacent properties.
9.4) Low acquisition cost?
If these are so promising, how come they have been acquired at such low cost? If the market now seems to value these properties at many multiples of their purchasing prices. The only new development since purchase is the Candililla 1&2 wells, which are indeed quite spectacular.
However, we cannot repeat enough that oil is produced, no matter in what spectacular quantities, adjacent to a block one participates in is by no means a guarantee that there will be any commercial find on the block itself.
Sellers of the like of LK Energy didn't seem to be in need of cash or expertise (you might wanna look at pages 18 or 19 of the recent investment presentation for a rousing description of SK Energy), so we find it difficult to assume that
(1) they were unaware of the potential
(2) were forced to sell cheap. Could it be that the market is getting ahead of itself?
One might also bear in mind that:
- the cessation of production and sales from the majority of our Colombian properties for 52 days in early 2009 as a result of unfavorable commodity prices 
That is, the majority of their Columbian properties were not profitable at the (agreed, rather depressed) oil prices early in 2009, despite all that favorable investment regime in Columbia.
9.5) Do they have enough funds to develop and drill in 2010?
According to bullish Mr. Snow , yes:
Hupecol is now producing over 1,200 b/d net to HUSA, up from 800 b/d in November. In 6/08 Hupecol sold its largest concession, to Cepsa, for US$920mm ($11.55mm to HUSA). Its other concessions are up for sale in '10, pending the right price. If they fetched $40-60mm net to HUSA, this would be on top of $15mm cash now, which with cash flow will fund this year's budget. The budget for '10 includes $15. 6mm for Colombia, $2.7mm for La, or $18.4mm total. 
At least the drilling budget is confirmed in the IR presentation:
- Columbian budget is $15,625,000 adding the Crown Mineral Acquisition ($513,000) and the drilling of a well in the North Jade Prospect ($2,250,000) and we arrive at a total budget of $18.388M. [3p36]
10) Coming catalysts
Drilling in what is supposed to be HUSA's part of the Ombu field:
- HUSA plans 2 wells in '10: 1 to HUSA's part of Ombu, and 1 to a north structure. Closest Ombu wells are 3-5 miles away, so the first task is to verify that the structure extends onto HUSA's block. Another 1-2 wells are possible. 
- The Phase One Seismic program was competed in September of 2009. We plan on drilling our first Serrania well in the first half of 2010 [3p14]
A domestic well in the North Jade property (for natural gas and liquids) is also planned.
The phase-1 work program for the CPO-4 block (the one where SK Energy is the operator and holds the other 75% interest) extents over 3 years, and involves two 2D seismic programs and two exploration wells (see [3p21]). This doesn't seem to provide any immediate catalyst.
11) Comparable Companies
We've found at least three foreign companies operating in Columbia, all with larger acreages, reserves, and production:
11.1) Canacol Energy:
- interests in 22 fields
- 2P reserves of 4.34M barrels of oil
- 2000 bbl/d production
- interests in 15 exploration contracts covering over 2.4M net acres
- 10% interest in Capella (a billion barrel discovery) and 100% interest in two nearby blocks, with similar geology
- 329.55M shares out
- $234M market cap
11.2) Alange Energy:
- 11 properties and a producing asset (Cubiro Block, which will reach 6,000bbl/d by the end of this year)
- 602.50M shares out
- $337.40M market cap.
- One might also consider their development program: 50 development wells and 7 exploration wells until the end of this year.
- 550,000 acres
- farm-in by Pacific Rubiales Energy on the CPO-1 block (pretty close to HUSA's CPO-4 block)
- 585M shares out (according to p.7 of a corporate presentation)
- $270M market cap
All three of these companies have either more acreage, higher production, more interesting properties with discoveries already secure, and they are way cheaper than HUSA.
We realize only a detailed comparison can establish whether the market is out of whack and where, but combining what we've argued above, it's hard to escape the market seems most out of whack with Houston American Energy.
12) Technical picture
Sometimes a picture really says more than a thousand words ...
We think the indeed rather spectacular Candililla 1&2 wells have provided much of the fantasy that has obviously entered into HUSA's valuation. But as we have argued above, all possible fantasy is already priced in (unless in the off-chance of finding really substantially bigger wells even than the Candililla 1&2 wells). But even then, it would need financing and dilution to act upon these.
Thus, we think that these shares are priced to perfection, and anything less will trigger a rather substantial implosion (which could very well happen by their own sheer weight as well).
1) Three Oil and Gas stocks with huge gains
2) Company website, areas
3) Company IR presentation
4) Snow: The Bull case for HUSA
5) Yahoo Key Statistics
6) Yahoo Profile
7) FinViz chart
8) Company website, background and philosophy
9) Company website Domestic areas of Operation
10) From the annual report
11) 10K Filing
12) Columbian oil, the next big thing?
Disclosure: Author short HUSA