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Galp: €13.40 (OTC:GLPEF); market map €11Bn = US$15Bn

Galp is a Portuguese integrated oil company with a domestic refining monopoly at home and some awesome exploration assets offshore Brazil and Mozambique. It is a great growth play, but perhaps suffers from some naivety (ineptitude?) when it comes to telling its story: so let's help this not-so-little pig to fly.


  • Galp has just announced the entry of Sinopec (SHI) into its Brazilian exploration assets, putting a pre-money valuation on those assets of $12.5bn, in line or slightly short of consensus. But this crystallizes the group's NAV at circa €24 per share vs. current market price of €13.40.
  • Further drilling and appraisal of the Brazilian assets over the next year will probably boost the level of recoverable oil by at least 20% as tertiary recovery techniques get tested and as reservoir mapping becomes more precise. The company has four high-impact wells drilling over the next 4 months which could add materially to its net reserves.
  • In the midst of the run-up to the Sinopec deal, and the on-going market torment in Europe's periphery, Galp's partner in Mozambique ENI (E) announced one of the biggest discoveries made by the industry in the past five years. On the back of just the first discovery well the find is worth €0.60 per share to Galp, but a further well about to be spudded could multiply this valuation a number of times.
  • So not only is Galp at a 40%+ discount to its NAV, but that NAV is set to be materially increased over the coming months. This little pig should be awarded its wings!

Galp has its domestic refining and distribution business in Portugal: "boring and stuck in a recessionary peripheral and problematic Euro-zone country," you might well say. Kind of, but it is just coming to the end of a major refinery upgrade program, so that side is actually set to do better. But it is the exploration business that is seriously interesting, and I would argue, very undervalued by the markets - even more so after Friday's bump in the road. So what has Galp got, and what has it just done?

Exploration assets #1: Brazil - Santos Basin

Galp is a junior partner in various offshore Brazilian licences operated by Petrobras (PBR). It owns 10% of the huge Bumi discovery (now called the Lula field), it owns 10% of the Iara field, 20% of Jupiter and so on: all in all it has net resources of some 3.5Bn boe, which when risked come down to about 1.9bn boe. Back during the summer sell-side analysts had an NPV on these Brazilian assets of US$10-12Bn. Galp's balance sheet already has a fair chunk of debt on it with a debt to equity of 105%, so with the development capex of these fields looming, Galp needed to find a way to finance its share of capex, which is estimated at roughly €2bn or $2.8bn. Management decided to farm-down the company's stake and grouped all of the Brazilian assets into a specific vehicle and opened the door to bidders. On Friday morning it officially announced the arrival of Sinopec as a partner in the business in a deal where the Chinese will put in $5.2bn of debt and equity and thereby get a 30% stake in Galp Brazil.

So why is the market miffed, why the 10% sell-off in the share-price? Galp state clearly that the pre-money valuation of the Brazilian assets is $12.5bn. Some analysts had clearly been more optimistic on the valuation (Credit Suisse at $17bn and Bernstein at $15bn), but in fact the pre-money value is just a couple of percent south of consensus. Unfortunately the wording of the press release is such that it implied that the valuation of the deal post-money was $12.5bn, and hence 30% below the actual money. With Galp's senior management abroad signing the deal, there was basically no one left in the shop to amend the linguistic mis-interpretation, but doubtless we will get more clarity over the next few days or weeks.

"Aha!" moment #1

The more perspicacious amongst you might ask why some of the brokers had such "high" asset valuations versus their peers, and this is where we get this pig's first "aha!" moment. Galp has two principal partners in the Brazilian assets: Petrobras and BG Group (OTCQX:BRGYY). Both publish periodic assessments of what they estimate there is in the way of possible reserves at the bottom of these sub-salt wells, with the boys from Brazil tending to be conservative in their assessment, and the Brits tending towards being shareholder-value orientated - aiming to tell what's really what. So back in November 2010 BG Group upped its guidance for what it reckoned was the real numbers for potential reserves. (A quick point of fact, BG Group and Galp are involved together is Galp's two bigger assets, but not in others). BG's assessment is based on 29 wells drilled to date, 19 drill stem-tests, pressure tests and initial prolonged flow rate tests at the Lula field: QED a serious amount of real data - not finger in the air analytics. Petrobras has been saying that the recovery factor, i.e. the % of the reserves that it will actually be able to get up from the oil-fields, is expected to be around 30%. BG's release points towards the recovery rate in fact being higher at 35%, but at the same time, on the back of a much more detailed reservoir model for the big Bumi field, it bumped up the expected oil-in-place by 15%. What this means is that BG reckons that there is at least 20-25% more oil recoverable from the Bumi/Lula field, and if the same dynamics are true of the Iara field (also in the Santos Basin) then the recoverable reserves there could be almost 50% higher. I could waffle on about the potential impact of tertiary recovery techniques and the tests to start in that next year: but what the heck, that is just further upside, should it come through. (In fact I will waffle further, but another day).

If this is the case, how come the Chinese didn't end up paying a higher price? Hmmm. At the end of the day, Galp is a forced seller. It has to raise funds to cover the capex spend, which starts next year, and in the current market conditions there aren't that many players flush with cash. What does need to be underlined is that GALP now enters a very active period of drilling with four high impact wells to be drilled offshore Brazil between now and end Q1'12.

Exploration Assets #2: Mozambique, Area 4

Over the last couple of weeks ENI, the operator of this licence offshore Mozambique, has announced a massive gas discovery. Amidst the frenzied bouts of Euro-phobia and in Galp's case the expectation built up ahead of the Sinopec/Brazil deal, the market seems to have ignored or passed over this discovery. To put it simply, you will be hearing an awful lot more about Mozambique for two reasons: it looks as if a new world-scale gas-oil region has been uncovered; and second it changes assumptions about how much and where Africa's energy frontiers are. Whilst you you might love Tullow (OTCPK:TUWOY) for its opening up of West Africa and more recently French Guinea, Tullow has in individual areas is dwarfed by the Area 4 find made by ENI and partners.

A bit of background geography: Mozambique is a Portuguese speaking country in East Africa, just south of Tanzania, north of South Africa, and in front of Madagascar - found it? Over the last couple of years this new frontier has been opened up by Anadarko (APC) who along with junior partner Cove Energy (AIM listed - up the Irish!), made a series of finds in what is known as Area 1 (see map below).

"Aha!" moment #2

As the map shows, the Anadarko consortium has made four gas discoveries and one oil discovery in the Area 1 zone to date. ENI and partners have the exploration licence to all of Area 4, and has completed its first well, "Mamba South", announcing on the 20th October the discovery of a 15 tcf gas find - which by itself is big enough for a self-sustaining LNG train. 15tcf of gas equates to 2.6bn barrels of oil, so this is clearly a big discovery by international standards. Then a week later ENI made a second announcement saying it had hit a further pay-zone and upped the estimated size of the discovery by 50% to 22,5bn tcf. Furthermore the company has gone on record saying that it expects a recovery rate of 65-90%: add to this the fact that the well took just 30 days to drill and you have one very gas-rich territory making its entré to the world stage. ENI is suggesting that Area 4 might be good for a total of 25-35bn tcf in all, i.e. an oil equivalent of 4-6bn boe, which at a 70% recovery rate equates to 3-4bn boe. That suggests that the Area 4 find is equivalent to one of the larger Brazilian sub-salt fields, but one heck of a lot easier to extract and far closer to thirsty Asian markets.

The ENI rig is now getting ready to spud what is to be called Mamba-North, so results from that well should be through before the year end. Mamba North is very close by two key Anadarko/Cove discoveries, Barquentine and Windjammer, which suggests that there is a high possibility of another significant find on the basis of continuity of the gas-bearning sands. Clearly these are very early days, but the key is that these wells are quick (30 days) and that ENI has accelerated its plans for Area 4. I suspect we will soon hear of further wells to be drilled in the area during Q1'12. So this zone will get proven up at a far quicker rate than was the case of the Santos Basin in Brazil.

We know from the presentations made by Cove Energy that the gas bearing sands are continuous and of high quality. The Lagosta discovery 4km to the west of Mamba South has a pay-zone of 550 net feet (170m). ENI's first announcement talked of 212m of continuous high-quality Oligocene sands, suggesting that the same gas-bearing strata is expanding to the east, i.e. into the Area 4 zone (for geology geeks: we are talking of a fan turbidite formation). Its second announcement was of a separate 90m of Eocene (older) sands, not picked up by Anadarko/Cove. Given that the latter are already suggesting continuity between Windjammer and Lagosta, should ENI have success in Mamba North, the implications are, well, highly significant.

So what did the GALP share price do on that back of all this? Not a lot, in fact....nothing.

"Aha!" moment #3

In the meantime a few analysts have started to beat the drum about what this means to GALP and ENI's NAVs, with Deutsche Bank quoting a Wood Mac analysis on a potential development of an LNG train in Mozambique. On the basis of the first reported discovery the early stage valuation is €0.40/share for Galp, taking in the second strata of gas-bearing sands, €0.60. But were ENI to hit gas in Mamba-North the volumetrics of the two finds together quite simply multiply. An interesting story to be following in the coming months.

Investment conclusion: this PIG tripped on the runway - a great opportunity, because this pig will fly.

Disclosure: I am long GALP PL, Lisbon listing, on behalf of clients and funds. I do not hold any direct positions.

Source: Galp: A Periphery-Impacted Growth Stock