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I worked in the oil industry in Kazakhstan from 1993 through 2007.  During that time, the price of crude oil fell to a low under $10/bbl and then began to hit new highs.  At the same time, the stock price of a number of Kazakhstan oil exploration and production companies increased by many multiples due to successful exploration, production, oil price increases and sometimes simply due to speculation. 

While this was happening, the stock prices of several other Kazakhstan oil companies were crushed as they were not able to navigate the politics; and at times corruption inherent in a new republic that was suddenly independent from the Soviet Union and the communist system. Although the risks were evident, at some point it became apparent that the potential rewards of investing in Kazakhstan oil companies more than offset the risks, at least for me. 

I currently own shares in a number of Kazak and Russian oil and gas producers and I have  recently increased my position in BMB Munai (NYSEMKT:KAZ), which I think by most metrics is the cheapest oil producer in Kazakhstan. 

Using the company's latest presentation, 10Q, press releases, and some other sources of recent production data, I will attempt to briefly summarize my reasoning.

General Information

(Primarily from the company presentation on the BMB Munai website):

  • Founded in December 2003
  • Portfolio of assets in Kazakhstan which includes 4 producing oil fields
  • Local management many with Western educations
  • Well established government relations
  • Over 133 million barrels of oil equivalent 2P (proven + probable) reserves
  • Located close to oil transport and other infrastructure required for development and delivery of the crude oil production to market – less than 50 km from Aktau Port, the main Kazakhstan port on the Caspian Sea
  • Shares outstanding 44.7 million (market cap of approximately $264 million based on the 2 June 08 closing price of $5.91/share)
  • Listed on the AMEX symbol KAZ
  • Average April 2008 daily production 3,714 barrels per day

Reserves

(From p. 9 of presentation on the company website):

click to enlarge images


I plan to update my information on other publicly traded Kazakhstan oil and gas producers but I believe (with the possible exception of Transmeridian which has a number of management, operational and financial issues to overcome) of the publicly traded Kazakhstan oil and gas producers, KAZ has the lowest market capitalization or enterprise value per barrel of reserve.

Production

(Through quarter ending 31 Dec 07 from company presentation converted to bbl/day, estimates based on unofficial Kazakhstan Ministry data, 7 May company press release and my estimates):

Based on some preliminary production numbers, I believe that production has continued to increase in May.  As the table above shows, production has consistently increased at a fairly significant rate since the quarter ending Dec 06.I

Income Statement

(3 months ended 31 Dec 07 from 10Q – the rest are my forecasts):

Using the latest 10Q for the quarter ending 31 Dec 07, I have forecast net income for several future periods using production estimates from the Kazakhstan Ministry of Energy and Mineral Resources (used to forecast the 3 months ended 30 Mar 08) company press release (used to forecast Apr 08) preliminary Kazakhstan Ministry of Energy and Mineral Resources information (used to forecast May 08). I assume operating expenses will remain a constant percentage of production, other income/expenses will remain constant and income tax will remain a constant percentage of income before income tax.  While this is obviously simplified and it is known that KAZ is liable for a new Kazakhstan tax on crude oil exports which was implemented in May 08 at $109.91/metric ton of crude exported, to offset this new tax and other potential increases in expenses, I have assumed that there will be no increase in production from what I estimate is the current level of production.  I believe increased production will more than offset potential increases in expenses.  I'm forecasting basic net income of $1.74 per share for the fiscal year ending 31 March 09.  With the closing 2 Jun 08 stock price of $5.91, I forecast a forward price earnings ratio for the fiscal year ending 31 March 09 of approximately 3.4.

Risks/Other Costs

Investments in oil exploration and production companies operating in Kazakhstan have many of the same risks of oil exploration and production companies operating in other regions of the world; some of the risks that I think are more unique to Kazakhstan and/or KAZ are the following:

  • Litigation – In the latest 10Q, there is a long description of litigation against the company instigated by Sokol Holdings. This litigation was initiated in Dec 03, when the company was formed and is by far my biggest concern for the company.  Sokol Holdings alleges that BMB Munai and some of its executives wrongfully induced the previous owner of the oil properties currently held by KAZ to breach a contract under which the previous owner had agreed to sell the company holding these properties to Sokol Holdings.  "The plaintiffs seek damages in an amount to be determined at trial, punitive damages, specific performance and such relief as the Court finds just and reasonable."  In the 10 K for the period ending 31 Mar 06 there was the statement "In the opinion of management, the resolution of this lawsuit will not have a material adverse effect on our financial condition, results of operations or cash flows."  In the 10Q for the quarter ended 31 Dec 07, this opinion was no longer included.  In addition the press release dated 21 May states that an attorney, Jason Kerr, has been added to the Board of Directors and that he "will bring an important legal perspective to the board as pending litigation in the Company is postured for final resolution."  Based on this comment in the recent company press release and the fact that KAZ has dropped the opinion that the resolution will not have a material adverse effect on the company, it looks like there may be a settlement in the not too distant future. 
  • Exploration license – the company is currently operating under an exploration license through July 2009 when KAZ expects to negotiate a production license.  I believe this should not cause problems for a company with positive government relationships that KAZ appears to have.
  • Gas utilization – The government of Kazakhstan requires all oil producers to develop programs to utilize all associated gas production.  This can be a significant expense for a relatively new producer and I have not seen information from KAZ providing details of their gas utilization plan or costs.
  • Government relations and export quotas – A number of foreign companies have had difficulty with government relations and obtaining a fair export quota but to this point I have not seen any indication that this is a problem for KAZ.
  • Rent export tax 33% - this tax will go into effect when KAZ moves from an exploration to a production license.  This will have a significant impact on costs but again I believe the effect this will have on earnings will be more than offset by additional production.
  • Export tax – this tax has been implemented in May 2008.  The current tax rate is $109.91 per metric ton of crude oil exported.
  • Current CFO leaving – this was also announced in the 21 May press release. 

Investment Summary

I believe KAZ is very undervalued based on reserves, production, forward price earnings and cash flow ratios.  I believe KAZ has not yet been revalued to reflect significant increases in production, the extent of which may not be fully realized by the market or revalued to reflect the significant run-up in oil prices.  Based on what I believe is current production, I think earnings of approximately $1.74 per share, while optimistic, are possible for the fiscal year ending 31 Mar 09.  Although additional export taxes are expected, further production gains should more than offset the effect these will have on earnings. 

My major concern is how the current litigation with Sokol Holdings will be resolved, but provided the outcome is not disastrous, I expect the stock price of KAZ to increase significantly in the next 12 months.  Due to the risks I have outlined, this stock is not suitable for all investors; but for those that have part of their portfolio allocated to riskier assets or are looking for exposure to a small independent oil producer in Kazakhstan, I believe KAZ warrants a closer look.

Disclosure: I am long KAZ.  Much of the information discussed above is available on the company website and SEC filings but some I have estimated or forecast based on information that may be less reliable. Please do your own due diligence.

Source: BMB Munai: Cheapest Oil Producer in Kazakhstan