For most oil & gas investors, South American oil is Petrobras (PBR) and Petrobras is South American oil.  Since Petrobras was one of the largest and most successful investor-owned oil companies in the world even before announcing the gigantic Carioca and Tupi discoveries, this focus on PBR is understandable. 

It is also shortsighted.  With the recent pullback in oil equities, several little known but high growth South American oil stories are also now value stories, especially Gran Tierra (AMEX: GTE), Pacific Rubiales [TSX: PEG], and BPZ (AMEX: BZP).  What these three companies have in common are:

The economic attractiveness of enhanced oil recovery, infill drilling, field workovers, and similar measures designed to increase production from existing or played out fields is based on predictability. A certain amount of capex on the front-end should yield a more-or-less predictable amount of production on the back-end. When a company's business model and market cap are based on delivering this kind of predictable result, any failure is a serious problem. When a company continually fails to deliver on this – as Cano Petroleum (CFW) has - it's both a crisis and an opportunity.

On the crisis side, at the current price of $3.75 Cano's stock is off more than 60% from its mid-June peak of $9.40. Part of the decline is due to falling oil prices but the larger part is due to yet another quarter of zero production growth despite a business model based not only on predictable growth but on claims of very high growth.

Anyone who closely analyzed BPZ’s (AMEX: BZP) rise from obscurity to a $2 billion market cap over the past year saw the same two things: 1) world-class oil and gas resource potential, and 2) insufficient technical and financial capabilities to develop that potential.

While BPZ’s drilling results over this period confirmed the oil and gas reserves and production levels in one small part of its vast resource base (Corvina field, one mapped structure on one block) and helped validate the company’s aggressive estimates of future results on a larger part of the resource base (Corvina complex and Albacora field, four mapped structures on one block), it was obvious that BPZ in its current configuration could not carry out the required development work across the total resource base (50 mapped structures and counting on four blocks) in any realistic time-frame.

Now that BPZ Energy (AMEX: BZP) has received the certified reserve report for its Corvina field, one can estimate forward-looking metrics for FD&A, recycle ratios, and capital efficiency.

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The Cano Petroleum (CFW) story is conceptually simple. Cano controls substantial acreage in the Permian Basin and nearby areas with very large enhanced oil recovery [EOR] potential. The company is producing at an increasing, if not yet profitable, level. For the past couple of years, Cano has repeatedly missed deadlines and production goals due to problems with weather, permits, equipment, piping, water injection, etc.

BPZ Energy (AMEX: BZP) came under heavy selling pressure Tuesday in yet another example of the market mistakenly focusing on a minor operational issue rather than a huge long-term success.

The two key takeaways from yesterday's press release are first that the 18XD well has tested 5,350 barrels per day with only three drill stem tests and that the testing is not yet complete. The use of heavy drilling mud (overbalanced drilling) is common in the region for well control. However, it also caused formation damage and made testing difficult. The important point is that these are typical operational issues for this type of well and formation, not indicators of poor reserves or production rates.

The hottest natural gas play in North America is the Marcellus Shale. The core area runs from southwestern New York through much of western Pennsylvania and parts of West Virginia and Ohio. Industry activity in the Marcellus has been growing rapidly in the past few years but only gained popular attention when a technical paper from Penn State and SUNY-Fredonia, estimating original gas in place at 168-516 Tcf and recoverable reserves of as much as 50 Tcf, got picked up by USA Today.

Vaalco Energy (EGY) will report year-end results next week. Depending on how Vaalco accounts for the North Sea dry hole announced in January (.pdf warning), either 2007Q4 or 2008Q1 will bear the write-off. Regardless of the accounting, the long-term investment story is only minimally affected. At current oil prices, Vaalco is generating exceptionally strong cash flows and setting itself up to internally fund major activities in Gabon, Angola, and a new North Sea farm-in. Net cash as of the end of November was $100M ($105M cash - $5M debt), up from $75M only two months earlier.

On Wednesday the stock in BPZ (BZP) was sharply lower on news that a Peruvian Navy tanker used to transport its crude oil caught fire and sank. Fifteen sailors were injured, some critically. The ship contained 1,300 barrels of crude oil, most of which burned before the ship sank but there are some oil spill issues. Production and testing operations at BPZ’s single production platform in the Corvina field were suspended pending an investigation and inspection of the other Navy tanker used to transport crude.

This was a serious accident and deserves the serious attention it is getting. For investors, the longer-term question is whether the market overreacted to the event.

On Wednesday, BPZ Resources' (BZP) stock was sharply lower on news that a Peruvian Navy tanker used to transport its crude oil caught fire and sank. Fifteen sailors were injured, some critically. The ship contained 1,300 barrels of crude oil, most of which burned before the ship sank but there are some oil spill issues. Production and testing operations at BPZ’s single production platform in the Corvina field were suspended pending an investigation and inspection of the other Navy tanker used to transport crude.

Houston-based Vaalco Energy (EGY) produces about 5,000 b/d net of royalties in offshore Gabon [1] and plans to ramp production to a stabilized 5,800 b/d net in the third quarter. At current production rates and Brent prices, Vaalco generates at least $16M per quarter in operating cash flow (excluding capital costs). At $70 Brent and third-quarter estimated production of 5,800 b/d, it would be a minimum of $14M per quarter. At $4.60/share, Vaalco’s enterprise value is barely 3-3.5x cash flows. [2], [3]

BPZ Energy (Amex: BZP) is up more than 50% in the past two months. The reasons are not hard to find. Consider the following very recent developments:

• The CX11-14D well in the Corvina field, announced preliminarily in September at 25 million cubic feet per day, tested in October at 104 mmcf/d, i.e., equivalent to 17,300 barrels of oil per day.
• The first Corvina oil production for sales, previously planned for the end of December via an FPSO, began November 1st via leased tankers at 2,500 b/d. Full-scale FPSO loading and commercial sales starting at 4,000 b/d will begin around the end of the year.
• The first tranche of debt financing from the World Bank’s International Finance Corporation ($15.5M) to fund the gas-to-power project, previously expected to be signed by the end of the year, was signed in October and has been disbursed. BPZ is negotiating to increase the entire package from the previously announced $100.5M to $165M. The IFC is BPZ’s second largest shareholder and a strong supporter of its energy and local development projects.
• The final contracts with the Peruvian government for rights to two large exploration blocks (bringing BPZ’s total to four), previously expected to be signed by the end of the year, will be signed any day now. One of these blocks has internally estimated reserve potential of 170M bbl and 1.7 Tcf. The other block is on trend with several nearby producers. Adding these blocks to the existing blocks will permit development of the very large Mancora gas play.

BPZ has begun to generate cash flow from oil sales, with a very sharp projected ramp-up rate. Production from the Corvina field in the Z-1 block is 2,500 b/d, limited only by the capacity of the tankers to offload the oil. Current plans are to produce 4,000 b/d when the FPSO becomes available around the end of 2007, 6,000 b/d in the spring, and 8,000 b/d in the summer. And this is only from the first four oil wells in a small part of the Corvina field.

Small-cap oil investors should look at Houston-based BPZ Energy (AMEX: BZP). BPZ has recently had three major drilling successes at its very large oil and gas prospects in Peru. Exploration work in the 1970s by other companies confirmed the presence of hydrocarbons but low oil and gas prices and challenging production requirements made the wells non-commercial. Today commodity prices are much higher, production is much more straightforward, and BPZ has just started to capitalize on this potential. Of its first three wells, completed over the past six months in the offshore Corvina field, two tested oil at a combined 8,300 barrels per day (b/d) and no water; and the three tested natural gas at a combined 105 million cubic feet per day. The company expects the two oil wells to be tied in for commercial sales at 4,000 b/d in December 2007, with additional oil wells in the field taking production to 6,000 b/d in April 2008 and 8,000 b/d in July.

Natural gas from Corvina will be transported via a to-be-constructed pipeline to a dedicated electric generation facility onshore. Debt funding for the pipeline and powerplant is scheduled to be provided by the World Bank's International Finance Corporation [IFC], a major holder of BPZ stock. With its drilling success, BPZ has met the IFC's key supply requirement for the project (three gas wells, each capable of delivering more than 20 million per day to a 40 million per day power plant). Extra gas could be used to expand the power plant, used elsewhere in Peru, or shipped overland to Ecuador. Demand for gas is strong locally.