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In 2011 Peter Epstein, CFA, left a $3 billion hedge fund where he was a senior natural resources analyst to help increase awareness of a number of natural resource companies in which he's invested in. PLEASE FOLLOW ME ON TWITTER: @peterepstein2 Mr. Epstein formed MockingJay, Inc., a... More
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  • Zodiac Exploration Sitting On Potential Monster Oil Shale Assets 0 comments
    Aug 6, 2013 11:38 PM | about stocks: ZDEXF, HES, OXY, XOM, DVN, APA, RYDAF
    Zodiac Exploration, U.S Listing on the Horizon

    Tuesday, August 6, 2013 · Posted in Oil & Gas, OIL & Gas Companies · by Peter Epstein

    Overlooked, Mispriced Security With Huge Upside

    Zodiac Exploration Inc. [ZEX.V & ZDEXF]
    Market Cap. = $32mm, Debt= $0, Cash= $17mm, (~$0.05 per share) EV= $15mm

    Given the renaissance in the U.S oil and gas industry, particularly in the prolific U.S. oil shales, Zodiac Exploration will greatly benefit from a U.S. listing as it has one of the larger land positions in the Monterey/Kreyenhagen Shales. Zodiac is one of the only pure-play juniors in a fairway providing exposure to a potential 15 billion barrel prize, as the majority of the best blocks have been gobbled up by majors. As it appears to be 2-3 years behind the Bakken and Eagle Ford Rush - entry is very compelling and a U.S. listing will add a global audience.

    Zodiac Exploration, Underfollowed and Oversold

    I've done A LOT more due diligence on Zodiac and remain convinced that it offers a very compelling risk / reward proposition. Zodiac's cash balance of $17 million equates to about 5c per share. The company has $85 million of tax pools with an estimated Net Present Value, "NPV" of 3.5c-6.5c per share, (a midpoint of 5c), for a total of 10c per share in cash + tax pools alone.

    That's 10c of tangible value vs. the current share price of 9c. And, that's before any consideration of the value of Zodiac's roughly 71,000 net acres in the heart of the largest U.S. oil shale basin - The San Joaquin in California. Importantly, the Company has spent approximately $85 million in land and seismic acquisitions, drilling and technical work since early 2009. These efforts were validated (but largely ignored by the market) by adjacent neighbor Aera Energy LLC, (JV between Exxon/Shell) who executed a 50/50 JV on 19,600 Zodiac net acres in late 2012.

    Substantial Upside With Very Limited Near-Term Downside

    Nothing I say in this article can possibly assure investors of a highly profitable investment outcome. This is a highly speculative opportunity. However, rarely does one find an investment that could be a 3-Bagger relatively quickly, (and possibly a 5-10-Bagger over time), that ALSO has limited near-term downside. I think that Zodiac shares could trade to 20c per share in coming months, with upside well above that over time.

    If one accepts that the near-term fundamental downside in Zodiac's shares is fairly limited, upside to 20c would be a spectacular risk-adjusted outcome. That's exactly where I believe the stock is headed, and possibly a lot higher. Why? Because at 9c per share, an investor is getting 71,000 net acres of highly prospective, oil shale property for free. We've seen this movie before in the Bakken and the Eagle Ford. Will the same extraordinary valuation uptick unfold in Zodiac's zip code?

    Land Value Can and Does Move Quickly

    Land values in prime areas, aka, "the fairway," of emerging oil shale basins start out low, but as multi-billion barrel resources are de-risked, land values can increase by 100-fold, i.e. from $100 to $10,000/acre. To be clear, not all acres are located in the fairway and not all formations warrant $10,000/fairway-acre valuations. However, at 9c per share, Zodiac's property is valued by the market at zero.

    This valuation disconnect won't last, Zodiac stock should move comfortably above 10c in coming weeks and much higher in coming months. How much higher? To address this question, one must recognize that last year's signing of the JV with Aera Energy has been completely ignored by the market. However, that JV values the JV net acres in the thousands/acre. Aera committed to pay 100% of the cost of 4 exploration wells forecast to cost a total of $45-$55 million.

    Location, Location, Location, Drill for Oil Where There's Oil!

    Zodiac's acreage lies in the heart of the prolific San Joaquin Basin in California where 13 billion barrels have been produced and approximately 3 billion in Zodiac's core area alone. Furthermore, California's oil shale is believed to hold more than 15 billion barrels of, "technically recoverable" oil, approximately 64% of the country's total oil shale resources! Peter Haverson, CEO of Zodiac Exploration, provided me with the following quote,

    "The quality of our 71,000 net acres is endorsed by our current joint venture with Aera Energy LLC (Exxon/Shell), one of America's largest private Oil and Gas producers. This JV not only validates our core acreage, but also demonstrates that large companies are prepared to make large investments into a world-class resource.

    There are currently some very large programs in progress close to our acreage. In addition, there are several wells in various stages of drilling. It is important to note that it is still early days, and projects of this size and scope require time and positioning. Zodiac is currently in discussions with multiple parties who are seeking to enter into the basin. We are currently experiencing excellent interest from industry in our multi-billion barrel resource."

    The San Joaquin fairway is dominated by majors, including OXY, Hess, Chevron, Exxon and Royal Dutch Shell, that have tied up the majority of the reserve potential in the basin. Zodiac's 71,000 net acres is a sizable block, for example Venoco Inc. has a better known, but smaller position of 46,000 net acres. Zodiac's block would make an ideal entry point for a company like Marathon Oil, Devon, Apache Corp, Total E&P, CNOOC, Statoil, BHP Billiton, BP, ConocoPhillips and Anadarko. All of whom already have extensive oil shale interests in the U.S. With deep pockets and superior technical abilities, it would be foolish for a major NOT to be in the San Joaquin.

    Zodiac's 71,000 net Acres, Valued by the Market at Zero!

    While it's certainly possible that Zodiac's property will ultimately be worth very little, investors have at least a 3-yr window of opportunity where the property could be demonstrated to be worth hundreds of millions. Given increased activity on and around Zodiac's property, most notably last year's JV with Aera, but also ongoing drilling and seismic work by neighbors, it's reasonable to assume that Zodiac's land has substantial option value.

    Key to my option value thesis is that Zodiac's acreage is worth far more to a major than to Zodiac. The majors smart or lucky enough to build substantial portfolios in the Bakken and Eagle Ford oil-heavy shale plays have been handsomely rewarded. Not only have investment returns been extraordinary, but the knowledge gained in these basins can be leveraged globally. There are several emerging oil-heavy shale plays remaining in North America, but the San Joaquin is estimated to contain 3-4 times as many barrels as either the Bakken or the Eagle Ford! There's no easier or more efficient way to gain entry or expand one's land position in this incredibly important basin then by seeking a JV or acquiring Zodiac outright.

    Option Value of Zodiac's Property

    As a valuation exercise, assume that Zodiac's 71,000 net acres are potentially worth $0 to $10,000/acre. If one conservatively assumes that 50% of the acres are ultimately worth $0, 25% $1,000/acre and 25% $2,500/acre, that's an average of $875/acre, or 17c a share. 17c + 10c a share in cash and tax pools = 27c per share. Alternatively, if one assumes that 50% are worth zero and 50% between $3,000 and $5,000/acre, then the all-in share valuation of Zodiac would be 55c.

    Of course, no one knows the true value, but it's certainly not zero. I strongly believe that Zodiac's property is worth $500-$1,000/acre, (all-in, 20c-30c per share) on option value alone. Hess, OXY, Shell, Exxon and Chevron and probably others, are exploring, drilling, permitting, and shooting seismic. Oil does not stop at property lines or borders. Good news for one player is good news for all.

    Aera Energy, a JV between Shell and Exxon, has committed to spend an estimated minimum of $45-$55 million to eventually earn-into 50% of 19,600 of Zodiac's acreage. As I understand it, Aera would have further significant investments to make AFTER spending the initial $45-$55 million on its 4 well commitment. Only then would Aera earn-in 50%.

    Zodiac's High Strategic Property Worth Far More to a Major

    If Aera is willing to spend such a considerable sum, they must believe those acres could be worth a tremendous amount. How much? No one knows, but the option value for a largely contiguous land package like Zodiac's must be in the hundreds of dollars/acre. If a single well costs $12-$13 million and proving up a meaningful amount of reserves potentially in the hundreds of millions, it should make little difference if a major has to pay [71,000 x $500 = $35.5 million, or twice that] to get into the game. Majors have both deep pockets and long time horizons.

    If, as I believe, Zodiac's property is worth a minimum of $500/acre, that implies a conservative per share valuation (including cash and tax pools) of 20c, more than twice the current price. If I'm wrong, falling back on 10c a share in cash / tax pools shouldn't be too painful. However, If Zodiac is sitting on a blockbuster asset, the Company's property would (over time) be worth in the thousands/acre. Is this a baseless or outlandish claim? No. In 2010, with oil prices 15% lower than today, Zodiac was trading at over $1 per share, implying a property value of about $5,000/acre at the time.

    What Has Changed Since 2010?

    Since 2010, land transaction values have cooled and there's been relatively little new information about activities in the San Joaquin. Admittedly, the basin has not ramped up as quickly as many analysts believed it would in 2010. One reason why San Joaquin has been developing slowly is the political arena in California, but there are signs that's beginning to improve.

    With oil prices nearing $110 per barrel and alternative exploration initiatives, (such as ultra-deep, offshore western Africa!), considerably more risky, expensive and politically challenging- drilling for oil in California is looking better and better by the day. The fiscal terms of U.S. oil production is significantly better than what U.S. majors achieve in the majority of international jurisdictions.

    The Monterey Will be Prolific, it's a Question of When, Not If…

    As the majors enjoy great success in the Bakken and Eagle Ford Shales, it is only a question of time and patience until they turn their attention to the Monterey. The value today, of an option on a land package that could be worth hundreds of millions, is a very considerable amount. It's essential to understand that the value proposition for a major is much more than just the 71,000 net acres, it's also the opportunity to unlock very difficult barrels and apply the knowledge gained globally. Would a major pay $500-$1,000/acre TODAY for that option? I argue yes.

    Would a major pay $500-$1,000/acre to exclude a rival from obtaining it? Again, I argue yes. If more than one major is interested in Zodiac's property, could its acres be worth $1,000-$2,000 each? Yes. Could technological advances and/or higher oil prices make the acres worth even more over time? Yes. Is Zodiac Exploration grossly mispriced at 9c a share? YES!

    Disclosure: I am long OTCPK:ZDEXF.

    Themes: E P, Oil Shale Stocks: ZDEXF, HES, OXY, XOM, DVN, APA, RYDAF
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