PetroTal: An Overlooked Spin-Off

Dec. 17, 2019 1:40 PM ETPetroTal Corp. (PTALF)6 Comments13 Likes
Alexander O. Stahel profile picture
Alexander O. Stahel
490 Followers

Summary

  • PetroTal is a small-cap oil production company, listed in Canada and headquartered in Houston, Texas. Its core asset is the Bretaña onshore field, located in Peru. It produces 9,000 bpd.
  • Our Core-NAV of CAD 0.9/share suggests 113% upside from today’s share price of CAD 0.43/share at a Brent price deck of $65 flat. But significant more upside is likely.
  • The key risks revolve around execution - not reservoir - and can be addressed every single day by the most competent management team which we explain in detail below.

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• One-Field Company: PetroTal (OTCPK:PTALF) is a small-cap independent oil & gas company domiciled in Canada with corporate offices in Houston, Texas. The company's operation is centered in Peru. Its main focus is to develop the Bretaña field in Block 95 and to explore & develop the Osheki prospect in Block 107, both located in the Peruvian Amazonian. Today, the company is dual listed in Toronto and London with a fully diluted market cap of US$ 240m.

• Spin Off: In 2017, Sterling Resources, a listed company with $41m cash but no assets, and PetroTal, a company with a credible local management but no assets or listing, merged and entered into an agreement with Gran Tierra (GTE) to buy its Peruvian assets in exchange for issuing shares to Gran Tierra. PetroTal effectively is the spin-off from Gran Tierra's Peruvian subsidiary. The latter now holds 46% of PetroTal.

• Production & Reserves: As at 16 December 2019, PetroTal produces approx. 9,000 bpd from the Bretaña asset, a conventional sandstone reservoir in which it holds 100% working interest and which it operates. The field holds 39.8 Mmbbl of Proved and Probable Reserves (2P) net to PetroTal. Today, the reservoir is well defined from 7 wells, of which 5 are producing. Going forward, management aims to exceed an exit rate of 12,000 bpd of production by year-end 2019. Base case, we forecast PetroTal to briefly exceed 20,000 bpd in 2021 (average of 14,600 bpd for the year) from up to 11 production wells and with the support of 3 water disposal wells (see page 16 below).

• Low Cost Asset: Once fully developed, Bretaña will produce at lifting cost of US$10/barrel (US$12/bbl incl. G&A). Over the life of the field and including transportation tariffs, royalties and after crude quality discounts for its medium-heavy oil (API 19.4), we forecast Bretaña to generate US$28/barrel of pre-tax free cash flow at a Brent price deck of $65/barrel. To do so, PetroTal is going to invest US$333m or about US$8.4/barrel to generate returns of 93% on its invested capital. A profitable business indeed (see page 18 below).

• Benefit from Sunk Cost: Between 2009-2017, Gran Tierra invested approx. US$390m into Bretaña's development. This is important for an investor into PetroTal for two reasons: Firstly, PetroTal became owner of a high quality oil asset in Peru that was geologically largely de-risked as Gran Tierra's four well drilling campaign substantially confirmed the volumetric of the reservoir. Within the sector, this is major - not minor. Secondly, it provided PetroTal with a tax asset of US$310m as at 31 December 2018. Combining the two, PetroTal's shareholders became beneficiaries of a substantially improved, risk-adjusted return on invested capital. We illustrate this on page 41 below.

• Fully Funded? Due to the merger with Sterling Resources and following a capital raise of GBP 20m (US$25m) in May 2019, PetroTal has the necessary funding to develop the Bretaña asset. As at June 2019, the company has zero debt and a pro-forma liquidity of US$58m. However, subject to oil prices and the payment terms of the ongoing development program, the cash generated from its full year average production forecast of 4,600 bpd on average in 2019 may not be sufficient to fund the drilling campaign. PetroTal may require a working capital facility to bridge a potential liquidity shortcoming in 2020. This is because oil sold to Petroperú is in transit for up to 180 days. Alternatively, PetroTal may address any liquidity shortage by establishing a factoring facility, given the quality credit of Petroperú. We also understand the payment terms for the drilling service company to be addressable. Either way, the company is well positioned to install a working capital facility once the new, likely revised CPR report is out in Q1 2020 to fund any shortcomings and once the production program is ramped back up after some maintenance work in January.

• It Gets A Lot Better: A geologist's way to estimate how much oil a field may yield is to assume a recovery factor on the fields Original Oil in Place (OOIP). The former is based on various factors such as oil gravity, reservoir porosity or its permeability. Bretaña's 2P reserve assumption is for 330 Mmbbl OOIP and a recovery factor of 12% for Netherland, Sewell & Co., the author of the reserve report and auditor of the field, to derive 2P Reserves of 39.8m barrels. However, based on other in-country analog fields, the recovery factor used by the report seems conservative - we mean ridiculously conservative.

• Going the Extra Mile: With the help of management and Petroperú, one of two state-owned oil & gas bodies of Peru, we have studied 16 analog in-country fields within the same basin (see page 93 below). The "same basin" is industry lingo for comparing apples with apples. The selected fields had a total of 2.5 billion of Original Oil in Place (OOIP) and produced 665 Mmbbl crude oil for a weighted average recovery factor of 27%. Is the CPR too conservative?

• API Matters Too: Bretaña produces medium-heavy, low sulfur crude with 19.4 API gravity, a measure of the crude's quality for its end user - the refiner. The lower the API, the heavier the oil, the more process intensive the refining of the oil becomes (and hence why there is usually a discount for heavier oil at the well-head). Our analog field work reveals that oil gravity appears to have the greatest impact on the recovery factors. In general, the lighter the gravity of the oil, the higher the recovery factor; and it shows larger fields have slightly higher recovery factors than smaller fields.

• Drilling Deeper: More concretely, our work illustrates that the most relevant analog fields yield recovery factors of more than 35% and that all medium crude fields have recovered 32%. This is important because the CPR used a lower API of 18.5 for Bretaña - not 19.4% - as it did not have the confirmation of its quality back in 2018. So yes, the CPR was conservative but also had to work with incomplete data.

• More Oil in Place? Meanwhile, Bretaña is producing oil every day at stable rates of between 750 and 8,250 bpd from 5 wells. The reported data from its first two horizontally completed production wells in 2019 suggest, among others, IP Rates of >6,000 barrels per day and 13% more net pay - a measure of the economically producible hydrocarbon thickness of a reservoir. On that basis, Bretaña may well have 45 Mmbbl more oil in place or a total of 380 Mmbbl.

• Common Sense Approach: Combining more OOIP and a higher recovery factor, Bretaña may well have 91 MMbbl of 2P reserves or 2 times more oil to be sold! Of course, it is early days and we are not suggesting a reserve revision by year end. But we are suggesting that paying attention to incoming well data and applying common sense and independent thinking does help buying low and ahead of the crowd, especially if the base case outcome would be just fine, too!

• Valuation: Base case, our Core-NAV of CAD 0.9/share suggests 114% upside from today's share price of CAD 0.42/share at a Brent price deck of $65 flat (see page 27 below). Modelling out a 24% recovery factor - which requires 7 additional producing wells and 3 more water injectors - will add CAD 1.5/share for a total upside of 3.5x today's share price (see page 30 below). This leaves an even higher recovery factor, the Osheki prospect, and/or higher Brent prices in the future as further upside potential, allowing an informed investor to generate significant risk-adjusted returns on his or her invested capital.

• What it comes down to: Such upside has risk. But in our view, far less risk than buying any fashionable "disruptor" at sky high valuations and with significant cash burn on the justification of profitable growth at some uncertain point, but then into perpetuity. At PetroTal, the risks are much more mundane. They mainly revolve around execution - not reservoir - and can be addressed every single day by a competent management team. For instance, in the risk section we illustrate the optionality for transportation in case of renewed pipeline downtime, in our view the main execution risk (see page 120). In other words, what it comes down to is "management, management and management".

• Management: So who manages PetroTal? The CEO since 2018 is Manuel Zúñiga, a petroleum engineer with 30 years of industry experience. Under his watch, BPZ discovered the Corvina field in Peru and delivered oil in less than two years. More importantly, "Manolo", with whom we interacted intensively, is a first class human being and a country insider. He started his career as a junior engineer with Occidental Petroleum (OXY) where he worked in Block 1-AB, an analog field of Bretaña. In other words, Manolo understands Amazonian reservoirs and knows engineers who understand Amazonian reservoirs. The latter is obviously more important. As importantly, he was born and raised in Talara, Peru and has established relationships with operators and government bodies in Peru.

• Family Affair: In Latin America, family matters. Manolo's father, Dr. Fernando Zuniga y Rivero, was President & Chairman of the Board of Petroperú until 1979, the local state-owned company. Prior to that, Oxy, under the leadership of Fernando, was awarded Block 1A - now better known as Block 192 and an analog field of Bretaña. In 1972, Oxy reported its first discovery. Block 192 produced until 2017. We think most casual researchers do not understand the relevance of this family legacy for the success of Bretaña. Well - we do!

• Trust, but Verify: We did not stop there: we visited all relevant authorities, the PetroTal team in Lima, the field in the Amazonian and met with board members. We also studied countless country, asset and research reports and spoke with high caliber industry analysts, such as Ian Macqueen from Eight Capital based in Toronto, in our view THE expert for Latin American oil & gas producer. The synthesis of our work over the past 18 months is outlined in detail in the paper below.

• Our Most Important Message: We at Burggraben buy firms, not stocks. What that means is that we look at a company through the lenses of an industrialist, not a hedge fund manager. The latter, in our view, buys stocks in the expectation of them going up tomorrow. Sadly, we do not have such magic touch. We do not know if PetroTal's share price will go up or down tomorrow. But what we do know is that if we buy into a high potential asset with world-class management at a deep discount to its intrinsic value, our loyal clients will be rewarded with superior risk-returns over the long term as the market catches up with its free cash flow realities. To do so, we go the extra mile and hence we are certain that this is a unique risk-reward project in the E&P industry worldwide (yes, we mean that as we looked at dozens of them in much the same detail). Manolo, a high integrity leader with a quality team, will manage this reservoir and the country-specifics with the necessary attention to detail so that PetroTal delivers the oil safely, on time & on budget - for the benefit of shareholders.

For a full analysis, please see the slide show below.

PetroT  al
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This article was written by

Alexander O. Stahel profile picture
490 Followers
Value Investor in Energy, Real Estate, Transport, Retail, Manufacturing, Banks2014-today: Burggraben Holding AG, Value Investing2006-2014: Babcock & Brown, Private Equity Investor for infrastructure & energy assets 1997-2001: UBS Warburg, Associate Director Corporate Finance, Operational Background: 2008-2012: Board Member & Controlling Shareholder Imperial Parking Corporation, parking services, Canada 2008-2011: Board Member Coinmach Services Corporation, laundry services, USA 2011-2012: CEO Gutta International AG, manufacturing of Bitumen Roofing Sheets, Switzerland 2004-2006: CEO & Owner Mewag AG, manufacturing of tube bending machines, Switzerland 2001-2003: COO Obtree Technologies AG, content management software, Switzerland
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Disclosure: I am/we are long PTALF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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