PetroFalcon Corporation: There's Still Value in Oil


China, India and other countries continue to consume more oil, and the dollar continues to fall, which has driven crude prices above $90 a barrel. Investor interest in oil remains strong. Oil is a good hedge against possible inflation and a way of playing emerging market growth. However, most oil companies now trade at several times book value, and oil prices could fall back to earth if the U.S. enters a recession.

In such an environment, are there any good deals left out there? Yes, indeed, as long as investors are willing to take some political risk. I was recently able to sit down with Garrett Soden, the CFO of PetroFalcon (OTC:PFCXF).

PetroFalcon Corporation is a publicly-traded natural resource company with 100% of its operations in Venezuela through its wholly-owned Venezuelan subsidiary, Vinccler Oil and Gas, C.A. With its acquisitions, it is now the largest oil and gas acreage holder in Venezuela outside of the government.

PetroFalcon's management team has a long operating history in Venezuela. Before taking PetroFalcon public in 2003, they started the Venezuelan oil and gas operations that later became Harvest Natural Resources (NYSE: HNR). Production ramped up from 0 to 50,000 bopd in a very short amount of time. They consider their extensive local industry and government contacts to be a strategic differentiator.

While other companies, with less extensive contacts and knowledge, are selling their holdings or turning over operations, PetroFalcon is taking advantage of the current market dynamics to expand. They recently announced a private placement with Lundin Petroleum and a simultaneous acquisition of a 5% stake in the Baripetrol joint venture from Lundin. Post-transaction, Lundin will own about 40% of the company, and PetroFalcon will have about $30 million in cash and no long-term debt. PetroFalcon is also partnering with Chevron in an offshore natural gas license (Cardon III). With the added financing from the Lundin transaction, they are considering further expansion onshore (in mature field bids) and offshore in 2008.

Before these transactions, PetroFalcon already owned 40% of PetroCumarebo, a joint venture with an array of producing and exploration assets. Current gross production of PetroCumarebo is 1,200 bbls/d of oil and 12 mmcf/d of natural gas according to the company, which should expand an additional 150 bbls/d and 12 mmcf/d once repairs on a government pipeline ("ICO") are finished (estimated before the end of the year). With a 2007 capex budget of $39.2 million, PetroCumarebo is looking to increase production to 2,500 bbls/d and 30 mmcf/d by early 2008. In 2007, PetroCumarebo drilled ten wells in its onshore East Falcon Block, completed eight, and tested five, about doubling production.

With a market cap (post Lundin transaction) of around $150 million, PetroFalcon is trading at a fraction of the after-tax Net Present Value of its current proven and probable reserves (36 mmboe before royalties and before the mergers and acquisitions). The cash, acquisitions and PetroFalcon's extensive exploration upside just add to its value.

Short-term catalysts are extensive. They include:

  • La Vela and Cumarebo well tests (potentially increasing gross production to 2,500 bopd by as early as December) and ICO pipeline repair completion (bringing online the 12 mmcf/d and 150 bop/d that is now shut-in)
  • PDVSA payments (cash payments of outstanding invoices to PetroCumarebo)
  • Cardon III and Baripetrol approvals (government approvals of these acquisitions)
  • Colombian/Venezuelan border dispute resolution (which would allow for exploration to begin on their Castilletes offshore block option)
  • Drilling information releases from nearby operators Repsol/ENI and Gazprom (working on adjoining blocks in the Gulf of Venezuela)
  • Announcement of additional acquisitions/partnerships

Obviously, investors are right to be concerned about Venezuela. Over the last several years, President Chavez forced foreign companies to accept terms that were more favorable to Venezuela. The fear is that Chavez will not honor these new terms (even though they were proposed by him), that PDVSA (the state oil company that is now the majority owner of all joint ventures) will burden the joint ventures with too many laborers and other costs, and/or that Venezuela's economy will sink and the country will decline into internal conflict.

According to Mark Turner, Latin American Equities Analyst at New York-based Hallgarten & Company, fears are overblown. The media has exaggerated the situation, and although life has changed in Venezuela, production of oil continues. PDVSA is generating billions of dollars in profits, and they have an extensive investment and production program. They are honoring their commitments to foreign companies, and they are soliciting new bids from companies to expand exploration and production.

PetroFalcon indicates that dealings with PDVSA have been reasonable and professional. Their view is that Venezuela is an essential source of oil for the world moving forward, that terms are competitive (especially since few countries that have comparable reserves), and that the ability to purchase production and reserves at a discount to global metrics will be rewarded over the long term. PetroFalcon is the only company that has managed to receive Ministry approval for M&A transactions over the last few years.

Certainly, with oil prices continuing to stay high, Venezuela may have greater stability than forecast. So much money is flowing through PDVSA and into the Venezuelan economy that Chavez should continue to be able to stay in power and honor his commitments without too much strain. Furthermore, Chavez is under tremendous pressure to show he can stabilize and increase production now that his reforms have been successfully implemented. He can only do so by maintaining good relationships with the companies that are helping sustain and expand the oil industry—especially local operators like PetroFalcon.

The situation doesn't need to improve. If it just stays as it is, PetroFalcon could prove to be an extremely lucrative way to play oil.

Disclosure: The author's family owns shares in PFCXF.PK

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