Explorers and producers need to go where the oil is.
But how do you balance resource upside potential with jurisdictional risk?
Amin Haque of Stonecap
Securities argues that jurisdiction risk isn't a deal-breaker if management
knows how to mitigate it. In this interview with The Energy Report, Haque shares some companies that meet those criteria,
favoring redevelopment plays that avoid exploration risk. Find out which
teams are using new technologies to turn proven reserves into economic
Report: Amin, you
started your career in the consumer credit industry, where you were involved
in risk management at a major bank. How does that translate to the securities
Amin Haque: The company I worked for was MasterCard International Inc., and as
director of risk management, my focus was on macroeconomic risk management in
international jurisdictions. That gave me a very good foundation for
evaluating sovereign, political and currency risks. In my four-year career
with MasterCard, I focused on countries in Africa, the Middle East, South
America, the Caribbean and the Asia Pacific. These are the same regions where
many of the exploration and production (E&P) companies I'm interested in
operate. My previous experience is proving quite useful as an oil and gas
TER: When you look at a company, do you consider the
jurisdictional risk first?
AH: Jurisdictional risk differentiates a company
focused in North America from one that operates internationally. For the
latter, geology, exploration history and reserves matter as much as they do
for a North American company, but equally important considerations are
geopolitical or currency risks. These issues affect operations as well as
TER: Do you focus on the downside?
management addresses the risks and has a program to meet and mitigate them, I
feel more confident. But if they paint too rosy a picture and gloss over the
risks, I try to steer away from that company."
AH: No, I try to look at the company as a whole. In the
oil and gas business, one has to be an optimist. As an analyst, I try to be a
rational optimist. I use risk as a tool to screen management. I make a list
of all the jurisdictional risks as I understand them. If management addresses
the risks I have identified and they have a program to meet and mitigate
those risks, then I feel more confident about the quality of the management.
But if the
management paints too rosy a picture and glosses over the risks, which seems
unrealistic for even a layman like me, then I try to steer away from that
company and its team. But I don't always start with the downside.
TER: You seem to be concentrating on a theme of oilfield
AH: Yes. Of the six companies, four are focused on
TER: Do redevelopment projects inherently carry less
risk, because reserves in the ground are already established?
AH: That would be a fair statement. I play to my
strength. I do not have a background in geology or petroleum engineering. I'm
trained as an electrical engineer. I can relate to the basics of oil and gas
science, but I am not an expert.
But if you
start with a proven reserve that has not been extracted for various reasons,
then you have a head start on the companies with exploration risks, where the
outcome could be binary. You either find oil or you drill a dry hole for up
to $50 million ($50M) per well.
you start with a proven reserve that has not been extracted, you have a head
start on companies with exploration risks that will either find oil or drill
a dry hole for up to $50M per well."
have a proven reserve, then the outcome is not binary. There are risks. There
are challenges in extracting the resources, both operational and
geopolitical. But if you have competent management in place, then you have
the confidence that they'll find ways to meet those challenges, mitigate
those risks, extract that oil and find a way to sell it.
TER: Is this redevelopment theme dependent on technology
that we didn't have a decade ago?
AH: That's an absolutely fair statement. With most of
these old fields, development success is predicated on applying new
technologies and new ideas. We take new technology for granted in North
America, but not so in these international jurisdictions.
start with examples. Two of my Nigeria-focused companies, Oando Energy Resources Inc. (OER:TSX) and Mart
Resources Inc. (MMT:TSX.V), are working mostly on oilfields that were
discovered some time ago but have not been fully exploited. Mart has been in
West Africa for quite some time, but its latest success was due to its use of
three-dimensional (3-D) seismic data that was acquired some 15 years ago. It
then used new technology to reinterpret it and the company found success. Oando is on the same path, and so are many other
Nigeria-focused independent E&Ps.
in another part of the world, Azerbaijan, is Greenfields Petroleum Corp. (GNF:TSX.V). Azerbaijan has been producing oil and gas for at
least 100 years. The field Greenfields focuses on has been producing at a
very marginal level for the last 30 years because operators were still using
Soviet-era drilling rigs and completion technologies. Greenfields acquired
new two- and 3-D seismic data and new ways to model the reservoir. It is also
using new drilling technologies. That's how it hopes to find success.
TER: Define "marginal field" for me.
AH: Different countries have slightly different
definitions. Generally, it is a field that has been discovered years ago and
may have been producing for some time. But the initial leaseholder, which in most cases is an international oil company of
substantial size, does not find it economic for continued development.
fields are economic for smaller E&Ps because they operate with a
shoestring budget and often introduce new technology."
these fields get marginalized and do not receive any new capital expenditure.
That's what's happening right now for many fields in Nigeria, for example.
Fields are declared marginal under new laws and regulations, and the original
discoverer farms it out to, in most cases, a smaller outfit. That smaller company
puts in new resources to start producing from it. Marginal fields are
economic for smaller E&Ps because they operate with a shoestring budget
and often introduce new technology. The government gets royalties and taxes,
and the original operator gets some farm-out royalties. So it's a win-win for
TER: It sounds like once the low-hanging fruit is gone,
it's necessarily going to cost more to drill these wells. Is that fair?
AH: It could go both ways. There are many marginal
field opportunities like that. If a marginal field is large enough, then from
the first well drilled to the, say, fifth or 10th well, the development cost
actually declines over time. But when people start hearing about these new,
unexplored opportunities, new companies come in and bid up the price for
not a marginal field story, let us think about Colombia, for example. About
five years ago, Canadian energy companies went into Colombia and found
success. More and more companies began flocking in, bidding up the price for
new fields. That adds to the cost. That makes it more expensive for even
established companies to expand and obtain access to new assets. So that's a
TER: You follow junior E&P companies, where
investors can hopefully get a large return on their money. Can you give us
some of your favorites?
AH: Yes. Let me start with Mart Resources. Only
recently, the institutional investors have been paying some attention to
Mart. In June, the company declared a very generous dividend payment to its
shareholders of $0.05 per quarter.
TER: Even after the dividend was paid on July 19, the
stock still behaved quite well. At times, after a one-time dividend, shares
fall. But investors have favorably viewed this stock.
AH: You're correct. I'd like to note that when
management declared this dividend, it made a strong statement about its
commitment to return of capital to the shareholders. Although it was a
one-time special dividend, management spoke of continuing special dividends
in times of good cash flow.
TER: Can the regular $0.05/quarter dividend be
AH: I believe so, despite some of the risks the company
faces. Since the end of October, Mart has not been able to produce and pump
oil because of pipeline disruption as well as flooding in the Niger Delta
area. Losing 15–20 days of production from its only producing field
made for a challenging quarter. But Mart has a large stash of cash it can use
to pay the dividend as well as continue its development program. In the
future, it expects to increase oil sales with the help of a second pipeline,
at which point a $0.05 quarterly dividend should not be a big challenge.
TER: Does Mart have prospects for increasing its
reserves and production?
AH: Let me address the production issue first. The field
is averaging about 12,500 barrels per day (bbl/d).
Depending on Mart's entitlement production, the production allocation to Mart
goes between 50% and 82% but averages about 65%. It has drilled 10 wells so
far, but the problem is that the field cannot produce to its maximum
has pipeline constraints. Five different producers in the area share the same
pipeline, so there is a rationing of pipeline capacity. Unless that restraint
is removed, Mart cannot produce to its maximum capacity, which I believe to
be on the order of 15,000 barrels per day (15 Mbbl/d).
company's management is working on two things to remove the constraints.
First, it is negotiating with the pipeline company that it uses right now to
expand the capacity. In addition, Mart and its partners, along with other
E&P companies in the area, are building a second pipeline that will
connect to a Royal Dutch
Shell Plc (RDS.A:NYSE; RDS.B:NYSE) facility. A second pipeline should do two
things—provide the company with redundancy and excess capacity, as well
as giving it access to a second export terminal. That should allow Mart to
significantly increase its production, which I expect to be achieved gradually
between the beginning of 2013 through the end of the
TER: What is it about Mart's management team that
AH: First, they have done a good job of building
relationships in Nigeria. Mart's two partners for the Umusadege
field proved to be sound partners. In Nigeria, many joint ventures by
international junior and intermediate E&Ps have failed because of
partnership issues. Secondly, the Umusadege field
is one of the few marginal fields that have succeeded. Mart's management has
shown that the marginal field is a viable concept and it works.
is making progress in building a corporate culture, and it has created a
middle class that's generating its own energy demand."
like to make one other point about Nigeria. The country is making some
tangible progress in building a corporate culture, in building a civil
society. It has created a middle class that's generating its own energy
demand, which is good for natural gas production in Nigeria. With increasing
demand for electricity, entrepreneurs are looking at natural gas as a source
for electricity generation. If smaller E&Ps get a chance to sell their natural
gas, that's a separate and new revenue stream for them. So the timing is also
good for Mart, Oando and other independent junior
TER: Mart's market cap is now just over $600M. At that
market cap, this is a company that now can be owned by mutual funds. Do you
expect to see this transition from it being a retail story to an
AH: Yes. Institutions expect to buy a sizable chunk of
shares and the market cap is getting to that level. Also, Mart did not have
any institutional coverage before. Institutional investors expect some
institutional broker support while they take an interest in a company.
TER: Could you talk about another story that you like?
AH: Sure. A similar story to Mart, also in Nigeria, is Oando Energy Resources. One risk about Mart is that its
production is from a single asset. For Oando, the
picture is different. It has interests in nine different blocks. It produces
from two. So it's not that dependent on a single field or a couple of fields.
It has production and cash flow. At the same time, it has some very lucrative
exploration blocks. Its management has worked for Schlumberger Ltd. (SLB:NYSE) and other international companies. But at the same
time, it's a Nigeria-based company, so the management team has more
appreciation of the issues on the ground.
TER: You have a really nice target price with over 100%
implied upside from current levels. But I see that 95% of outstanding shares
are held by one entity, its parent, Oando Plc
AH: You are correct. But other than Mart, there are not
many opportunities to get exposure in Nigeria. Oando
will need additional capital to develop these assets. My belief is that it
will come to the capital markets, and that will create an opportunity for
investors who have interest in Nigeria.
TER: As an investor, you're not concerned that 95% of
these shares are owned by one entity?
AH: I think that should change over the short term. Oando Energy Resources came into being as a spinoff of
the upstream assets of the parent company, Oando
Plc. The current shareholding structure is a result of how this company
became public, through a reverse takeover and through a spinoff of assets.
But my strong belief is that that's not the ideal situation for any of the
parties involved and that situation is going to change.
TER: Is there another story you'd like to talk about?
AH: I mentioned Greenfields Petroleum earlier. It has
assets in Azerbaijan, the Bahar project, where it
has a one-third interest. An Azerbaijani company holds the remaining
two-thirds. Azerbaijan is a country that has the longest history of producing
oil and gas. But in the middle of the last century, when Azerbaijan was part
of the Soviet Union, all the capital was shifted from Azerbaijan to Western
Siberia, so it did not receive any new capital, new ideas, technology, focus
resources are there. It was very astute on the part of the Greenfields
management to find this particular asset. Greenfields' management team is
trying to prove what can be done in an old field using new technology. When
you are operating in a country that has not seen the introduction of new
energy technologies for over a half a century, you face
challenges—getting trained people, moving equipment, procuring
project has been delayed by a year or so, but it looks as if everything is
lined up and drilling should start within a couple of weeks. Greenfields
should be able to get some good results out of its current drilling program.
also like to mention that several key people in the management team of
Greenfields have worked in Central Asia—in Azerbaijan and some of the
neighboring countries—for over a decade. So management has connections
there. They know the country and the people. I would say those relationships
and that knowledge are extremely important for any junior E&P getting into
a lesser-known international jurisdiction such as Azerbaijan.
TER: Another you might mention if you wish?
AH: The last one I'd like to mention is Touchstone Exploration Inc. (TAB:TSX.V; TCHSF; OTCPK). It is located in Trinidad and Tobago, which is a
country with a very long history of petroleum production. Again, it's a
redevelopment story, where production went down in some fields because there
was no infusion of new technology or capital.
oil and gas company, Petroleum Company of Trinidad and Tobago Ltd. (Petrotrin), owns this concession. Touchstone went into an
arrangement called a lease operatorship agreement whereby Petrotrin
would still hold the concession but Touchstone would get a percentage of the
production when it brings in new capital and increases production. But one
major challenge in Trinidad and Tobago is its vast bureaucracy.
like about Touchstone is its dogged persistence. In the last year, it has
faced many challenges. But it still has been able to increase production from 500 bbl/d to about 2 Mbbl/d currently. Consider that there are
thousands of old wells that can be recompleted and brought into production.
Even if they contribute 15–20 bbl/d, you are
talking about a very large level of incremental production at a low cost.
That's what Touchstone is targeting.
TER: Did you want to mention one more?
AH: Another company on my list is New Zealand Energy Corp. (NZ:TSX.V; NZERF:OTCQX). For Canadian companies, New Zealand is a
comparatively new jurisdiction. There are a couple of Canadian companies
active there. New Zealand Energy had some impressive initial successes. It
has a large land position right now. The thesis is that it can replicate the
initial success in the remaining land base.
TER: The stock has suffered over the past six months.
It's down about a little bit more than one-third. What
were the issues that contributed to that?
AH: The first three wells were quite successful, but
the decline rates were high. So current production has come down. I guess the
market is waiting for new wells to start augmenting production.
TER: It's been a pleasure. I thank you for taking the
AH: Thank you. It's been a great pleasure talking to
Amin Haque joined Stonecap
Securities' oil and gas research team in Calgary in October 2011. He provides
research coverage of international explorers, producers and oilfield service
companies. Haque brings 14 years of financial
market experience, seven of which have been devoted to equity research
analysis. He worked as an analyst both on the buy and sell side, focusing on
energy and other resource sectors. Prior to joining Stonecap,
he provided independent valuation services to oilfield services, logistics
and related companies.
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1) George S. Mack of The Energy Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: Mart Resources Inc. and New Zealand Energy Corp.
Interviews are edited for clarity.
3) Amin Haque: I personally and/or my family own
shares of the following companies mentioned in this interview: None. I
personally and/or my family am paid by the following
companies mentioned in this interview: None. I was not paid by Streetwise
Reports for participating in this interview.