HRT, an oil and gas development stage company, may not be a classic value investment but, I think, offers intriguing risk/reward potential at the current price.  Many investments that have 10X potential are situations where you can lose all your money.  I believe the odds here offer that kind of upside optionality without the risk of a goose-egg on the other side.   I have dedicated a small percentage of my portfolio to situations like HRT.   I describe these as venture type investments that are purchased at prices in which all the “sizzle” in the price has been knocked out for one disappointment or another…. But that still have the same potential as they did when priced multiples higher.   In the case of HRT, it came public through an IPO $10, which raised $1.5 billion.  The current price is $2.75. 

Brazil

 HTR controls two large oil and gas prospects one in the Amazon in Brazil, acquired from the Brazilian government, and the other offshore Namibia, acquired from UNX and others.   The Brazilian play is in a region known as Salimoes.  HRT controls 21 blocks in this area which is a proven hydrocarbon region with production nearby.    Results of the first four wells, drilled in 2011, were mixed, with gas found but no commercial oil.   That caused the stock to sell off dramatically.   While the gas may have value, it will  take years to put together a comprehensive plan for development and use of the gas.   The goal was to find oil in this region by drilling deeper.    HRT has identified 130 drilling targets in Solimoes, with 8 wells planned for 2012.  They are in the "top of the first" with this prospect but the market has, for the time being, decided that there are "two outs in the ninth".

Based on the 2D seismic and other information, the prospect blocks have prospective resources of about 1 billion barrels of oil and natural gas reserves of 1 billion barrel equivalents, based on a reserve report by D&M (DeGolyer and MacNaughton).     In 2011, HRT sold 45% of the 21 Salimoes blocks in a farm in agreement to TNK Brazil a subsidiary of TNP-BP for $1 billion.  TNP-BP is 50% owned by BP and 50% by the Russian oil consortium AAR.    Extrapolating from this we could put a current “private market” value of HRT’s remaining interest at say $1.2 billion.    Just last week, the company announced an oil find in the fifth well.   Whether commercial or not is still to be determined. 

Namibia

I will start here with some information on the background and management of HRT and the formation of the company.   Many of the people came from Petrobras including the man at the top, renowned geologist Marcio Mello.   Mello authored the book Petroleum Systems of South Atlantic Margins.  The idea of "petroleum systems” is to look at all manner of data in identifying hydrocarbon rich areas offshore including geology, biochemistry, geochemistry and seismic and other geophysics.  Mello spent 25 years at Petrobras and ran their research center at one time.   He was instrumental in Petrobras’s discovery of pre-salt oil deposits offshore Brazil including Tupi, which is estimated to contain 8 to 12 billion barrels of oil.  In total the pre-salt deposits offshore Brazil could contain up to 100 billion barrels. 

Namibia is just south of Angola with a long coastline along the South Atlantic almost directly across from Brazil.  It is, geologically speaking, the analog off the petroleum system offshore Brazil discovered by Mello and others at Petrobras.   

HRT has a working interest in 12 offshore blocks and operatorship on 10 of them and has completed an extensive library of 3D data covering 9,700 kilometers with 38 prospects  identified to date.   D&M has estimated 6.9 billion BOE of risked prospective resources. 

Adjacent to some of HRT’s blocks is a large gas field called Kuda, currently estimated with resources somewhere between 1 and 3 trillion cubic feet of gas.   Many believe that this proves the area is a “gas” province not and “oil” province.  HRT believes that the Kudo gas is the hydrocarbon cap for much deeper oil.    In analyzing satellite data for last 10 years Mello and his team have identified hundreds of oil seeps on HRT’s concessions.   Analysis of this oil found that it is coming from a deep source and that it is the geologic geochemical equivalent of the transatlantic pre-salt of Brazil. 

HRT has opened a data room in Houston and is currently in process of selling (through a farm out) an interest in Namibia to a major oil company or companies, which should not only provide capital but more technical resources in all aspects of the development of the Namibia concession.  HRT would like to conclude this process by end of June and complete a drilling plan by late 2012.   

Valuation

HRT has a current market capitalization of $1.7 billion with $700 million in cash, which is equal to about 90% of the capital employed in the business to date.    HRT has stated that current cash will fund development through 2013.  If we assume $1.2 billion valuation for the remaining 55% interest in Solimoes (based on TNK’s purchase of 45% for $1 billion).  Then the current value of HRT with cash and its Solimoes interest is equal to $1.9 billion or approximately $200 million more than the current market cap.   That still leaves Namibia,  un-accounted.  A successful farm out of Namibia prospect for a big number will highlight the value disparity here and create a potential near term catalyst.   I would guess the process has the potential to value Namibia at a number at or greater to the value of the company as a whole currently (Solimoes risked prospective resources of 1 billion BOE compared to Namibia at 6.9 billion).  I would think the market would at least recognize some of the value discovered through the farm out process.  Longer term, the stock price will likely move with the level of drilling success at Solimoes and Namibia.   To me, the real potential for 10X rests with finding similar producable oil structures offshore Namibia that Marcio Mello had a hand in finding offshore Brazil.