Value Investors Club / PETROTAL CORP (TAL.)

Description

All values are given in US Dollars

PetroTal is a compelling risk-reward in the oil space. The reason is probably because it is a small cap

spin-off into a reverse merger of a failed oil and gas company. The rationale behind the spin-off was that the
asset was non-core (other country of operations) and wouldn't move the needle for the parent, Gran Tierra Energy,
to develop it by itself. Petrotal has just one quarter of reporting revenues, which again doesn’t help it getting out of obscurity.

Normally I don’t like development assets since all sort of things can go wrong and it is hard having a

definitive image of the underlying profitability of the field/company. With PetroTal, there are some

mitigating factors. A conventional field with many comparable fields with long operating histories, a

decent balance sheet and a big discount to what I think is a fair value makes me more comfortable.

This write-up won’t be very long since all risks are pretty obvious but hard to quantify. The company

only has a single real asset, the Bretana field in Peru, which is still in development.

Valuation

PetroTal is valued in the market at around 100 Million (fully diluted around 107 Million). The latest

quarterly report mentions net cash of nearly 28 Million, but this amount has come down to 22

million due to ongoing capex to expand output at the field according to a recent press release. This

equates to an EV of 78 Million.

For this EV you get understated 2P reserves just shy of 40 Million barrels or less than 2 dollars a

barrel. If they can get the reserves closer to 3P over time, which I think is likely, you are paying

around 1 dollar a barrel.

The Bretana field

The field was discovered in 1974 by Amoco. There were some delineation wells drilled afterwards to

determine the size of the field, but these came up dry. The license was abandoned until it was taken

up by Gran Tierra Energy from which the company was spun out.

Bretana is a large OOIP, sandstone, unfaulted field but with a heavy crude (18-20 API). The OOIP is at

least 330 Million, with upside possible. As of now, the recovery factor mentioned by Netherland

Sewell & Associates inc (NSAI) is 12% percent to get to the 2P reserves of 40 million barrels. This

recovery factor is very conservative, and I think the real recovery factor should probably be a

multiple (2-3 times) of the current recovery factor.

Not only management mentions this and makes a pretty compelling case in their August 18

presentation, but the reserve auditor makes a similar claim in their reserve report. NSAI states:

“Bretana field is analogous to 16 oil fields that were discovered and developed by Occidental

Petroleum and PetroPeru in Blocks 8 and 192 in the 1970’s. These fields are on the same geological

trend to the northwest of Block 95. Vivian formation sandstones from the primary reservoir in these

fields with similar oil characteristics, reservoir characteristics, and structural trapping styles as

Bretana Field. These analogous fields provide a guide for production profile modeling, and recovery

factors (RF) are predicted to be over 20 percent.”

The fields mentioned above are now operated by Fronterra Energy and Puspetrol and are at the end

of their reserves in their current development. Notwithstanding, these were low cost conventional

oil fields for most of their lives.

So, what is Bretana worth?

While I don’t like NPV’s (especially now when the assumptions for oil prices in a few years are quite

aggressive – many calculations I see use mid 70 to low 80 prices a barrel in 2-3 years, which

dramatically increase the valuation), Petrotal has made a few NPV calculations using different price

assumptions. Even in the most pessimistic case, the NPV-10 on a 2P basis that is derived by the

reserve engineer is 282 Million, and that was before 21.5 million of capex.

Below you can find a few different NPV’s and price scenario’s:

2P NPV-10 of $282 Million 2P NPV-10 of $ 405 Million

Period Ending Oil Price (US$/BBL) Oil Price (US$)

12-31-2018 67.76 78.84

12-31-2019 63.98 75.08

12-31-2020 61.07 70.19

12-31-2021 59.53 66.53

12-31-2022 58.97 64.15

12-31-2023 58.89 62.58

12-31-2024 59.09 61.86

12-31-2025 59.28 61.83

Thereafter, escalated 2 percent on January 1 of each year.

These NPV-10’s only take the understated 2P reserves into account. If you would be more

“aggressive” and use a 3P valuation you end up in a range between 670 and 1,300 million. Off

course, that seems a bit too generous, but not impossible.

Another nice number mentioned by management in 2018 was that there has already been 300

million invested with exploration, seismic, production tests and production facilities to

date in a low cost and commercial field. In a way, we are buying all these efforts for just 100 Million,

or 35 or so cents on the dollar.

The economics

The field is currently producing about 1000 barrels a day from a 45 meter lateral sidetrack of a 2012

drilled exploration well. This is not an ideal production well, and despite this the company had a 12%

net profit margin last quarter selling 750 barrels of oil a day at 61.68 dollars a barrel and Brent at

74.65. That is quite impressive given the high fixed cost in oil fields. Management guides at 35+

dollar netbacks with 65$ oil in 2019 when the field should average 4,000-5,000 barrels a day and 40+

dollar netbacks in 2020 when the field would be producing +10,000 barrels a day.

This guidance seems realistic given comparable fields.

The discount to Brent is large and should get smaller when Bretana becomes a more consistent

producer.

The most important part, Risks..

The number one risk is balance sheet risk in a development company. While the company is debt

free with 22 million net cash as of February, I would have preferred more cash. This is somewhat

compensated given that the company is producing, is profitable and cash-flow positive at current oil

prices.

One should not forget however that the company anticipated to spend close to 67 million in capex in

2019 to expand production.

There is a mitigating factor given that execution has been better than anticipated. The company was

producing oil a quarter earlier than anticipated and under budget. Another point to like is a

reasonable SG&A.

Since this is Peru, there is always some country risk because Peru has not always been friendly to foreign oil companies

operating there. The same can be said about local tribes and some guerilla organizations.

Another major risk is that the company is highly dependent on just 1 asset and any difficulty with it

can have big complications for PetroTal.

The company is very lightly traded, which can also be considered a risk.

Petrotal has one more block in Peru with a few exploration leads. I would probably give the block a

pretty large negative value. The company is trying to farm out this block to lower the risks though.

These blocks do have a small chance of a very large discovery, which can give some nice option

value.

Since the company has no other field or discovery, there is a risk that cash-flows from Bretana can

be malinvested.

Management is not highly incentivized with insider ownership at just 1.1 percent. Again, something which I would

prefer to be different. Gary Guidry, who has a good track record and is currently CEO of Gran Tierra

Energy is member of the board. Douglas Urch is Chairman and had a very good track record

managing heavy oil field companies. Both Bankers Petroleum and Rally Energy, of which he was CFO, were taken over after

proving growing and profitable production in challenging oil fields.

Given these points, I would not consider management either a positive (given the low insider

ownership) nor a negative.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Growing production at Bretana
2P and 3P at Bretana growing larger trough drilling and production
A discovery at Block 133 or 107, but I don’t count on it
Rising oil prices

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			2019	2020
Price:	0.25	EPS	0	0
Shares Out. (in M):	538	P/E	0	0
Market Cap (in $M):	100	P/FCF	0	0
Net Debt (in $M):	-22	EBIT	0	0
TEV (in $M):	78	TEV/EBIT	0	0