Description

Petro Rubiales is a new Latin American E&P that is suffering from several easily fixable valuation discounts.  It has a good chance for revaluation in 2008 as production goes from 9k boepd to 62k by 2009.

Why is PEG cheap?

PEG.v started trading 5 months ago as its Colobian oil field operations merged into a Toronto-venture listed shell company (CSX).  PEG is heavy oil, has limited street coverage and exposure to E&P investors, and there are substantial doubts as to whether its recently proposed stock merger with Pacific Stratus Energy (PSE.to) will go through.  The deal requires 2/3’s of PSE’s shareholders’ approval, and after a recent gas discovery, PSE shareholders are said to want a higher premium.  PEG is also at a high valuation on trailing numbers as it is experiencing rapid current production and reserves growth.  In addition, it suffers from an outdated reserve report.

There’s plenty of reasons for confusion and a valuation discount here.

Valuation

All $ amounts in USD

FD Shares outstanding                1B

Net Cash                                      $165M

Net Cash w/ Warrant Exercise    $316M

Market Cap                                  $1,334M

EV                                                $1,018M

Est Dec 2007 2P Reserves Net    86.3 Mboe

2P Valuation EV/boe                   $11.80 per barrel

PEG is approximately 2x 2010 cash flow (even if the PSE merger fails)

PEG was at net production of 4,700 bpd in July 2007 and had grown to 9,100 as of Dec 2007.  PEG’s main growth spurt will happen between 2008-2011 as it spends about $300M over the 4 years for pipeline construction and drilling.  PEG’s share of the pipeline cost will be $190M.  Management forecasts production to grow from 9k bpd currently to 45k by 2009 and 62k by 2011.  They forecast that production will be maintained through 2016 at 62k bpd net with reasonably low annual capex in the $40M range.

As a standalone company (without PSE), PEG is currently averaging a netback of about $31 on realized prices in the $50’s for its heavy crude from inland Columbia (2/3’s is trucked out currently).  Netbacks will edge higher to the mid $30’s once the pipeline is done.

Here’s how this translates into the numbers:

This is assuming average sales prices in the high $50’s.  This is likely 10 dollars below what they are realizing on average in this environment.  This is heavy crude and these are conservative netback numbers.  Their worst netbacks were $24 in the last 12 months ($40 Columbian market realizations with $10 of transportation costs that could be removed as the pipeline is built).  Some of PEG’s crude is able to be upgraded and get close to $90 realizations as it is moved by PSE’s pipelines several hundred miles north to the south Caribbean Sea.  This also helps to make this netback estimate conservative.

Even if we give PEG no credit for its large stockpile of net cash, at an EV of less than $1.4B, PEG is less than 2x 2010 EBITDA on conservative netbacks.

Why should we have confidence in this production growth?

Management explains this expansion as being an engineering project, not a risky exploration project.  The geology of the sands is known and there is no fracing necessary.  This area has been producing for years (but at much lower rates) because of previously untenable netbacks.  These are shallow reservoirs (less than 3000 feet).  They have already been able to double production in the last few months.

PEG’s chief asset is the Rubiales Field in Southeast Columbia, of which it has a 36% working interest after royalties.  The partner in the concession is state-owned Ecopetrol.  It should also be noted that PEG’s asset is owned through its 100% ownership of Meta Petroleum.  Part of their interest Meta was acquired from PEG board member German Efromovich, a billionaire investor and 15% owner of PEG.

Original oil in place is estimated to be almost 4 billion barrels.  At a conservative 15% recovery factor (Venezuela’s heavy fields have had 20% recoveries) this implies well over 200 million barrels net resource to PEG.  More than half of this large possible resource was ignored in my EV / barrel calculation earlier (based on 2P).

Merger with PSE is a boost to the valuation, but not necessary for PEG to work

In November, PEG proposed to buy PSE for 500 million shares – due to a recent large gas discovery at PSE, this is substantially accretive to PEG’s shareholders on an EV / barrel basis.  This is also substantially accretive to PEG’s netbacks as it allows them more pipeline access to the high price realization territory in north Columbia.  As mentioned, this requires 66% approval from PSE shareholders.  If the merger goes through, it will be a substantial catalyst for PEG as PEG’s 2008 production would immediately double to over 30k bpd.

Catalyst