Description

It is rare to find a company that can liquate for way more than it is currently trading and has the near term potential for explosive growth. Petrobank is an undervalued oil and gas company that the pieces are currently worth over $45 in a liquidation with recent transactions in the industry and has the potential for explosive upside. Petrobank has two operations in Canada and one in Latin America.

Latin America (worth $11.65 at current market)

Petrobank owns 80% of publicly traded Petrominerales (PMG on Toronto) that is headquartered in Bogotá, Columbia. The company started producing from two development fields in 2003 and came public in June 2006. Petrominerales has accumulated 1.5 million acres of exploration land in two attractive basins.

The exploration activities are located in the Llanos Basin which has a geology and topography similar to Western Canada’s Sedimentary Basin.  Petrobank’s goal is to apply Canadian geo-technical evaluation techniques to the under-explored Columbian basin. It is one of the first companies in Columbia to explore using 3-D seismic exploration tools. Large blocks of land can be obtained with no initial land payments.

In the last two months, Petrominerales has announced several positive results of drilling activity in the Corcel Block. The ultimate sizes of the prospects are still unknown and will be defined over time. They are starting a six-month test at 4,000 BPD in September.  Petrominerales plans to drill eight exploration wells over the next year. It is likely, the company will do some form of financing in the next six months to fund the exploration. Tristone Capital's Chris Theal's research report indicates that it is not unreasonable assuming 3 wells in the region at 14mmb would equal 42mmb with 15 year reserve life.  Corporate slides indicate the wellhead differential is 11% WTI, royalties are $5.09, and production cost are $6.74 (CDN$/BOE). So at C$71.32 equals $51.46 netback.  The current proved and probable reserves are 9,148 MBOE.

Petrominerales also has three heavy oil blocks in Columbia on .8 million acres. Royal Dutch Shell just signed a contract with Ecopetrol on 1.6 million acres located in the middle of its heavy oil blocks.  Petrominerales has license rights for the THAI process in Columbia.

With the successful exploration results, Petrominerales stock has tripled to $11.64 in last 60 days.  Petrobank owns 76.694 million shares (80.725%) which is worth $892 million or $11.65 to Petrobank (roughly same share count at 76.591 shares outstanding).

Canada Light Oil (worth well over $4 per share)

Corporate slides indicate the light oil has a wellhead differential of 5% of WTI, royalties $5.43, and production cost of $51.30. Operating netback is $51.30 on C$71.32. Petrobank has 348,000 net acres of undeveloped land. Petrobank is drilling 60 horizontal wells in Bakken region (117,000acres) in 2007. They have four active rigs and are currently targeting six horizontal wells. Petrobank owns 183 sections in the Bakken fairway with an estimate of 4.5mmbbl oil per section. The current proved and probable reserves are 24,531 MBOE.

Canada Heavy Oil – Whitesands (worth over $30 per share)

The size of the oil sands near Ft McMurray in Canada is approximately the size of the state of FL and contains about a vast amount of heavy oil. With the recent rise in oil over last few years, there is a modern day gold rush in the area. The town of Fort McMurray has about 60,000 full time residents and over 60,000 transients. There is a huge labor shortage in the region, I heard stories of local Burger King employees earning $18 hour. All of the land in the region is leased. There currently two ways two extract oil from the heavy oil sands in Canada. The first is the means is leaching the sands near the surface (Suncore SU) and the other for oil sands 100 feet below surface (about 75-80% of the heavy oil in the region) uses process called SAGD.  SAGD is a process where companies inject steam into their reservoirs to move the thick deposits, Steam Assisted Gravity Drainage (SAGD). The downfall of SAGD:  process uses a tremendous amount of water, natural gas, expensive capital expenditures, low recovery, and is not friendly to  environment.

Petrobank has 72 sections in this region on 46,240 acres with 2.5 billion barrels in place. Under SAGD, it is estimated that 799 mmbbls are recoverable. Marathon Oil just announced the purchase of Western Oils Sands on August 13^th for $6.6 billion or $2.50 per recoverable barrel of oil. Under SAGD, Petrobank's shares are worth over $30 for the White Sands interest under price assumptions that Marathon paid. The lowest valuations in the region are $1 per bbl where timing of projects is unclear. This gives no credence to the THAI technology which Heywood Securities Alan Knowles (Aug. 13, 2007) writes that the technology eventually could make the valuations as high as $4 per bbl over time for Petrobank (process works better, lower capital cost, more refined oil, etc.) which is over four times the current stock price with no value for the other two business units.

Petrobank bought the THAI Technology from the University of Alberta. Petrobank and the Richardson family invested $40,000,000 into a THAI test site in Whitesands to see if it would work to remove heavy oil from the area (note: Petrobank recently bought out Richardson’s interest). Basically, the THAI technology injects low pressure hot air into the zone and the bitumen is lit and sustains high temperature combustion to separate the oil. A year ago the company started out with one well pair and the project in now through the final test as all three of the well pairs are up and working. The results have come in better than expected, 70% -80% more oil is recovered with 50% lower initial cost than SAGD! I have been following progress as a stockholder for two years, visited the test site last spring, etc. THAI is working! The recent addition of the third well pair is starting to upgrade the quality of the oil.

 There been several naysayers to the technology: olefins, this existing fire flood technology, etc. To date, I have not found justification in these arguments in countless hours of research. For example, fire flood has been around since 1920’s where hot air is injected down a vertical well and oil is extracted. This is different because the THAI process that uses a horizontal extraction well with a patented steam pipe to extract the oil.

The real risk in THAI process was oxygen breakthrough (if air got to the backside the site it would cause a massive explosion). To date, this is not a problem as Petrobank has notched up the air pressure to stress test the production process. The process does have a couple of obstacles to manage through. For example, the THAI process produced lot sand. Yet, Petrobank has devised and tested a device to remove the sand.  Another problem is storage. Since this was a test site, Petrobank did not build enough storage. The THAI process is working better than projected so management had to restrict the well flows. Eventually, Whitesands will connect to a pipeline. The only other risk I envision to the THAI process is some obstruction underground (an act of “mother Nature” so to speak) that disrupts the burn.  To date, I found the management team to experienced, on point, realistic on their projections, and not full of hype.  I refer to recent article in September  2007 issue of Oilsands Review ( http://www.oilsandsreview.com/articles.asp?ID=449 ).

In short, THAI is a lower capital outlay; lower operating cost (minimal natural gas and water handling), will have a higher netback for the partially upgraded product, and has faster project execution time.  The process is much better for the environment than SAGD.

In the forth quarter, Petrobank will submit plans for a 10,000 BBL/day project.  The cost will be about $150 million dollars and take a year to construct at cost of about $15,000 per flowing barrel. With the test results coming out more favorable than expected, the company announced that the horizontal leg on the THAI process will be able to be lengthened to 700 meters from 500 meters and the spacing between well pairs will be expanded to 125 meters from 100 meters which should lower capital cost. During this phase the company will test CAPRI which is a nickel based catalyst is added at the well bore to as an in-situ cracker to further refine the oil. Management will also set out a strategic plan for 100,000 bbl/day facility at Whitesands. For more information, I would refer you to corporate website (http://www.petrobank.com/hea-whitesandsproject.html).

Corporate slides indicate that the White Sands project on heavy oil has a wellhead differential of 23% of WTI, royalties $4.35, and production cost of $8.86. Operating netback is $41.70 on C$71.32. The current proved and probable reserves are 25,290 MBOE.

Catalyst