VAALCO ENERGY INC EGY
February 13, 2012 - 9:25am EST by
mendoza
2012 2013
Price: 6.93 EPS $0.70 $0.70
Shares Out. (in M): 57 P/E 10.0x 10.0x
Market Cap (in $M): 396 P/FCF 10.0x 10.0x
Net Debt (in $M): 0 EBIT 115 115
TEV ($): 283 TEV/EBIT 2.6x 2.6x

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Description

Vaalco Energy (EGY) is a Houston based E&P with interests in Angola, Gabon, and the United States. At under $7 a share, Vaalco’s stock price offers an asymmetric way to play pre-salt exploration in Angola and Gabon. Apart from Cobalt, it is the only publicly listed non-major I am aware of with a material interest in the Angola pre-salt.

The recent announcements by Cobalt and Maersk are early evidence that the Angolan pre-salt formations in the Kwanza Basin are high quality analogues of the pre-salt formations in the Campos and Santos Basins of Brazil. More sensationally put, the Angolan pre-salt might be the biggest offshore oil discovery since the 8 billion barrel Tupi Field was found in Brazil. It’s no longer insane to think that Cobalt, Maersk, Chevron, and BP will report phenomenal, potentially multi-billion barrel, discoveries over the next 18 months as they drill Angolan pre-salt hydrocarbon structures.  EGY offers cheap investment exposure to West African pre-salt energy prospectivity. The company is a fully funded, producing E&P with growing reserves and direct interests in pre-salt formations.

EGY stock hasn’t yet priced in the full significance of Cobalt’s and Maersk’s monster pre-salt discoveries in Angola.  I think there are implications for West African pre-salt hydrocarbon prospects that the market hasn’t thoroughly considered.  Investors are still digesting the information released last week by Cobalt (CIE).  Last Friday the company presented its drill stem test findings on its Cameia well and revealed a 900 foot hydrocarbon column with 44 degree API oil capable of flowing over 20,000 barrels a day. Cameia looks like a world class discovery by any standard. Vaalco holds a 40% interest in Angola’s Block 5, which has over 350mm barrels of oil estimated in place, and is near Cobalt’s Cameia well.  I think Block 5’s resource current estimate is conservative, and will increase once EGY initiates a new 3D seismic campaign that identifies pre-salt prospects along the block’s western border.  

ANGOLA

Vaalco operates and holds a 40% working interest in Block 5 in offshore Angola.  Sonangol, the Angolan state oil company, holds 20% and is carried by the other participants in the block.  Originally the Norwegian based Interoil was third partner, holding the other 40% interest in the block, but was delinquent in paying its share of costs in 2009 and eventually removed from the production sharing contract.  Sonangol is in the process of marketing Interoil’s 40% interest. The recent discoveries in nearby blocks should intensify industry attention and help bring in a top-tier partner for Vaalco. 

Block 5 is big. It covers 1.4mm acres. It’s in the northern part of the Kwanza Basin and in vicinity to where both Cobalt and Maersk operate.  Vaalco and Sonangol have identified pre-salt lacustrine and sag reservoirs (analogous to Brazil’s Campos Basin), and also post-salt Albian sandstone and carbonate reservoirs on the block.  The western part of the block shows additional exploration potential in the Cretaceous and Tertiary.  Also intriguing is the block’s proximity to Cobalt’s Block 20, home to the Lontra pre-salt prospect estimated to hold in excess of 2 billion barrels

Over its history Block 5 has seen twelve wells drilled, mostly with mixed results. Six wells recorded oil, and three were drill stem-tested to produce approximately 30°API oil at around 1,000 barrels a day.  Six of the twelve of the wells drilled entered the pre-salt, though the pre-salt was never a primary target (the 2D seismic data used for detailing Block 5 prospects was insufficient for defining structures under the salt layer). 

After Interoil withdrew from the block, Sonangol offered Vaalco a two year extension on its initial exploration period to November 2012 to find a replacement partner and fulfill the remaining terms of the work agreement. Today all seismic obligations in the Production Sharing Contract have been performed, and the only unfilled commitment is to drill two exploration wells.

At this point VAALCO has received approval from Sonangol to drill two prospects, Loengo and Kindele:

The Loengo Prospect has both pre-salt and post-salt targets, and will be drilled in water about 100 meters deep. Loengo will target post-salt Cenomanian and Pinda, as well as pre-salt Cuvo formations.  Total recoverable is estimated to be over 100mm barrels.  I suspect the potential for the pre-salt in the Cuvo along the southern portion of block 5 will be more material in the event of a success. There’s an emerging pattern of pre-salt wells in Angola with oil column depths in excess of their pre-drill estimates.

The Kindele-Mubafo Prospect, also to be drilled at around 100m water depth, is located on a post-salt closure near a structure on which Conoco drilled a discovery well in 1987. That well, called Mubafo-1, was drilled on a prospect based on 2D data. Mubafo flowed 33° API oil during two DST's with the best interval flowing at a rate of 1,100 BOPD. The resource estimate here is much smaller, in the range of 50mm barrels recoverable, but is of lower risk well since it sits on trend with a proven structure.

Both of these prospects, admittedly, are somewhat underwhelming compared to the multi billion barrels prospects that Cobalt investors are now factoring into their valuations.  Knowledge of pre-salt potential in Angola is still early stage, and the prospects Vaalco and Sonangol have identified show what is likely the bare minimum in terms of resource potential.  Fortunatley Vaalco does not need to drill immediately at this time.  As operator of Block 5 it has an option in its PSC to have three additional years added to its exploration phase of its contract if it chooses to acquire and process 600km of additional 3D seismic data. I expect EGY will elect this option, and anticipate the 3D seismic program will be dedicated to identifying pre-salt formations along the western border of the block.  There’s a high probability that a 3D seismic campaign uncovers prospects that dwarf the two approved wells.  Vaalco’s proximity to the giant prospects in Blocks 18, 19, and 20 suggest the company is also in the presence of material hydrocarbon deposits.

 Gabon

The company’s main asset in Gabon is a 28% stake in the 760k acre offshore Etame Marin block.  The company has partnered with Sinopec, Sasol, Tullow, Sojitz, and Petro Energy on the block; and EGY is operator on behalf of the consortium.  The company signed on to the block on 1995 and has a successful operating history in the area.  The Etame Marin block today has 10 active wells and produces 23k bbl/d gross, or 5.5k bbl/d net to the Vaalco. There are four different producing formations on Etame Marin, all of which are connected to a single FPSO facility. Proved reserves are 6.9mm barrels, and proved and probable reserves are 11.6mm barrels.  99+% of reserves are oil which sells at Brent-linked pricing. The company sees additional prospects in the southwest corner of the block. The one nearest to being drilled at this time is a post salt prospect called Elili, which has an 85mm barrel gross potential. Elili will be spud in the second half of this year.

Onshore the company has a 50% interest in Mutamba Iroru block. This block covers 270,000 acres and was previously operated by Shell.  Two wells were unsuccessfully drilled in 2009.  In 2010 the company performed a 50% farm-out with Total. As a condition to the farm-out, 400km of 2d seismic is being reprocessed, and an exploration well will be drilled later this year.

United States

The Company has a 70% working interest in approximately 5,200 acres in Sheridan County, Montana in the Middle Bakken formation. It also holds a 65% working interest in approximately 22,000 acres in Roosevelt County, Montana in the Middle Bakken and lower formations. The company also has 364 acres in the Granite Wash formation of North Texas.

Valuation

EGY current market value is $395mm.  The company has a cash balance of $113mm and no debt as of 9/30/2011.   Since the spirit behind this write up is to alert others that EGY stock is an asymmetric situation, I am not going to hazard a hard price for the stock.  Value depends on what you think existing reserves are worth, as well as what odds you ascribe to future drilling success in Gabon and Angola, the size of discoveries, as well as how much capital and time will be needed to bring those online.  I estimate Gabon represents around $200mm of value for the company in a conservative case. Adjusting for the U.S. interests and probably $10mm of cash build in Q4, you’re paying today around $60mm for the company’s 40% interest Block 5.  Given the magnitude of neighboring discoveries by Cobalt and Maersk (likely in the hundreds of millions of barrels, if not billions), the possibility of M&A by one of EGY's enormous neighbors, and the likely flooding of new investor interest into the region, I think the Angola option embedded in the stock is underpriced today.

Catalyst

New Partner in Block 5
3D Seismic Acquisition
Pre-Salt success by other neighbors in Angola
Elili Prospect
M&A
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