Ultimately the cause of the oil price decline is down to a softening of global growth prospects, but there is no getting away from the fact that the actions of Opec have helped undermine the economics of US shale gas producers and heaped further woe on Russia – oil accounts for two thirds of Russia’s exports and half of its federal budget revenues. Conspiracy theories aside, it's difficult to believe that Opec, and Saudi Arabia, the world's largest swing producer, are unaware of the full consequence of their action.
I am not going to even try to attempt to call an end to the current rout, but what is apparent to me is that the indiscriminate sell-off has thrown up some appealing investment opportunities even if the oil price stays below $60 a barrel for a prolonged period of time.
Indeed, it was reassuring to see Aim-traded South American oil explorer and producer Global Energy Development (GED: 45p) complete a major asset sale and one that transforms the company’s finances. The disposal of its Llanos Basin properties in South America to a subsidiary of Canadian listed oil and gas exploration company Platino Energy Corporation (PVE:CVE) completed earlier this month and at a favourable price too considering the fact the oil price has fallen a third since the deal was announced. The cash consideration of US$50m (£31.8m) represented a 35 per cent premium to the valuation analysts attributed to these assets and equates to five times their annual cash flow (pre-capital expenditure). The properties generated a pre-tax profit of $4.7m on revenues of $75m last financial year and accounted for 95 per cent of Global Energy’s total cash flow. But those figures were based on an average oil price of $90 a barrel, or 50 per cent higher than the current price.
Free ride
Moreover, having paid off its net debt and accrued interest of $8m, Global Energy now has net cash of $42m, or £26.7m at current exchange rates. To put this sum into perspective, the company has a market value of just £16m based on 36.1m shares in issue. Or put it another way, net funds now account for 74p per share, or 68 per cent more than the current share price,
This means that we are getting a free ride on the company’s development programme, albeit the slump in the oil price means that hitting pay dirt in the current environment is less likely to be fully recognised by investors who can cherry pick bargains amongst the debris of the oil sector sell-off. That said, the funding costs of the ongoing drilling programme are being met by partner Everest Hill Energy following a farm-out agreement earlier this year whereby Global Energy retains a 50 per cent interest in its Bolivar license area, located in the Middle Magdalena valley in Colombia, and has a fully carried interest on three wells. The portfolio contains 32.2m barrels (1P-proved), 55m barrels (2P-proved and probable), and 184m barrels (3P- proved, probable and possible) and importantly Everest is fronting drilling costs of $24m (£15m) which mitigates risk for investors holding Global Energy’s shares.
Investors are also getting all of Global Energy’s Bocachico properties, in Middle Magdalena, held with partner Ecopetrol, in the price for free too. These contain 11m barrels (1P-proved), and 40.4m barrels (2P-proved and probable).
Clearly, these Columbian assets have some value, but even if we ignore them completely, then Global Energy’s shares shouldn’t be trading 40 per cent below net cash on the balance sheet. It’s a crazy valuation in my view. It’s worth noting too that we can expect Global Energy in due course to make a further announcement with regards to the use of the cash proceeds from the aforementioned asset sale following the completion of the Llanos transaction. An earnings enhancing share buy-back programme would not go amiss given that 86 per cent of the company's issued share capital is controlled by the top nine shareholders, so it wouldn’t take much buying to propel the share price upwards and reward Global Energy's loyal shareholders with a much fairer valuation for their equity holdings.
Admittedly, the investment has not worked out since I initiated coverage two years ago (‘Insiders major buy signal’, 17 December 2012), and the shares are close to their 40p all-time low (‘Overdue and ripe for a bounce’, 10 September 2014). But with such substantial cash backing they are a value buy ahead of an announcement from the company on the use of the cash windfall.
A compelling valuation
The slump in the oil price has also put the Aim-traded shares of cash rich SeaEnergy (SEA: 23.5p) under pressure even though it reported robust trading last month (‘Exploiting valuation anomalies’, 18 November 2014). In fact, the price has fallen below my original buy recommendation price of 29p ('Making waves', 20 February 2014).
As reported last month, the Aberdeen-based small-cap energy services company is set to turn profitable in the current calendar year, mainly due to the strong growth at its R2S's core service division which offers a Visual Asset Management (VAM) technology that produces 360 degree spherical photographs of locations and builds up three-dimensional (3D) models. In particular, VAM enables oil rig operators to keep a visual record of all key parts of an oil rig, monitor its condition and changes to the fabric, with a view to carrying out maintenance.
Clearly, investors are worried that with the oil price under pressure then this will impact on demand for SeaEnergy’s services. However, this completely misses the point because if anything the need to keep costs down intensifies when the oil price is low and R2S offers a cost advantage to operators whereby they can monitor rig activity without making expensive offshore visits. Moreover, when SeaEnergy released its trading update early last month the company reported R2S had a strong order book for the rest of the year, and for the first half of 2015 too. The oil price had already fallen 29 per cent from its June high at that point, so if major oil operators were going to start deferring investment decisions then that process would have already begun.
Another knock-on effect of the slump in the oil price concerns the ongoing farm-out negotiations on the Barryroe licence located in the North Celtic Sea Basin and which has 346m barrels of oil equivalent of recoverable 2C resources. Aim-traded Providence Resources (PVR: 67p) is the operator of Barryroe, with an 80 per cent interest in the field, and has been negotiating a farm-out deal on behalf of its partners. These include Aim-traded North Celtic Sea-focused oil and gas explorer Lansdowne Oil & Gas (LOGP: 6.5p) which has a 20 per cent holding in the licence. In turn, SeaEnergy owns a 21.4 per cent legacy stake, worth £2m, in Lansdowne Oil and which has been earmarked for disposal. It goes without saying that the slump in the oil price will impact the terms of any farm-out deal, and negatively impact the negotiating position of Providence Partners, but that is already being factored in with the equity valuations of both Providence Resources and Lansdowne Oil on the floor.
Investors who have sold down SeaEnergy’s shares also seem to be ignoring the fact that the company is cash rich and had net funds of £675,000 when it last reported. Moreover, the R2S business, which SeaEnergy acquired for only £10.1m (including earn-outs) in August 2012, is easily worth more than SeaEnergy’s own market value of £13m. That’s because in its last financial year R2S reported cash profits of £2.8m – in excess of the £2.5m hurdle rate for the maximum earn-out – and continues to grow strongly. In effect, SeaEnergy’s ship management and energy consultancy businesses are in the price for free as is the stake in Lansdowne Oil and the UK royalty interest in Block 21/8a (located adjacent to the Forties field in the Central North Sea which contains the Scolty discovery).
SeaEnergy may be unloved, but there is no getting away from the fact the company’s equity is being seriously undervalued. And with upbeat full-year results expected to be released in the first quarter next year, I view the current depressed valuation as a buying opportunity.
■ Subject to availability and for a limited period only, Simon Thompson's book Stock Picking for Profit is available to purchase at a special discounted price of £10.99, plus £2.75 postage and packaging, for all internet orders placed at www.ypdbooks.com. The book is priced at £14.99, plus £2.75 postage and packaging, for all telephone orders placed with YPDBooks (01904 431 213). Simon has published an article outlining the content: 'Secrets to successful stockpicking'
