Picking a Winning Junior Oil Stock – Fundamental Analysis of Petro One Energy (TSX-V: POP)

Thursday June 23, 2011: World Oil news caused some market confusion today, but I suggest we look at it with great consideration and a critical mind.

Oil prices have softened to a 4-month low as the IEA released emergency Oil reserves for the 3^rd time in history. The IEA is releasing 60 million barrels from Strategic Reserves around the world to help lower global Oil prices. In terms of fundamentals, this is inconsequential. 60 million barrels is approximately 18 hours of global production – not even a full day. Some traders were caught offside and liquidated due to emergency supply coming online. But when the dust settled, the implications of the IEA’s actions were decidedly bullish for Oil.

Over the past 30 years, the IEA has released emergency reserves only during the onset of Gulf War 1 and after Hurricane Katrina. Desperate times call for desperate measures and we saw that then and now.

There will be no ongoing material weakness in the price of Oil. This is not new supply coming on line. The IEA has simply shocked hedgers and traders by releasing emergency reserves to help hurting countries in a highly inflationary environment. The Saudis simply couldn’t bring it up quickly and cleanly enough to stave off Europe’s Oil starvation. This will come as no surprise to my blog readers as just a few days ago, on June 16, 2011, I posted information from the IEA Executive Director that the world was desperate for more Oil. Today’s anxious measures are not indicative of a price correction due to oversupply. It is really just a desperate move to retard the price of Oil.

My top pick, Petro One Energy (TSX:V – POP) faced some light selling as nervous investors took stock of the news. Luckily for me, I was able to get into the market during this time and accumulate on weakness. When the dust settled, most Oil companies had sold off, but Petro One was up a keen 13% to close at .68 cents on the day. Bargain hunting turned into outright buying as the market wised up to the IEA’s move and just how undervalued POP is. In fact, scared selling in the wider market turned to panic buying for Petro One.

Petro One’s aggregate Oil, across all properties, is nearly 1,000,000 BBL before they began drilling and exploration. The average cost of production in southwest Manitoba and southeast Saskatchewan is from $5-15 /BBL.

They have signed a production agreement with Chapman Petroleum Engineering. Chapman will not be paid unless Petro One produces Oil. All of Chapman’s work is 51-101 compliant. In fact, Chapman is one of the few firms in the country that can write up a 51-101.

Petro One’s Oil development program is run by Dr. Hairou Quing, Ph.D. McGill University (Dean's Honor List), 1991, who is the Geology Department Head at the University of Regina, who works with only two companies: Petro One and the state-run Chinese National Oil Company (CNOC).

On January 26, 2011 Petro One Energy (TSX-V:POP) closed at .38 cents. WTI Oil was trading around $90 / BBL, which is the same as it is today. At that time I wrote and published the post “Breaking down the math on Petro One Energy” which discussed their Yukon Gold deal with Goldstrike. I strongly recommended Petro One then, and my recommendation is even stronger now. In fact, I think this is the best buy on the market. Why? I add up the fundamental values from three key factors: Yukon Gold assets optioned to GSR, core-business Oil value, and lastly company share structure and business fundamentals.

On June 21, 2011 Petro One announced that Goldstrike (TSX-V: GSR) had begun exploring POP’s excellent Yukon Gold projects – as well as a number of their own. Goldstrike is cashed-up and requires no financing. Their program is being run by Trevor Bremner, who worked eight seasons in the Yukon with Archer Cathro (founders of ATAC Resources) and he served as Chief Geologist of the Yukon and as Yukon’s Acting Director of Mineral Resources.

Petro One’s two deals with GSR has allowed Petro One to divest itself of all risks and costs associated with exploring the Yukon Gold assets in exchange for shares in fully-funded, expertly-crewed GSR to do the work and make the following payments to Petro One’s bottom line:

Lucky Strike Claims 70% optioned to GSR:

• Petro One receives $500K cash, 2 million common shares of GSR on closing, 5 million common shares over 5 years, and 4 million warrants @ .25 more over a five year period.

BRC Claims 100% optioned to GSR:

• Petro one receives 2 million common shares of GSR and 3 million warrants @ .70 on closing, with another 1 million shares and 3 million warrants @ .70 in November 2012.

= $9,300,000

Setting the $9.3M dollar current value aside, the sum total of these two transactions is $500K cash and 20 million shares of GSR at end of of the 5-year period.

Next, I look at Petro One’s pre-exploration Oil assets, which are:

• 214,000 BBL Light Sweet initial on Viking / J5
• 500,000 BBL Light Sweet initial on Frobisher-Alida / J1
• 228,000 BBL Light Sweet initial on Spearfish / J4

= 942,000 BBL Light Sweet

942,000 BBL * current WTI price $90 BBL = $84,780,000 Gross

• Conservative average cost of Light Sweet / BBL from vertical wells with no fracking in Saskatchewan and Manitoba = $15 / BBL
• 942,000 BBL * $15 = $14,130,000 Cost

• $5.5M current cash
• $9.3M current conservative valuation of Yukon Gold transactions
• $71M current conservative valuation of Sask / Manitoba Oil assets

= $86M value of all assets excluding share price growth or exploration potential

- $27M MCAP

= $59M undervalue difference between cash / assets and market cap.

POP is trading at 31% of the most conservative valuation of its cash and assets.

With this in mind, the stock chart over the last year has been technically perfect to the upside. Petro One’s share price has more than doubled, on strong volume against an overall weakening market, over the past year.

On June 6, 2011, Petro One announced it had begun drilling with an aim towards near-term light, sweet crude production. Folks, we are looking at textbook case of an emerging junior Oil producer doing all things right. I expect we will see significant cash flow sometime this year.

There is no question as to what direction Petro One’s share price is headed. It will simply be a case of how much production will come online, how fast, and how long the company will last before it is taken out.

Fundamental Investment Case Summary:

From top-down, supply and demand macro fundamentals, Petro One is perfectly positioned in both Oil and Gold bull markets. Geographically and politically, POP’s Oil assets are in the best jurisdictions with the most open ground, political stability, and lowest royalty policies in North America. All of their projects have year-round 2-wheel drive access, significant existing infrastructure, and are framed on multiple sides by long, strong cumulative producers within a few hundred meters. In terms of geological potential, POP’s Oil assets are in elephant country, surrounded by Halliburton and EOG.

At the same time, Petro One’s Yukon Gold claims, optioned to GSR are the closest claims to the Underworld / Kinross Golden Saddle discovery, with all the geological and structural earmarks of significant deposits, while also featuring better Gold in soil anomalies than those that overlaid Golden Saddle. Risks and costs associated with Yukon Gold exploration have been divested to the experts at GSR, who are well funded and already executing a significant exploration program.
On the corporate side, Petro One has now become a pure light sweet Oil production-focused junior with first-rate management and technical teams who have discovered and put into production numerous world-class Oil and Gold deposits. Petro One is run with a $7K a month all-in burn rate, has a tight share structure owned primarily by top institutions and insiders.

With regards to the stock, it has more than doubled in price against a sagging market, over the past year, and the technical indicators are near-perfect. This said, Petro One’s market cap is still grossly discounted to its most conservative fundamental value. Which, in my opinion is why the stock continues to rally on even the toughest market days.

This is my number one pick. Anyone who doesn’t own it ASAP does so at the peril of their portfolio!

Happy hunting,

James Hudson, AlphaFlight Portfolios Inc.