maysteeler would be proud , lots of information toKurdistan Trip – Greater Expectations
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Our recent trip to the Kurdistan Region of Iraq was incrementally positive given the KRG's constructive comments that exports will commence this year and the KRG'sOil Minister's belief that PSCs will not be altered following ratification of a federal Oil and Gas Law. In our view, the ability for the Tawke (DNO) and Taq Taq (Sinopec (Addax)/Genel) oil fields to resume oil exports via the Ceyhan-Kirkuk pipeline and receive consistent payment for oil sales represents a key catalyst that should not be overlooked for all regional players. Furthermore, the prospectivity within Kurdistan and significant uplift in activity this year makes the region one of the most catalyst rich areas within our coverage universe in 2010. That said, our meetings with various political officials within the KRG highlighted Iraq's fragile state and the potential for further civil unrest post federal elections and following the exit of the U.S. Forces. However, the KRG's message was one of its commitments to maintain stability within its borders.
Our visit to both the Niko Resources operated Qara Dagh Block (Vast at 37% wi) and the Longford operated (40% wi) Chia Surkh Block, also reaffirmed the exploration potential unfolding this year. There is no doubt in our minds, Kurdistan holds the highest potential reward for small to mid-sized companies as targets are generally in excess of 200 mmbbl (gross) recoverable. With upcoming wells at Qara Dagh (spud early-May) and Chia Surkh (late-2010), the catalyst potential remains extremely high for Vast and Longford, respectively. It also appears increasingly likely that shareholders and the board on both sides support the merger of Vast and Longford that would create a combined entity with two sizeable and highly prospective blocks, which could also diversify/lower its overall risk profile. We see a potential merger benefiting Longford to a greater extent given its requirement to issue shares to the KRG in-lieu of capacity building payments for its incremental 20% working interest (total of 40%) in the Chia Surkh Block.
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We were also extremely impressed with the depth of Vast/Longford's relationships within the Kurdistan region, particularly those of its Advisory Board and Management team members - General (U.S. Army, Retired) Jay Garner and Colonel (U.S. Army, Retired) Dick Naab - who clearly hold the people of Kurdistan in the highest regard.
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We are reaffirming our 1-Sector Outperform rating on Vast Exploration and one-year target price of $1.40 (based on our risked NAV analysis). Vast remains our top pick amongst the Kurdistan names given its near-term catalyst potential as it spuds its first well in early-May (vs. early-April, previously) and the Qara Dagh Block prospectivity of ~450 mmbbl (P50 gross recoverable) prospective oil resource estimates.
We are also maintaining a 2-Sector Perform rating on Longford Energy and one-year target price of
.45 (based on our risked NAV analysis). While Longford's first exploration well is unlikely to spud until late-2010, we view a potential merger with Vast as offering incremental value to Longford as it could capitalize on the early success of the first Qara Dagh exploration well, reducing the number of shares its would require to issue to the KRG.
¦ For further details on the Kurdistan Region of Iraq and for our initiating coverage reports on Vast Exploration, Longford Energy, and ShaMaran Petroleum see our April 1 report titled "Kurdistan - A Region Full of Ambition" available on SC Online.
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ound Table with the Minister - Dr. Ashti Hawrami
Our meeting with the KRG's Minister of Natural Resources, Dr. Ashti Hawrami, left us with a greater level of confidence in both the establishment of an export payment mechanism this year and the security of the oil PSCs signed. The minister was impressive and open with his responses, noting discussions have been "quietly continuing" around establishing an export payment mechanism and federal Oil and Gas Law, but moving slow due to the federal elections. That said, Dr. Hawrami's message was one of working with the central government to increase exports of all "Iraq's oil" (not Kurdish) and his anticipation that cash flow for oil exports from Kurdistan will be received this year. Negotiations around a payment mechanism appear to be at the front of the Ministry's priorities once the new central government is sorted and likely to fall ahead of ratification of the federal Oil and Gas Law. Finally, the KRG has been pleased with the majority of the contractor progression, but noted that slow movement on certain capacity initiatives has been a point of concern.
8 Industry Comment Monday, April 12, 2010 PSCs are not expected to be altered. Dr. Hawrami was clear in his expectation that current PSCs would not be altered even for "cosmetic purposes" following the ratification of the federal Oil and Gas Law, a fear generally held by the market and some of the companies operating in the region. This added level of reassurance is comforting, but we are reluctant to place 100% certainty on any events in Iraq. Despite the Federal Oil Minister's comments that exports from Kurdistan would commence within months, timelines remain highly uncertain until the new government is formed.
¦ Federal election - results within the month? Former Iraqi Prime Minister, Iyad Allawi appears to be the front runner in the minds of the KRG for the next President of an Iraqi coalition government, the result of which appears to be viewed favourably by the government official we met with, including the President of Kurdistan, Masoud Barzani (see Exhibit 1). The Kurdistan region has some political sway given the rift between the Sunni and Shia political factions, and is likely to throw its support behind the presidential candidate most likely to negotiate the export payment mechanism and federal Oil and Gas Law terms in the near term. The election of Allawi could also results in a shuffling of the Federal Oil Ministry in Baghdad, a net positive in our view for the Kurdistan region.
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ctivity on the Rise, Catalyst Rich in 2010/11
¦ The success of the KRG and overall relative attractiveness (versus other Middle East nations) of its PSC terms is highlighted by the fact that >40 companies have now signed 38 PSCs within the region since 2004. Given the fact that most PSCs require one to three exploration wells to be drilled in the first three-year exploration sub-phase, activity in the region is no doubt set to increase dramatically over the coming years. Dr. Hawrami noted that 10 rigs are currently operating in the region (set to increase), six to seven seismic crews and discoveries have been made on eight blocks thus far. Furthermore, the KRG has identified the route of a potential pipeline through Turkey that could be constructed within 12 months, likely contingent on central government approval. A summary of the potential exploration wells we anticipate this year is contained within Exhibit 2.
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ompany Updates - Vast and Longford
¦ The Forbes & Manhattan Group put on an impressive tour of the Kurdistan region that highlight most importantly how "Kurdish" the company is given its President and CEO (Dr. Ahmed Said) is Kurdish born and ~20 years of experience/relationships in the region held by its Advisory Board and Management team, specifically General Garner and Colonel Naab. In our view these relationships offer both Vast and Longford a key competitive advantage in the region that could help to ease some of the political risk.
ast Exploration (1-Sector Outperform)
We remain bullish on Vast Exploration given its first exploration well is set to spud in early-May and material prospectivity of 450 mmbbl gross P50 recoverable that falls toward the high-end of resource estimates released by the Kurdish peer. Vast noted that slow movement through customs has delayed delivery of all the rig components and will push back its spud date to early-May versus our April expectation.
A summary of various discovery sizes, oil prices and NPV10 net to Vast's working interest is contained within Exhibit 3Exhibit 1 - Iraq Election ResuMackenzie; IHS Energy; Company reports; Scotia Capital estimates.
The staff from Niko and Vast are anticipating the loss of drilling fluid right from the start that is fully consistent with other operators (WesternZagros, Heritage, Sterling, TTOPCO) and has taken steps to manage this primary risk by sourcing water wells and setting up three sizeable water pits to ensure plenty of fluid is available. The drilling plan appears sound and anticipates commencing the hole at 20" with the primary objective in the Qamchuqa (Cretaceous) occurring at ~1,600 m-2,470 m to be reached with 12 1/4" casing that should provide plenty of contingency if sidetracks or earlier-than-expected casing is undertaken. Despite the delay, we were also impressed with the overall operation execution in what we view as a logistically complex operating area with the well site constructed on the side of the Qara Dagh mountain (see Exhibit 4).
Exhibit 4 - Qara Dagh-11 Well Site Construction
Source: Analyst photo Exhibit 3 - Vast Exploration - Qara Dagh Net Working Interest NPV10 and NPV15 Scenario Analysis longford Energy (2-Sector Perform) We look positively on the Longford story given the previous discovery wells on the block and active oil seeps observed at surface that help to lower its exploration risk profile, but remain neutral in the near term as its first exploration well remains a minimum of eight to 10 months away in our view. That said, the company plans to commence a 305 km 2D seismic shoot in May, which could also yield updated resource estimates (vs. current P50 gross recoverable of 132 mmbbl) and the inclusion of the deeper Cretaceous potential that has yet to be assessed. That said, if additional financing can be obtained and/or a potential merger with Vast, timelines of the first exploration well could be moved up vis-à-vis our base expectation to late-2010 and would make us incrementally more bullish toward the name. As noted, the merger of Vast and Longford makes strategic sense, and in our opinion, would benefit Longford as it could capitalize on any early success from Vast's Qara Dagh-1 well. The combined entity would offer a more diversified operating base with two blocks with material working interests that could help to lower its overall risk profile. The synergies could also include shared resources and the ability to lock up rigs/crews for longer periods at potentially lower cost.