|Shares Out. (in M):||392||P/E||NA||NA|
|Market Cap (in $M):||3,533||P/FCF||NA||NA|
|Net Debt (in $M):||0||EBIT||0||0|
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Cobalt (CIE) is a Houston based E&P with deepwater assets in the Gulf of Mexico, Gabon, and Angola. At today’s share price you’re getting a low cost, if not free, look into one of the most catalyst rich E&P portfolios in the market over the next 12 months. With the current market value covered by the company’s $1.65bn of cash and investments, its interests in two material deepwater Gulf of Mexico discoveries, and the company’s remaining Gulf of Mexico leases recorded at historical cost; buying Cobalt today offers a good margin of safety and an asymmetric risk return profile.
In addition to the two year exploration program in the Gulf of Mexico that starts next quarter, Cobalt is conducting an unprecedented drilling in the pre-salts of Angola. With a preliminary resource estimate of more than 7.5bn barrels of oil, the ongoing campaign could uncover structures comparable to the major pre-salt plays in Brazil. Pricing in just a 10% chance of success in the African portfolio would yield $4 of option value to stock (or ~45% of the current stock price). On an un-risked basis Cobalt’s interests in Angola and Gabon could be worth as much as $45 a share.
A thin float, a pure exploration portfolio in a tape where exploration is heavily risked, and a short term and somewhat tepid operating history since the company’s IPO have combined to cause Cobalt stock’s to appear undervalued at the doorstep of some major events. It is one thing for Mr. Market to overlook the potential of an exploration portfolio with drill bit events two years out in the future, I think it’s a mistake to neglect the option value of a fully funded drill campaign that on some prospects has already spud. Over the next six months CIE stock could move from trading at 0.1x unrisked NAV (a lean valuation for a pure exploration book) to 0.4x to 0.6x NAV (a typical value for development portfolio with first production three years out) in the event of a single exploration success.
Since inception in November 2005 Cobalt has been led by Joe Bryant, the last COO of Unocal, and previously President of BP Exploration in Angola. Bryant and a group of engineers formed the company to capitalize on a wave of lease expirations then about to occur in the Gulf of Mexico. It was 10 years earlier, in 1996, when Congress enacted the Deepwater Royalty Relief Act to promote deepwater drilling activity in the Gulf. Under the act 3,000 leases were issued over two years, with most requiring that an exploration well be started within 10 years to avoid cancellation.
Because of inadequate seismic technologies and rigs that couldn’t handle ultra deep water exploration, most of those GOM blocks went undrilled and saw their leases cancelled. A record number of them came back to auction in 2006 and 2007. Recognizing an opportunity to accumulate high quality Gulf acreage, Cobalt sought private equity funding and raised $600mm from Goldman Sachs, Carlyle, and First Reserve. Management further raised another $1.1bn in 2007 and 2008 to pick up additional Gulf acreage, shoot 3D seismic, and fund exploration wells. The company spent over $600mn to accumulate 113 blocks, including some of the most competitive leases in the auction (CIE was the top buyers of leases that received at least 4 bids). Today Cobalt is the 5th largest lease holder in the deepwater portion of the GOM with subsalt blocks in the Tahiti Basin, the Adjacent Miocene, and the lower Tertiary.
While acquiring interests in the Gulf, Cobalt also pursued pre-salt prospects in West Africa. In 2007, by leveraging the CEO’s previous role as President of BP Angola, the company entered negotiations that have lead to 40% working interests and operatorship of 3 large offshore Angolan blocks with prominent pre-salt reservoirs. The pre-salt refers to oil that was sealed beneath shale and salt, usually at deep or ultra deep levels (15,000+ feet). The timing was propitious as six months after Cobalt started talks, Petrobras revealed a major pre-salt discovery in the Santos Basin with Tupi. For those unfamiliar the Tupi field is an elephant: holding over 8 billion barrels of oil and gas, and is one of the largest discoveries in the Western Hemisphere in the last 30 years.
Cobalt thinks that Angola’s Kwanza basin is analogous to the Santos and Campos basins in Brazil. The over simplified geologic hypothesis is that 130mm years ago, when Africa and South America were still the same land mass, rift basins formed in the fissure between what became the two continents. On the South American side those basins filled with organic matter that became oil and gas. Layers of salt and sediment later formed over the reservoirs to make a seal that keep the hydrocarbons in place.
The multi-billion dollar question is whether the corresponding basins along the coasts of Angola, and Gabon experienced a similar phenomenon. Cobalt’s geologists have noted the symmetry in geology in the deepwater areas along Angola and Brazil, and identified source rock along Angola’s coast similar to that in the Santos where the pre-salt fields were found. While there haven’t yet been any direct pre-salt wells drilled in Angola (the numerous offshore discoveries in Angola over the past 15 years have all been above salt), a well drilled by Mobile in 1997 hit a 300 foot oil zone in the Angolan pre-salt while it was going after another trend. Mobile never flow tested that well so the reservoir quality and porosity are unknown, but the discovery confirmed the presence of oil in the Angolan pre-salt. And for what it’s worth, that well happens to reside on Cobalt’s Block 20. It also helps that Mobile’s well found oil since Cobalt’s license is solely for oil. The company’s contacts do not entitle it to any gas deposits that might be found on its blocks.
Cobalt’s Bicuar and Cameia wells, on Block 21, are the first two wells in Angola’s history to target the pre-salt. Cameia spud in late August, and will take 100 days total to drill and test. Bicauar was spud first actually, back in July, but on the second day of drilling hit some over-pressured water sand that caused the company to abandon the surface location of the well. The shallow hazard was not a significant issue and does not affect the company’s ability to drill the prospect later this year from a different entry point. While re-planning the Bicuar well, management decided move the rig to Cameia. After Cameia, the rig will return to Bicaur.
Like the recent pre-salt discoveries in Brazil, the prospects in Angola may be look massive. Bicuar and Cameia are targeting structures with estimates of 1 billion barrels of energy each. Cobalt’s Block 20 is also significant with an unrisked resource gross estimate of 3.9 billion barrels. One prospect on Block 20, Lontra, appears larger than both Bicuar and Cameia combined, and has a resource estimate of 2 billion barrels. The well economics on this block however are not comparable to those Cobalt is pursing in the Gulf. Cobalt carries Sonangol, the Angolan state oil company, in its Block 21 and Block 9, which in effect reduce CIE’s 40% interest on those two blocks to something closer to 25%. Cobalt’s Block 20 will further be subject to a production sharing agreement that reduces the company’s stake effectively down to 15% interest. At this point Cobalt has only a contingent license for Block 20 in place and expects the PSA to be signed shortly. Cobalt has full licenses for Blocks 21 and 9.
It’s interesting to consider whether a wildcatter like Cobalt would have won its Angola blocks had it entered Angola after the Tupi discovery. While previously offshore explorers historically avoided pre-salt prospects because of a lack of capable seismic technology, the discoveries in Brazil caused a rush among the majors toward ultra deep plays all along the west coast of Africa. Cobalt was an early mover and is the sole independent in deep water Angola today. In the most recent round of licensing earlier this year, a half dozen companies were selected as operators for pre-salt blocks, all of them international oil companies: ConocoPhillips, Repsol, Statoil, BP, ENI, and Total. Word is that bids in excess of $1.0 billion were made for some of the blocks. There is a serious amount of investment going into these pre-salt formations, and it’s no doubt positive that Cobalt’s neighbors are majors. I wouldn’t expect Cobalt to farm out interests in any of its blocks, but in the event of an Angolan discovery, it’s hard not to think that the company goes into play.
Cobalt also holds a 21.25% working interest in the 2.2mm acre Diaba Block in offshore Gabon. Here Total is the operator, and the first pre-salt well has been scheduled for next year. While Cobalt’s stake in Diaba is less than the company’s 40% interests in Angola, financial terms with the Gabonese are more favorable and provide Cobalt meaningful upside commodity exposure. Like Angola, the offshore pre-salts in Gabon are early stage. The Diaba block however is on trend with a 1bn BOE onshore pre-salt field (Rabi-Kounga) and not far from another off shore pre-salt discovery that was found in the early 1980’s but never developed. Harvest Natural Resources also recently discovered about 50 feet of pay in a pre-salt well about 5 miles away from Cobalt’s block.
Gulf of Mexico:
While West Africa offers significant potential, there is value in the Gulf of Mexico portfolio that Mr. Market isn’t charging you much for either. After the 2006-2007 auctions where Cobalt acquired over 100 blocks, the company widened its exposure to the deepwater Gulf further in 2009 in a deal with Total. The two companies agreed to pool their deepwater holdings in the Gulf of Mexico. The agreement put Cobalt as operator of all the pooled blocks, and gave the company a 60% working interest in the venture (Total holds the other 40% stake). In exchange for Cobalt’s participation in the alliance, Total will Cobalt on a 2:1 basis up to $150mm in a 5 well, ultra deep exploration program.
Today CIE has about 225 blocks in the deepwater portion of the Gulf targeting trends in the Miocene (primarily the Tahiti Basin) and the Inboard Lower Tertiary. The Tahiti Basin is a proven zone with considerable existing oil and gas production. The Inboard Lower Tertiary of the Gulf on the other hand is a much less developed area, with older rocks and deep waters; but is in the vicinity of recent giant discoveries like Jack and Cascade. Just 25% of CIE’s acreage expires in 2015 or earlier. I expect management will farm out some of its interests and roll the proceeds into other prospects in the Gulf.
To date Cobalt’s drilling history in the Gulf has been a mixed bag. The company has drilled five wells, and found success in the first two wells with Anadarko: Heidelberg and Shenandoah (both operated by APC, Cobalt holds a 9.375% and 20% interest respectively). Heidelberg found more than 200 feet of net oil pay in the Miocene, and Shenandoah hit close to 300 feet of net oil pay in the Lower Tertiary. The wells were drilled in February 2009, and first production should come in 2013. Cobalt doesn’t have proven reserves with these discoveries yet, but should book between 50 and 60mm barrels eventually.
Cobalt next three Gulf wells were disappointments:
1) Criollo: found oil but was deemed uneconomic on a stand-alone basis.
2) Firefox: was abandoned after drilling down to 30,000 feet. CIE claimed that the well had deeper potential, but not enough as stand alone. Both Firefox and Criollo can be tied into a larger development down the road.
3) Heidelberg #2 (also operated by Anadarko), was abandoned because of mechanical problems before reaching target depth. Anadarko will drill another well at this prospect upon receiving well permitting. The target structure at Heidelberg #2 is estimated at 300mm barrels, or about 28mm barrels net to Cobalt.
In addition to Heidelberg #2, Cobalt plans to drill an appraisal well around the original 2009 Heidelberg discovery. This well, Ligurian #2, should enter the deeper sands in the Miocene that weren’t reached by the original Heidelberg well. Cobalt is the operator here and holds a 45% working interest. The resource estimate is 300mm barrels or 135mm net to Cobalt. The well will spud early next year. It’s an exciting well. The Ligurian prospect, located on Block Green Canyon 858, was the most expensive block the company bid on the MMS auction. (lease bonus of $85mm and 19% royalty).
After Ligurian, CIE will drill North Platt, a lower tertiary prospect with a resource potential of 400 mm barrels or 240mm net to Cobalt. North Platt falls under the partial carry agreement with Total, and Cobalt will pay just 20% of the drilling cost up to $150mm (after which costs are shared according to ownership split: 60% Cobalt/40% Total). The well targets a depth of nearly 35,000 feet, should take about 200 days to drill, and cost between $150 and $200mm.
Cobalt has identified more than 30 prospects picked out along the Tahiti, the Miocene and Tertiary trends and plans to drill six exploratory wells in the Miocene alone through 2012. The average target is approximately 300mm boe, so just a couple discoveries would lead to material reserves. Cobalt’s reserve auditor, DeGolyer and MacNaughton, estimates the risked resource potential of Cobalt’s Gulf of Mexico portfolio to be 1.1bn.
In total Cobalt will spend about $1.3B to drill exploration and appraisal wells over the next 24 months. At this point 11 Gulf of Mexico wells, 5 Angolan wells and one well in Gabon are planned. The company is probably 18 months away from first production in the Gulf of Mexico; and, in the event of a discovery at Bicuar or Cameia, probably 4 years away from production from offshore wells in Angola.
IPO / Ownership History:
Cobalt went public at $13.50 in December 2009 when it raises $1 billion. In April of this year management had a follow up offering at $14, and raised another $450mm. With proceeds from the two offerings, the company has fully funded its drilling program through 2013. Cobalt has no debt.
Goldman Sachs, Riverstone/Carlyle, and First Reserve were the three original investors in CIE and own 19%, 19% and 14% of the stock respectively. Kern Partners and management both own another 8%. The free float of the stock is less than 30% of shares outstanding.
The spirit behind this write up is to alert others that CIE stock is an attractive exploration situation with nearly imminent catalysts near what I think a defensible floor, rather than to provide a hard target price. Ultimately Cobalt’s value depends on drilling success, the size of discoveries, and how much capital and time will be needed to bring production online.
Conclusion:Most junior and midcap exploration stocks have underperformed in the weak tape of the last six months, and it’s no wonder why. There are real challenges in identifying the intrinsic value of an E&P without producing assets or even reserves. Valuation is further complicated when the company needs to come to the market to finance its drilling program. To some degree I think Cobalt has mistakenly been cast as this type situation, when the reality is it is not. CIE’s drill campaign is funded, the company will record proven reserves in 2012 from its two GOM discoveries, and 3 wells are planned over the next 6 months with minimal timing risk. The company trades at approximately 0.1x NAV, which I think is low. Cobalt is an event rich situation with major value defining catalysts unfolding over the next 6 months worth spending time on if you have the appetite (or stomach) for exploration plays.
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