Ivanhoe Energy common equity dual-listed on NASDAQ: IVAN; TSE (IE.TO)

Among the high-risk/high-reward opportunities we study, Ivanhoe Energy is attractive because of its patented technology, high-impact exploration projects, modest debt levels, and leadership/owners with deep pockets and international project finance expertise.

 IVAN’s HTL (“heavy to light”) technology is used in heavy-oil upgrading and is applicable on its 100% owned oil sands project (Tamarack) near Fort McMurray, Alberta, its other properties, and potential customers around the world. 

The combination of valuable patents and an imbedded call option at its oil sands project (Tamarack) could provide an asymmetric pay-off in the equity.  

Funding this option will come from asset sales, a separate business selling HTL technology to producers, and some potential debt issuances (hopefully with minimal equity dilution). The likelihood of actually raising capital for Tamarack is where IVAN seems unique versus similar situations.

Ivanhoe Energy’s chairman and largest shareholder, Robert Friedland, also controls mult-billion dollar miner Ivanhoe Mines (IVN) and Ivanhoe Capital (Private). Unlike many smaller situations with big projects, IVAN has significant experience raising project finance capital, deep pockets, and a network of contacts in international finance.

Friedland controls 101.3 million shares of Ivanhoe Mines putting his publically declared stake at $1.7billion. Forbe’s estimated Friedland’s net worth at $2.3B. Given Friedland’s resources to bring to the problem, we think it is hard to ignore his other significant holding, Ivanhoe Energy.

As the Tamarack project moves through the regulatory process, the property itself becomes more valuable for an acquirer providing further downside protection. IVAN estimates its Tamarack tar sands project can generate 20k boepd in stage 1 production and 20k boepd in stage 2 which would put it in the intermediate producer by 2014-2015 with a projected total production of 40k boepd. While the long-term is bright, there are numerous near-term (2012/2013) catalysts that could cause the market to revalue the shares for a quick 50-100% return.

IVAN has fully diluted shares outstanding of 381 million for a market cap of USD$381(~$1.00/sh.)

Operating cash burn rates were -$12.29m,-$31.9m, and -$26.45m for FYE 2009-2011.

Description of the E&P portfolio

The portfolio consists of heavy oil assets with interests in Canada (Tamarack), Ecuador (Pungarayacu), and Mongolia (Zitong, Dagang, Nyalga). Zitong was recently sold to China National Petroleum Corp (“CNPC”) the terms of which are described below. The two primary near-term drivers of value are drilling results in Ecuador and Tamarack approval. An analysis of the other projects are key, as IVAN will/is carefully advancing them through exploration drilling and subsequently selling them using them to finance Tamarack.  Successful well-tests at Zitong allowed IVAN to monetize that asset.

Developed and Undeveloped Acreage as of 12/31/2011

Reserve Report 12/31/11 prepared by GLG (1)

(1)    http://www.sec.gov/Archives/edgar/data/1106935/000095014212000622/eh1200415_ex9901.htm

Tamarack

IVAN’s 100% owned Tamarack project is surrounded by the major players in the oil-sands namely Suncor, Syncrude, and Exxon. IVAN acquired this block in 2008 from Talisman and had a 20% back-in right on the property which expires in mid-2011. Presumably IVAN has delayed work on Tamarack to retain 100% interest. Management estimates Tamarack will require $1.4b in capital to bring online. Phase 1 drilling will consist of 20 initial well pairs spread across two pads.

Description of HTL (“Heavy-To-Light”) Technology

HTL has been in development since the 1980’s and traces its roots to pyrolysis, a term used to describe the decomposition process of organic material into usable fuels which is better known in green-technology/bio-mass/venture capital investing.  Ensyn Group developed the technology and merged with IVAN in 2005.  IVAN has control of the rights to use HTL for heavy oil production while Ensyn has rights for HTL’s usage in bio-mass. After successful test runs, IVAN successfully built a test facility for HTL in 2009. We believe HTL could be disruptive technology.

HTL allows a producer to convert heavy oil, or in Canada, Bitumen, to synthetic crude oil solving the problem of transporting heavy crude to a large-footprint Upgrader facility where it then requires more energy for conversion. A traditional Upgrader facility consists of seven major components for a facility capable of handling 30kboepd.  HTL shrinks that size of the Upgrader facility footprint into a much smaller area without sacrificing facility throughput capacity.  HTL solves all of the issues with heavy oil with greater capital efficiency and improved economics.

In Fort McMurray, the raw bitumen itself is too viscous to transport via pipeline so it must go to an Upgrader which makes all the major operators in the area potential HTL customers for IVAN.  As is true with a traditional up-grader, HTL also addresses the issues of heavy oil’s high viscosity, low API (8.5), and large residuals content. An additional benefit of HTL is that energy released from the process can be used directly on site and provide energy to the project location. Heavy oil accumulations are wide-spread around the world, but are concentrated geographically in Canada, Columbia, Venezuela, Saudia Arabia making the applicability for the technology far-reaching.

IVAN can potentially license the technology for HTL or operate it as a services segment within the corporate parent. We believe HTL could be worth multiples of IVAN’s current market cap as a separate business within IVAN or in an outright sale after more commercial-scale tests are completed.

Logical customers for HTL include PEMEX, Ecopetrol, CNPC, Chevron, or Shell. Given that Friedland and Ivanhoe have sold their China natural gas assets

A potential new customer announcement for HTL would act as a catalyst and further put Tamarack in the money.

Financing

Ivanhoe entered into a $10m loan with Ivanhoe Capital in 12/2011

Downside protection

Management

IVAN is primarily owned by Robert Friedland who holds 15% of the equity and is co-Chairman of the board and founder of Ivanhoe Mines Ltd (NYSE: IVAN) a $12billion market cap mining company listed on the NYSE.

IVAN is a SEC filer versus a SEDAR filer. Without going into former mistakes, this fact can be somewhat important from a corporate governance and legal perspective for US shareholders.

Catalyst Timeline:

• Q2/Q3-2012 – Exploratory drilling results in Pungaraycu expected.
• Q4-2012: Regulatory approval by Alberta Government for Tamarack.

Valuation

It does not take a great deal of modeling to show that IVAN is grossly undervalued given the potential for 40,000 boepd. It is almost irrelevant at this point to ascribe value to the asset because stock performance will be driven by asset sales, drilling results the ability of the company to unlock Tamarack.

Risks

• Friedland might have interests contrary to public equity holders which are difficult to ascertain

Sources:

http://www.ivanhoecapital.com/

http://www.ivanhoeenergy.com/index.php?page=canada_-_tamarack_overview

http://www.ivanhoeenergy.com/index.php?page=htl_process_history_development

http://www.bechtel.com/assets/files/PDF/DetailDesign.pdf

http://www.total-ep-canada.com/upgrader/upgrading_process.asp

http://www.sec.gov/Archives/edgar/data/1106935/000095014212000622/eh1200415_ex9901.htm