JSC Kazmunaigas E&P KMG
May 11, 2009 - 11:50am EST by
2009 2010
Price: 18.40 EPS $4.49 $2.50
Shares Out. (in M): 439 P/E 4.1x 7.4x
Market Cap (in $M): 8,078 P/FCF 5.3x 8.9X
Net Debt (in $M): 0 EBIT 2,800 932
TEV ($): 7,330 TEV/EBIT 2.6x 7.9x

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JSC Kazmunaigas: $18.40 US.  Growth From Inexpensive Acquisitions.


All figures are converted from Kazakhstan Tenge to US dollars at the rate of 1 KZT= $.0066 US as of May 10th, 2009.   Estimates are my own, and will differ materially from published analyst reports. GDR trades in US dollars.


GDR listing: London Stock Exchange.

Ticker Symbol: KMG

ADRs outstanding:  439 million.


Market cap:  $8.078 billion.

Cash and cash equivalents: $1.893 billion

Total liabilities:  $1.145 billion.


Enterprise Value:  $7.33 billion

Enterprise Value per flowing barrel: $39,836

Enterprise Value per barrel of 1P:  $10.43


2008 Revenue:  $4.018 billion.

2008 EBITDA: $2.27 billion.


2009 forecast EBITDA (assuming $50 Brent):  $1.26 billion.

2009 forecast EV/EBITDA ratio:  5.7X


Dividend declared for 2009: $.73 US per share.


Corporate website:    http://www.kmgep.kz/


Kazmunaigas (KMG) is a cash rich conventional oil producer with low F&D costs and low depreciation.


KMG is second largest oil producer in Kazakhstan.


Net production averaged 190,000 boepd in 2008, overwhelmingly oil.


Roughly 76% of 2008 oil production was exported at world prices.  The remaining 24% was sold domestically, at prices that are less than 40% of world benchmarks.  Production is unhedged.


Shares of Kazmunaigas have been listed on the LSE since September 29th, 2006.  The republic of Kazakhstan indirectly holds 62% of the outstanding shares.


KMG has a unique strategic advantage in Kazakhstan.


The republic carries the right of refusal to match any takeover offer for oil and gas assets in Kazakhstan. This ROFR has resulted in a limited pool of suitors for Kazakhstan assets.  Fewer bidders consistently produce low prices (on a relative basis) for asset purchases in this nation.


Once the republic enters into an asset purchase on takeover, the government has the right to offer participation in onshore takeovers to Kazmunaigas.  KMG has "cherry picked" several extremely long lived conventional reserves, in recent years. 

Reserves are impressive for a company with such a modest enterprise value.


Kazmunaigas reports approximately 702.9 million barrels of proven producing reserves, or 1P.  The 2008 reserve replacement ratio was 113% of production.


If one uses 2P (proven and probable) as their metric, KMG reports 1.77 billion barrels of 2P reserves.


At crude oil prices of $55 for Brent, management estimates that KMG fields will be productive until 2047.


Reported reserves do NOT include a 50% equity interest in two joint ventures.

Since 2007, KMG has obtained equity stakes in Nations Oil and Kazgermunai LLP.   Obtained for total consideration of $1.9 billion, proven reserves (1P) were purchased for a net cost of $6.92 US per barrel, or $38,000 per flowing barrel.


These acquisitions currently produce 50,000 bpd of oil production net to KMG.  


    1.  KMG holds 50% of the equity in Nations Energy. CNOOC holds the remaining 50% interest.  Nations reported 363.8 million barrels of 1P at the start of 2008, or 466 million barrels of 2P reserves.  The bulk of reported reserves are contained within one field.  The Karazhanbas field is roughly 35 km long and 6 km wide.   This oil is heavy, with an API of 19 degrees.  Nations Energy is the 9th largest producer in Kazakhstan.


     2.   KMG holds 50% of the equity in Kazgermunai LLP.  This firm reported 285 million barrels of 2P reserves at the start of 2008, of which 185 million barrels was 1P.  Kumkol crude is light, with an API of 38 degrees and .015% sulphur.   Kazgermunai is the 8th largest producer in Kazakhstan. 


The JVs added $512.3 million of profit to KMG's bottom line in 2008.  $648.7 million US of dividends and cash income have been received from the partnerships to date. 


A bearish scenario assumes that the partnerships were unable to replace produced reserves since acquisition. In this case, "off balance sheet" reserves might now represent 237 million barrels of 1P reserves, or 275-338 million barrels of 2P.  


This prices remaining purchased assets at $5.27 US per barrel, or $25,006 per flowing barrel.


86% of the joint venture production was exported during 2008. 

KMG is one of the most efficient producers of oil globally.


2008 finding and development costs (F&D) were roughly $4.8 per barrel, less than 20% of the 2008 global intermediate/large cap worldwide reserve replacement cost.  Kazmunaigas 2008 F&D costs represented the lowest (of any publicly traded intermediate producer) in my coverage universe.   

Depreciation, depletion and amortization (DD&A) in 2008 was approximately $4.1 per barrel, or 5.7% of revenues. 


Operating expenses amounted to less than $8.65 per barrel in 2008.


In 2008, KMG spent approximately $348 million on capex.  Output fell by roughly 1%, reflecting uncertainties with respect to Kazakhstan's new mineral tax codes. 


After a precipitous year end decline in oil prices (which are a factor in calculating producible reserves), 2P reserves rose by ½ of 1% for 2008. Reserves were calculated using $40 WTI for crude oil. 

By way of comparison, the median intermediate to large cap producer had to spend more than $2.1 billion US in 2008, in order to find the same quantity of oil reserves.


Management's conservative planning serves shareholders well during periods of low oil prices


Kazmunaigas uses $40 US WTI as a reference price, to determine the 2009 budget.  For 2009, management estimates that production will decline by roughly 3.3%, factoring in a capex budget of less than $300 million. Operating expenses are forecast to be in the range of $500 million. 

With anticipated revenues of more than $2.2 billion forecast in 2009 (net of the new mineral extraction taxes and assuming $50 Brent), Kazmunaigas seems quite capable of generating $1.3 billion of EBITDA.


Kazmunaigas maintains a sizeable cash reserve. This buffers shareholders from capital market issues facing most intermediates.


Using my criteria of determining net cash (total liabilities-short term cash), I estimate that KMG held more than $748 million of short term cash on 31/12/08.   Conventional analysts use less stringent models. Some report Kazmunaigas is holding $4 billion+ of short term liquidity. 


In the near term, a $350 million US share repurchase program is ongoing.   At current prices, this should retire more than 4.5% of KMG's share count in 2009. The buyback program should prove accretive to EBITDA per share in 2009, without leveraging the balance sheet.  


Tax relief is set to occur in 2009 and beyond.

A sweeping change in Kazakhstan's energy taxation policies wreaked havoc on the income statement in 2008.

From Q2 through Q4 of 2008, a short term export energy tax was applied to all producers.  It became problematic, as the tax was based upon trailing crude prices. Subsequently, while the price of crude collapsed in the 4th quarter of 2008, the tax almost doubled over that of the 3rd quarter.   In December of 2008, export taxes exceeded the domestic price for Kazakhstan crude oil.  This proved to be disastrous for revenues of all producers in that country.  Some companies shut in production, rather than sell at a loss. 


The 2008 tax change was brought about, by a government realization that the nation was unable to participate in windfall profits, when oil prices were high.  For many years, the republic of Kazakhstan boasted an attractive fiscal regime for oil production.   Taxation was low, write-offs against earned income were high, and up to 80% of oil production was allowed to be exported for hard currencies. 


At KMG, payment of the export taxes resulted in total operating expenses soaring to more than $2.47 billion in 2008.   This was felt most keenly in the 4th quarter of 2008, when export taxes were set at $27.7 per barrel, whereas crude oil prices averaged just $52 US.     

A new energy management tax system based has been adopted in 2009.  Policies now feature a mineral extraction tax applied on all production, and progressive taxation tiered to oil prices.  




Sub $60 WTI, KMG appears to be better off under the new taxation system. The drawback will be that a greater portion of windfall profits will go towards taxation, should oil prices ever recover to the glory days of late 2007-early 2008.

Importantly, corporate income taxes are also set to decline substantially over the next 36 months.   In 2008, the Kazakhstan corporate income tax rate was set at 30%.  In 2009, this rate falls to 20%.  In 2010, corporate income taxes fall to 17.5%.  In 2011, this rate will drop to just 15%.

What some consider as criticisms against owning Kazmunaigas, I consider being strengths.

1.  Bearish types note that the Kazakhstan government is the majority shareholder of KMG. They infer that government objectives may override the goals of common shareholders.

To date, common shareholders of non-government controlled oil companies in Kazakhstan have generally been short-changed.  Kazakhstan's energy policies have been developed to create a viable national oil firm, that being KMG. . 

Foreign firms operate at a disadvantage in this republic.  Virtually all energy initiatives, in the last five years, were expressly designed to aid KMG.  Foreign oil companies have been forced to sell portions of their most lucrative fields to Kazmunaigas, during takeovers.  KMG will have an opportunity to expand over time, perhaps dramatically, via accretive acquisitions.      


It seems abundantly clear, at least to me, that Kazmunaigas is the "chosen son" of the republic's energy program.

2.  Bearish types note that KMG spends little on exploration, and focuses largely upon development of existing assets. They question where reserve growth will come from.

Exploration is expensive, risky and has long lead times.   Globally, far less than 1/3 of exploration wells find a commercial reserve.  Even when commercial reserves are found, infrastructure required to tie in new fields generally exceed the cost of the discovery.  Kazmunaigas has proven to be capable of increasing reserves, to the point that they replace annual production and then some, simply through development drilling.    

Due of the government's interventionist policy (a pre-emptive right of first refusal) on oil asset purchases in Kazakhstan, takeovers in this country sell for a healthy discount to comparables in other nations. The ROFR completely negates the need for Kazmunaigas to spend vast amounts of capital on exploration.   
Management of KMG can simply cherry pick the best onshore takeovers when transactions take place.  

At the current price of crude oil, it is cheaper to buy reserves, rather than explore. 


KMG's sizeable cash balance places the firm in an enviable position indeed.  Opportunities to grow via acquisition might be plentiful and cheap in 2009.   There is little risk of shareholder dilution at the bottom of the oil cycle. 



Mangistaumunaigas is reportedly up for sale. This is another long lived asset. Oil production is primarily derived from the Kalamkas field.   Proven reserves at this sandstone formation are estimated to exceed 500 million barrels.  2P reserves are suggested to exceed 1.3 billion barrels.  The oil is heavier (25-29 API), sulphurous (2%) and waxy (up to 15% paraffin).  The paraffin content has not posed any transportation challenges over the last 10 years. Sulphur extraction does not represent an issue at Kalamkas.  

KMG has the financial capacity to take a 25% stake.  This could add roughly 30,000 bpd of production, at a potential cost of up to $900 million. 


Event without Mangistaumunaigas, KMG has almost 30 years of commercial production potential already on the books.   When a company with an enterprise value of just $7.3 billion controls more than 1.77 billion barrels of commercial reserves (not original oil in place or OOIP), I question ANY near term need to find more oil.    

The geological risk that many oil producers undertake in this country simply doesn't apply to Kazmunaigas.

A very superficial glance at Kazakhstan indicates purported oil reserves in this sparsely populated nation bordering on the absurd.  Juniors have historically been able to assemble large tracts of acreage for exploration. Investor enthusiasm was very high for almost a decade.


Retail investors once called Kazakhstan the "Eldorado" of the oil industry.  Now, many think a more appropriate nickname should be "black death".

The issue is geological complexity.  More than 70% of the US Geological Survey's assessed reserves for the region are contained within highly fractured carbonate formations. Carbonates are about as unpredictable a source rock to pump oil from, as can be found.    

Attempts to produce from carbonates in Kazakhstan have largely been disastrous.  A number of high profile juniors have failed in the attempt.  Even major producers, such as ENI, have not cracked the secret of carbonates in Kazakhstan.  As a prime example, the Kashagan field is estimated to contain as much as 6.5 billion barrels of crude.  This field was discovered in 2000.  Technical issues on how to extract waxy, sulphurous oil from a claylike source rock abound.  Production has still not commenced, after 9 years of trying.   A "guesstimate" now hopes for initial production in 2010-2011.  Hydrogen sulphide content of up to 19% seems to be the issue now preventing extraction from Kashagan.

Kazmunaigas oil reserves on the other hand, are largely contained within conventional sandstone formations.  This should minimize the geologic risk somewhat.  KMG has also passed on opportunities to purchase carbonate oil producers in the past several years. 

Mittal purchased half of Nelson Resources, which operates the carbonate Alibekmola field.  KMG did not act upon the chance to buy into Nelson.  In this instance, management's understanding of the complexities of fields in Kazakhstan saved shareholders a lot of grief.  Production at Nelson has fallen for almost 3 years now.  Mittal is now looking to sell this company to whomever he can.


Judging by what KMG has NOT purchased, + what they have purchased, I'm comfortable with how management intends to build out the company.

In comparison to several prominent international producers deemed to be "good values", Kazmunaigas appears VERY inexpensive.

Nexen (NYSE: NXY-$22.15
) is a crude oil and natural gas producer slightly larger than Kazmunaigas.  Oil and gas revenues were $5.57 billion US in 2008.   The company also generated about $145 million of pre-tax income from oil and gas trading and chemical operations in 2008. The energy trading division did not generate sufficient profitability to offset the cost of capital, over the past 36 months.   

Nexen invested $2.36 billion on capex in the oil and gas division during 2008.  This added 66 million barrels of oil equivalent to the reserve base in 2008.  Unfortunately for shareholders, production was 86 million barrels.  Finding and development costs (F&D) in 2008 amounted to $35.75 US per barrel.  The reserve replacement ratio in 2008 was 69%.   In total, reserves fell by a larger degree (9.5% year over year) due to asset write downs. 2008 DD&A was $16.5 per barrel, before factoring in sizeable asset write downs.

In 2009, management of Nexen anticipates capital spending of more than $2.1 billion US.  The goal is to boost production by 5%. 

Nexen reported 664 million barrels of oil equivalent of proven reserves at the end of 2008.  Roughly 80% of this reserve base is crude oil. Production in 2008 was about 250,000 boepd.   NXY has an enterprise value of more than $25.77 billion.  At $50 US WTI, NXY appears capable of generating $2.4 billion US of EBITDA in 2009 from core operations. 

In comparison to Nexen, KMG sells for a discount of roughly 53% on an EV/EBITDA basis.


Noble Energy (NYSE: NBL-$59.52) is considered to be one of the most efficient intermediate producers.  Since 2003, an investment in Noble has outperformed the peer group by more than 4% per annum.  NBL spent $1.97 billion on capex during 2008.  53.5 million Boe (barrel of oil equivalent) was found.  The reserve replacement ratio was 77%.   NBL's 2008 F&D was $36.82 US per barrel.  DD&A averaged $10.44 per barrel in 2008.

At year end 2008, Noble reported 830 million barrels of oil equivalent of proven reserves at the end of 2008.  Roughly 66% of this reserve base is natural gas.   While the SEC allows for a standard 6-1 gas oil reserve ratio, in reality, natural gas reserves are worth just a fraction of that of crude oil.  This is due to the perpetual price differential of gas to crude oil.  

Noble's 2008 revenues were $3.9 billion.  The company has an enterprise value of $15.2 billion.  2008 production was roughly 197,000 boepd. 77% of this production was weighted to natural gas.   At $50 WTI, Noble might generate $1.2 billion US of EBITDA in 2009.  

In 2008, Noble produced lower revenues than KMG, earned just 82% of Kazmunaigas' EBITDA and incurred asset write downs.   


In comparison to Noble, KMG sells for a discount of roughly 53% on an EV/EBITDA basis.   

To find oil producers with enterprise values roughly equivalent to Kazmunaigas, one has settle for about 50% of KMG current production.

Addax Petroleum (LSE- $32.42 US)
had 2008 production of 138,000 bopd. The enterprise value is $7.9 billion US.  Addax has announced some potentially significant discoveries.  The proven reserve life index is about 5 years at current rates. Tax rates in its major producing nation (Nigeria) are much higher than Kazakhstan.

Newfield Exploration (NYSE-NFX: $36.01) had 2008 production of 108,000 boepd. The current enterprise value is $8.40 billion US.   Production is set to climb by about 10% in 2009.

Pioneer Natural Resources (NYSE-PXD: $29.87) reported 2008 production of about 114,000 boepd.  The current enterprise value is $8.7 billion.    Production is set to climb by about 7% in 2008. 


KMG is often appraised against Russian oil producers.


In the past, this may have been appropriate.  Problems with the Russian system of oil taxation have been identified in the past 36 months which represent a disincentive to invest. In brief, Russian E&Ps essentially earn a fixed fee on output which caps profits, irregardless of oil prices.  


The republic of Kazakhstan has sought to modify its oil extraction and mineral extraction taxes.   The republic's energy industry has been the source of significant investment interest from China since 2007.  This has continued in 2009, with CNOOC's announced desire to acquire an interest in Mangistaumunaigas.


Nevertheless, investors might wish to appraise KMG to publicly traded Russian peers.  Attached is a link which highlights the value differential between KMG and leading Russian peers.




My positive views on fundamental valuation aside, the risks of owning KMG are likely TOO high to merit retail investor consideration.

At this time, there is limited North American coverage to reassure investors during periods of market volatility.  10 global firms follow KMG.  Outside of the government stake, Kazmunaigas is largely held by European investors.  US investors presently hold less than 1% of the outstanding GDRs.

Political risk may be high with a foreign security in an FSU (former Soviet Union) jurisdiction.  Those who would consider owning KMG should brace themselves for periodic bouts of extreme buyer's remorse.

This pick is really only suitable at the institutional or mutual fund level.   There might be a handful of intrepid, ultra high net worth investors, who will find KMG to be intriguing.  If so, a growing number of full service brokerage firms and selected discount firms execute transactions on the London Stock Exchange


KMG's current enterprise is only modestly higher than the IPO valuation.


In 2006, KMG reported net liabilities of more than $974 million, and had an enterprise value of $6.95 billion US.


Brent oil averaged $65.14 US per barrel in 2006. KMG was able to export 73% of its production, and received an average of $46.99 US per barrel for its total output.


Revenues in 2006 were $3.3 billion. KMG generated roughly $1.7 billion of EBITDA.  Proven producing reserves were estimated at 685 million barrels. 


The growth, post IPO, appears to be unrecognized by the marketplace.


Since late 2006, KMG has invested $1.9 billion in two highly productive joint ventures. Production has been stable. More than 34% of the gross purchase price has been repaid from distributions.


Production from wholly operated assets also appears to be relatively stable.  Proven producing reserves (ex JVs) have increased by about 2.6%.   Cash reserves have grown dramatically.  2009 exports may exceed 82-84% of output. A transparent tax policy now exists in Kazakhstan.   


I believe that KMG represents a potential double in the next 24 months.


Globally, it is estimated that the oil industry (aggregate) requires an "all in" price of $70 US per barrel to break even.  I consider $70 US to be an equilibrium price that will eventually be reached during the next 24 months.    


As one of the lowest cost producers of oil on the planet, shareholders of KMG have fared relatively well over the past 52 weeks.   At the current price, the shares are down roughly 46.6% from the 52 week high of $34.

Successful oil companies are inevitably separated from the pack, through the longevity, quality and low production cost of an asset base.  I believe that the only things that matter to an oil investor is the amount of oil in the ground, how easily it flows to the surface and the jurisdiction where the oil is located.   For my account, I want an oil firm that accomplishes the following objectives:

1. Buys or finds long lived reserves cheaply.
2.  Produces long lived reserves cheaply.
3.  Finds more oil than is produced, and cheaply
4.  Maintains a strong balance sheet.  

Kazmunaigaz meets my criteria precisely.  I know of very few oil companies capable of generating consistent profitability, while maintaining production within 10% of peak output, using crude oil at $40 US.  KMG is such a firm. Arguably, the firm boasts the strongest balance sheet and reserve profile, in relation to the current EV, that I have EVER appraised.  When I add in the joint venture reserves, the disparity grows proportionately. 

Takeovers are by no means assured.  However, if KMG is able to get its way on Petrokazakhstan, Mangistaumunaigas, Kazturkmunai, Kazpolmunai and Kazakhoil Aktobe, production could rise by 85,000 boepd, or 35%.   These assets contain more than 400 million barrels of proven reserves (net to KMG's proportionate interest under negotiation).   

My estimate of the capital outlay for all tabled potential purchases, falls in the range of $2.8 billion-$3.2 billion US.  This could be a cost between $7-$8 per proven producing barrel or $29,000-$38,000 US per flowing barrel.  If all deals are completed, KMG total daily output could rise to 320,000 bpd, within the next 36 months.  

320,000 bpd of output and 1.3 billion barrels of proven reserves should catch even the eye of even the most jaded oil investor.  Provided that Kazakhstan's tax policy remains stable for several years, I predict KMG may become a core holding with many large cap international "value" funds


Crude oil prices have improved beyond forecast.  Tax stability will lead to increased investor confidence throughout 2009.   At least two highly accretive acquisitions are under negotiation with government.

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