We think a long position in Pacific Rubiales (PRE.CN) at $24.50 offers 40% upside over the next 12 months.
Pacific Rubiales, despite its $6.5bn enterprise value and having rallied 55% so far in 2010, is not well known by most energy investors. PRE is a Colombian heavy oil producer that trades on the Toronto and Bogota stock exchanges. It's lack of a US listing, along with an non-current perception of Colombian geopolitics, creates what we think is still an under the radar situation that will reprice over the next year as more investors recognize that this a catalyst rich, low cost, energy value play with ample upside.
In our opinion the current stock price:
- Undervalues the company's reserves at less than $10/bbl.
- Does not reflect the high probability of continued success in the company's drilling campaign on its Quifa field, and the material implications it will have for the company's yearend reserve report.
- Overlooks almost entirely the highly prospective nature of the company's exploration portfolio, which we estimate to be worth more than $8/share on a risk adjusted basis.
- Does not fully appreciate the dramatic transformation Pacific Rubiales is making from a pure exploration play to a cash flow machine. The company will increase its net production from 60k barrels a day (bbl/d) in this year to 150k bbl/d in 2013, and free cash generation increases from flow breakeven in currently to $1.2bn in 2013.
- Does not contain any M&A premium. Overlaying a cheap fundamental story is the meaningful probability that PRE is acquired in the next year by any number of deep pocketed, foreign oil companies who are active in acquiring properties in Colombia.
We're betting that Pacific Rubiales stock will continue to outperform as the market better understands these five points. Short term catalyst include results from 4 wells in Quifa that remain to be drilled this year, additional drill results from several Pacific Rubiales JVs (including one that's imminent with Alange), further clarity on enhanced recovery negotiations with Ecopetrol, and the potential for increased production guidance on the company's earning call on August 13th.
Quick Description of Major Assets:
Pacific Rubiales is the 2nd largest E&P in Colombia. The company has 7 producing fields and participation rights on 31 exploration blocks. The company holds the 2nd largest portfolio of exploration acreage in Colombia and also has prospective land in Peru.
Rubiales, the heavy oil field located in the Llanos Basin in central Colombia, is Pacific Rubiales's most productive asset. The company holds a 35% interest in this field and acts as its operator. The majority interest in the Rubiales field belongs to Ecopetrol (EC), the national oil company of Colombia. By the end of this year the Rubiales field will be producing over 170k bbl/d (up from 20k bbl/d in 2007), and net approximately 60k bbl/d to Pacific Rubiales. Production will increase to 220k to 250k bbl/d by 2013, and between 77k bbl/d to 87.5k bbl/d net to the company.
In June 2016 Pacific Rubiales's interest in the Rubiales field will revert back to Ecopetrol. To make up for the loss of the operating concession on the Rubiales field in 6 years the company is in the process of developing its other major field, Quifa, in which it holds a 60% interest and a 15+ year lease. Quifa is adjacent to the Rubiales field and based on the well results so far this year looks to be as big, and most likely, bigger than Rubiales. We expect Quifa to ultimately add represent 400mm barrels of reserves to the company, and on a net basis produce between 70k to 80k bbl/d by 2013. Net production could eventually be as high as 100k/bbl's a day.
Negotiations are ongoing with Ecopetrol regarding Pacific Rubiales's participation in the Rubiales field after 2016. PRE is developing an enhanced recovery fireflood technology that will stimulate exhausted pockets in the Rubiales field. Management has suggested that of the 4bn barrels of oil in place in the Rubiales field, fire flooding could potentially raise the current recovery estimate of 12.5% to something closer to 25%. While the split from enhanced recovery hasn't yet been determined, if Pacific Rubiales were to receive 20% of the additional recovery, then company reserves could increases by as much as 200mm barrels. The company expects to conclude negotiations sometime next year, and begin enhanced recoveries by 2013.
PRE also owns and operates the La Cresciente gas field in northern Colombia. The field has reserves of almost 600 billion cubic feet, and the potential to produce 120 million cubic feet a day. It is currently producing 60 million cubic feet a day but will increase through this year as compressors are added to the field's pipeline.
We have thus far not been able to find a way to insert our Excel valuation sheet into VIC's upload format. In lieu of that sheet, and by way of summary: we arrive at a $38 base case fair value for PRE, with these key assumptions: $75 long term oil, 15% discount applied to heavy oil, 10% WACC, 5x terminal multiple. In this valuation, we ascribe ~$26 of value to Quifa and Rubiales, $2.50 to La Creciente, and $9.50 to PRE's additional exploration opportunties. We will try to work with VIC's administrators to facilitate posting our detailed valuation sheet from Excel, which shows (among other things) sensitivity to long term oil prices and WACC.
Investing in Colombia:
Colombia does not enjoy a reputation for political or economic stability, but we think this is an out of date view that does not consider the significant security gains and peace that were won over the last 8 years by the outgoing President Uribe. These policies will continue under President-elect Santos, who was Uribe's defense minister and won 70% of the ballots cast in the recent election back in June. Santos takes office on August 7thand we think his commitment to security and defense will continue to help shed Colombia's reputation as an ungovernable nation, de-risk perception, and continue to attract foreign investment in its oil and gas industries. Pacific Rubiales will be one of the largest beneficiaries as it will screen well on those looking for cheaply trading, low cost, on shore oil producers with high cash flow, significant proven reserves, and highly prospective assets.
1. Quifa drilling campaign progress
2. Test wells in exploration portfolio
3. Eventual take out by China or Korean oil complexes -- we have spoken with management, to us it seems clear they are preparing the company for eventual sale