Africa Oil Corp (AOIFF)

[DanielBostrom]

I dare say I'm the one spent most time analyzing Africa Oil (AOI) since January this year, apart from company management. This doesn't mean that I know the company best of all but I've done the hours and numbers on the company. I thought I'd summarize my view on AOI and at the same time point out the main differences in my view and the analysts take on AOI. Analysts, feel free to copy. You'd be the first to point out what I do below. The value of the company, in my opinion , is the value of the oil that have been found today + the value of the drilling program until December 2014 + the value of the prospects / leads that have not yet been drilled until dec 2014.

TLW / AOIs recoverable resources today
TLW says they have 300mmboe in Lokichar. They have a long history of making cautious initial assessments tha later are revised up but this in Kenya is quite extreme, I'd say. Analysts are at around 500mmboe . Bernstein is the only company I've seen that takes up the idea of 300mmboe probably being much too low an estimate. However, they have a different approach than I have but the result is similar to mine. I'll show you some volumetrics exercises that show why it is probably more like 1000mmboe that has been found so far :

Lake Albert cross reference
In Lake Albert Tullow expects 1.8bln bbl recoverable resources with a total net pay for the wells been drilled at 797m, which means that every net pay meters corresponds to 2.27mmboe. In Lokichar we now have 375 - 505m net pay (based on assuming the min/max for Ekales and Etuko ) which with the analogy correspond to851-1146mmboe , corresponding 62-83SEK/share for AOI. This is assuming that the aerial extension for wells in Lokichar is similar to Lake Albert .

Ngamia pre drill estimate as cross reference
If we look at Ngamias "pre -drill P50 recoverable resources" that was 45mmboe based on 17 m net pay you will see that this assessment corresponds to each meter net pay being 2.65mmboe . In Lokichar, we now have 375-505m net pay, which with this analogy corresponds to 993- 1337mmboe, corresponding to 72-97SEK/share for AOI . This is assuming that the aerial extension for wells in Lokichar is similar to Ngamia.

It is in any case difficult to arrive at TLWs 300mmboe or analysts 500 when you start looking at the numbers, I'd say. The average of the above volumetrics estimation is on 1082mmboe corresponding 78SEK/share assuming $6/bbl reserve value.

Value / barrel
Most analysts are now at $4-5/bbl. It has fallen since last December as the shares dropped. The value of the reserves is determined by:
• Oil API (API 22-30 medium API , what AOI found so far 25-37 )
• PSC (global average 75% , AOI 65%)
• Political risk (I am not the right person to judge but Kenya is not over global oil cut , I'd say )
• The cost of taking up the oil (AOI is below global average )
• Proximity to the pipeline (decision on the pipeline is not taken yet)

Based on the above facts each can do their own analysis of what reserves in Kenya are worth. However, I would say that they at least are worth $ 7 ( global average ) when the decision on the pipeline construction is decided . $7/bbl is what AOI itself expects internally. I expect $ 6/bbl for a number of reasons but mainly based on previous transactions and industry specialist Wood Mackenzie believes that estimates $6.1/bbl is the value of reserves in Kenya. They are not analysts at brokerage firms so their estimates are not changed when AOI share price changes. Two transactions in Uganda have been made since 2010, which has similarities with the oil in Kenya. They are:

• TLW / Heritage deal - January 2010 where the deal was done at $4.53/bbl. It is the deal that analysts refer to even though there was a clause that gave Tullow priority to purchase Heritage assets which did not give an open bidding .
• TLW / Total / CNOOC deal - March 2011 where the deal was done at $5.6/bbl. No analysts refer to this deal as I've seen and I've read most of the reports on AOI. They all refer to the Heritage deal, despite the clause.

These transactions were made before a decision on the pipeline has been taken. Would these deals made when a pipeline decision is reached TLW would have received at least $ 1-2/fat more I would say. Also, the PSC in Kenya is better than Uganda. $4-5/bbl? I do not agree.

The value of the drilling program through December 2014
The big boost in AOIs share price comes the day the market will do with AOI as with other shares on any stock exchange, which is to give a value today of future yet to be realized profits / reserves. AOI will drill 30-35 wells until December 2014 according to the company itself. There has generally, but not always, been delays so I estimate 25-30 wells. There will be more appraisal wells and more focus on Lokichar which makes me think the delays won’t be as extreme as with Ngamia and Sabisa . They were both basin openers and, as such, they take much longer time than later wells in the same basin. Average drilling times to date is 121 days and 28m/day (table below). It's, as said, Sabisa and Ngamia that out a drag on historic drilling time. Looking at Lundin Petroleum’s drilling time the respective figures are 29 days and 75m/day (mix of Norway and Malaysia). Lundin companies are one of the few companies that report spud date so it’s difficult to calculate a global average for all wells. Now, I don’t estimate AOI TLW wells to go as fast as LUPEs but if you work on the assumption of 25 wells in 2014 (they will magage 5 wells during the rest of 2013, so it corresponds to 30 in total), 7 rigs and 30 day transport time between the wells you get a drilling time of 72 days. It is not entirely unreasonable, I would say. The number of wells is also very dependent on how the money they takes in. If AOI takes in more money than expected, it might mean more rigs and thus more wells.

Depth Duration m/day
Sabisa 2600 171 15
Twiga 3250 97 34
Pai 4112 153 27
Ngamia 2340 161 15
Etuko 3051 79 39
Ekales 2500 64 39

The value of the drilling program is a function of the hit rate , the value/hit and number of wells they manage to drill. Counting on the average of the wells announced at TLW/AOIs material (11 in total), the average value per success is 15.6kr/share based on auditors estimates, with my assumption of $6/bbl. What brings down the average are the South Omo wells where AOIs share is 30% and the auditors pre drill estimates are low. If they’d strike oil in South Omo, auditors would raise the estimates. Don't forget that Ngamia pre drill estimate was 17m net pay and 45mmboe, which turned out to be more than 10 times more post drill. The table below shows the value/share per well.

Bahasi 23 Block 9
Sala 29 Block 9
Ekosowan 11 South Lokichar
Amosing 12 South Lokichar
Ekunyuk 15 South Lokichar
Agete 20 South Lokichar
Ewoi 23 South Lokichar
Etom 34 South Lokichar
Tultule 1 South Omo
Kesami 1 South Omo
Shimela 2 South Omo
Kiboko N/A Block 10BA
Lingam N/A South Kerio
Tausi N/A North Lokichar

There will be many appraisal wells in the future which is not really worth that much other than for auditors. With really big oil bearing zones such as Ngamia , Etom or Etuko you usually need appraisal wells for the auditors to give you full credit. I expect every fifth well being an appraisal, which pulls down the value/success to 12.5kr/share. The matrix below shows the value/share of the drilling program given the number of wells you have time to drill and success ratio assuming 12.5kr/share per success. The mean value of the matrix is on 234kr/share.

Number of wells drilled to December 2014
HitPerc 25 30 35
50% 156 188 219
55% 172 206 241
60% 188 225 263
65% 203 244 284
70 % 219 263 306
75% 234 281 328

58% is Tullow's historical success ratio for exploration wells and Tullow won’t be operator of all wells but on the other hand the hit ratio will be higher in 2014 as there will be more appraisal wells. With appraisal wells Tullow's success ratio is 90%. Drilling times will be shorter when they will have dropped some blocks that have not proven to be oil bearing and focus only on derisked blocks, which means you do not need to transport rigs over large distances. Focusing on derisked blocks also makes for a higher success ratio compared to wild cats. Moreover you could add that Tullow’s success ratio in Uganda was over their own average. Overall, I really do not think 50% success ratio for AOIs drilling through 2014 to be an aggressive assumption.

It is here in particular where my view of AOI differs from analysts. There is no analyst assigning AOI/TLW 58% success ratio when AOI shares are at 54kr. Should the share price go up, they’d raise their estimates, that’s the way the market works.

The value of the drilling inventory at Dec 2014
They will have drilled some 40 odd wells in December 2014, resulting in about 90 undrilled prospect/leads left in the drilling inventory. The wells they have left will be less interesting than the ones drilled obviously as you start with the most interesting blocks. It’s difficult to assign a value to the drilling inventory, I’d say but I would say that half of the current value of the drilling program through December 2014 is not entirely unreasonable. Just over a hundred kr/share I’d say, but it should be said that this sub-component is more of a guess than hard numbers.

Summary
78 + 234 +100 = 412kr/share may sound daft but is the value that comes out if you look solely at the numbers. There will be dilution and government back in on those numbers and the last subcomponent 100kr is more of a guess than estimate that should be said again. The most important point with regards to the above analysis is that the greatest value lies in the drilling program until dec 2014. It is here where my view differs from the analysts. For me, I cannot understand that if you get the chance to pull 30 lottery tickets from where you know half of the tickets are winning tickets and each win is worth 12.5kr, how that opportunity could be worth zero or near zero. That market cannot assign a reasonable value to the AOI shares is a huge market failure, I’d say. I’ve been seen some over the years but this is one of the biggest, I'd say.

Finally, I’d show the below chart for those who consider the market to be efficient. It shows the value of recoverable resources and AOI share price. This then is the value ex the lottery tickets and assuming lowest net pay for Etuko and Ekales.

http://postimg.org/image/3ouciwmjv/

/Daniel