Petro Matad Ltd (MATD)

[Zouf]

Petro Matad: exploring for oil on China’s doorstep
by Robert Waterhouse



source: http://www.proactiveinvestors.co.uk/companies/news/10809/petro-matad-exploring-for-oil-on-chinas-doorstep-10809.html

Meeting the growing needs of a fast-developing China is, directly and indirectly, a key objective of many natural resources companies. Mongolia-focussed, AIM-listed Petro Matad (MATD) has the advantage of being right next door to China – and the petroleum industry in Mongolia is being driven hard by the needs of its neighbour. We take a look at the rapidly developing oil industry in Mongolia, which remains unknown to many Western investors, before reviewing the Petro Matad portfolio which includes three large exploration Blocks. Drilling on the first of these, Block XX, will begin in April 2010.

THE MONGOLIAN OIL INDUSTRY: BACK IN BUSINESS

Oil shale was discovered in Mongolia in 1922-23 in the Gobi region. Soviet exploration between 1947 and 1963 led to the discovery of two small oil fields and 80 buried structures, and a refinery was built in 1947. Various factors including declining production, a refinery fire, and the discovery of huge reserves in Western Siberia led to production ceasing in 1969. Only in recent years has the industry started to gather real momentum following Government encouragement and incentives; the first free flowing oil was recorded in Block XIX, which is adjacent to Petro Matad’s block XX, in June 1997
Mongolia sits between Russia and China. It has been a free-market democracy for almost twenty years, holding regular parliamentary and presidential elections during that time. About double the size of the UK and France combined, the population is just 3 million, and mining currently represents over 80% of the country’s total export revenues. Mongolia is a member of the WTO, and established its Petroleum Law in 1991; this was ranked by Van Meurs as being in the top 10% of world petroleum laws and to encourage exploration and development, materials are exempt from customs, VAT and excise taxes, and earnings are exempt from income taxes.
These factors have contributed to a major lift-off in the Mongolian petroleum sector; from a relatively modest baseline, investment began to grow significantly in 2005 and is currently running at some $600m per annum. Most of the activity has been focussed on drilling: 359 wells had been drilled by September 2008, and 88% of these had oil shows. Daqing Oilfields (a Petro China subsidiary) has alone drilled more than 340 wells including 207 wells in 2008, over 90% of which were successful (defined as “oil shows”). Whilst Mongolian oil production is still at a relatively early stage, officially being classified as “test production”, Daqing – some of whose wells are less than 5km from Petro Matad’s Block XX – entered 2009 at about 3,300 bopd.
Significantly, on 21 October the Minister for Energy and Resources vested Petro Matad’s General Manager Mr. B. Dendevchuluun with one of Mongolia’s highest civil awards, the “Order of the Red Banner of Labour”. He has been a leading figure in the Mongolian Petroleum sector for many decades, and was the conceptual originator of the company’s application for Block XX.


“The Company is excited that the Mongolian people have recognised the valuable contribution of a lifetime’s work in the petroleum sector” – Douglas McGay, CEO Petro Matad, 22 October 2009


FROM ONE BLOCK TO THREE BLOCKS


Petro Matad was listed on AIM just 18 months ago, with 100% ownership of a Production Sharing Contract over Block XX, close Mongolia’s eastern border with China. This large Block covers over 14,250 square kilometres, and at the time of listing had been studied using gravity and magnetic survey, as well as re-processed and newly-acquired 2D seismic. A 3D seismic study of part of Block XX was already underway at listing, and the interpretation of the data subsequently helped the company to firm-up its initial drilling targets.


Before such drilling could commence, however, Petro Matad surprised the market by announcing the award of a further two Production Sharing Contracts: Block IV and Block V covering an additional 71,000 square kilometres.

This greatly expanded an already substantial exploration portfolio and, to date, none of the company’s acreage has been farmed-down, so Petro Matad retains the full 100%. As a relatively small company operating alongside such large operators as Petro China, these assets make Petro Matad a far more substantial player than its market capitalisation might suggest - but of course having exploration acreage is not the same thing as finding and monetising commercial hydrocarbons. We now take a closer look at what the three blocks appear to offer.


MONGOLIA BLOCK XX AND THE DAVSAN TOLGOI PROSPECT


Block XX contains a number of leads and prospects; 15 of these prospects were assessed following studies in 2008 as offering mean “unrisked” prospective resources of 638 million barrels, or 112 million barrels on a mean “risked” basis which takes into account the estimated chances of success. These numbers are recoverable estimates, rather than gross oil-in-place.


Petro Matad commissioned a 145 square kilometre 3D seismic study of the most advanced of these prospects - Davsan Tolgoi - and this has helped mature it to “drill ready” status. This overall prospect contains three separate component prospects: Davsan Togoi, Davsan Tolgoi North, and Davsan Tolgoi West. On an “unrisked basis”, these three prospects offer a combined mean prospective resource of 147 million barrels, or 55 million barrels on a “risked” basis.


The company has developed an accelerated well drilling programme in conjunction with IPS Australasia and Isis Petroleum Consultants, and a variety of play types have been matured to prospect status, including anticlinal closures, horst blocks and rotated fault blocks at Davsan Tolgoi. Drilling contractor Ansai Yuehua has been selected to drill the first well DT-1 on an independent anticlinal closure within Davsan Tolgoi. This well is updip and just 5 kilometres from the nearest discovery well, and 10 kilometres updip from the Tolson Uul Oil Field in Block XIX. Up to a further 5 additional wells will then be drilled, with approval to be given on a progressive basis.


The site at Davsan Tolgoi has recently been fully prepared and the drilling rig is on-site and was ready to spud the first well on 2 November 2009. The short drilling window immediately before the onset of the harsh Mongolian winter has however been affected by a severe cold snap, and the site and rig have now been secured for the 5 month winter, with spudding now expected to occur in April 2010 as soon as weather conditions permit. Drilling delays are an occupational hazard in the oil and gas industry, and whilst some short-term investors were disappointed that Davsan Tolgoi did not feel the drill bit in 2009, strategic investors are looking forward to an uninterrupted drilling programme next year - and will doubtless be pondering the potential of the company’s two recently-acquired blocks, to which we now turn our attention.


MONGOLIA BLOCK IV AND BLOCK V


Petro Matad recently announced the award of two new Production Sharing Contracts which adjoin each other, together representing an area of some 71,000 square kilometres. The CEO has commented:


“The granting of these two important and large areas is another significant stage in the development of both Petro Matad and for the development of oil exploration on Mongolia” – Douglas McGay, 8 July 2009


Such comments suggest that the company feels there is considerable potential in this acreage. Whilst there are as yet no volumetric estimates to analyse, gravity and magnetic surveys together with geological field mapping and shallow boreholes have given indications as to the petroleum geology and structural style of the blocks. This will no doubt be followed by seismic study and investors will be keeping an eye open for any related announcements.


The studies done so far suggest that the basement rocks probably follow a variety of structural styles. The available data indicates that large and potentially deep sedimentary depocentres occur in both blocks; the sediments are thought to be up to 6,000 metres in section, of sufficient organic richness and depth to be productive for the generation of hydrocarbons. This belief is supported by bitumen occurrences, oil shale deposits, and the presence of brown and black coal. These indicate that generation and migration of hydrocarbons has occurred in the basin and that an active petroleum system exists.

The generation of oil is the first step; suitable reservoir rocks and seals to contain it are the second. Geological field mapping has identified numerous conglomerate and sandstone intervals within the Jurassic-Cretaceous sequence. Petro Matad considers it likely that sandstones of reservoir quality exist in the subsurface because the sub-basins in these two Blocks are likely to have had depositional histories similar to other basins in Mongolia. Analogues for Block IV and Block V are the productive Jurassic and Cretaceous basins to the west, south and south-east of China.


Whilst it is clearly very early days as regards these two blocks, the potential upside does appear to be considerable and increases the probability that the company’s total “unrisked” potential might be as much as one billion barrels recoverable across all three blocks. But as always, the drill bit and the production flow test are the only way to establish what is actually there.


SHAREHOLDER STRUCTURE


Petro Matad was the first company with a substantial Mongolian shareholding to be listed on an international exchange. Investors who favour companies in which key board members hold significant numbers of shares – thereby aligning their own interests with those of other shareholders – will be interested to note that the Chairman, the Deputy Chair (who is also the General Director and Chair of Petrovis, who are Petro Matad’s largest shareholder - see below), the Chief Executive Officer and Finance Director held between them some 21.5 million shares at the start of 2009 representing over 22% of the issued share capital at that time.


The company’s single largest shareholder is the leading Mongolian company Petrovis LLC, which the Chairman and CEO of Petro Matad describe as “particularly supportive” (10 June 2009). Petrovis has very recently increased its holding on the company to 45.88% (5 November 2009); this arose as the result of a sale of stock by an equity fund.

Such a large position requires certain actions by the shareholder and the company under IOM law; as a result, Petrovis has entered into a revised Relationship Agreement with the company, which limits its voting rights to 40% of the total voting shares. Whilst some investors sometimes feel a little uneasy about dominant stakes in companies, others take the very opposite view: any company with undeveloped assets, and a share price which would potentially rise significantly on success, is always potentially vulnerable to a hostile bid - but a large supportive shareholder, and directors with a significant stake, make such things less likely.


FINANCIALS AND SUMMARY


Petro Matad is currently in the exploration phase, and consequently has no income from petroleum sales; the loss in 2008 was $6.277m. Methods of funding of early-stage exploration work can include farming-down part of the asset base, borrowing from a bank etc. (which is not easy in the current financial climate) or issuing new shares. So far, the company has chosen to retain 100% of its Blocks, and has raised the necessary monies by issuing equity.


The volumetric estimates Block XX (see above) have enabled Petro Matad to produce various Net Present Value assessments of that block, using different oil price and operational assumptions. These have shown that Davsan Tolgoi is economically robust, even with oil in the $40 to $50 range. On the PSC terms with a 5% royalty and applying a 10% discount rate, the nominal value – assuming $70 oil and 100 million barrels recoverable – is $1.4 billion. This assumes that the oil would be shipped using a pipeline, and that the wells would produce 200 bopd each. On a more conservative 100 bopd per well assumption, the NPV reduces to some $1.2 billion. The potential benefit of future horizontal drilling upon the NPV is necessarily unknown at the current time and cannot therefore be taken into account; conventional vertical wells are assumed.


These valuations clearly represent very considerable potential upside for a company whose market capitalisation at the time of writing is £20 million; taking the NPV as perhaps some £700m, this is no less than 35 times the current market capitalisation. The BPS index is also significant; using the current 125.34m shares in issue, the Block XX volumetric estimates represent some 5 barrels per share “unrisked” and some 0. 9 barrels per share “risked”; the potential upside from Block IV and Block V is unknown. The shares are currently trading at some 16p; the price at IPO was significantly higher than this and as noted above, the company has made operational progress and substantially expanded its portfolio during the subsequent eighteen months.


Converting resources into production, throughout the natural resources industry, requires substantial amounts of capital. Some E&P companies never intend to go very far down that path, preferring instead to sell to a major as soon as the assets are proved-up. Whilst it is much too early to speculate on any such issues involving Petro Matad – not least because no oil has yet been discovered – we note that the 100% stake in these three blocks appears to put the company in a strong position, because any farming-down would still potentially leave the company with a sizeable asset. We also note that the company’s estimated drill costs at Davsan Tolgoi are some $1m per development well; this is very low by industry standards and results from the target being relatively close to surface. This suggests that, on success, the development of Davsan Tolgoi should be able to commence on a relatively modest capex budget.


The Mongolian oil industry and Petro Matad seem relatively unknown to most investors - especially with places such as Kurdistan currently grabbing the headlines. Bearing in mind the operational progress made since listing, the very large increase in the exploration acreage, and the rig being on-site and ready to kick-off the drilling programme as soon as the winter snows have melted, it remains to be seen for how much longer Petro Matad will remain off investors’ radar screens.