I’m being flummoxed by extremely slow WiFi on my flight today, so can’t get the research completed for the new article I had planned. In case you’re looking for something to read on this lovely Tuesday afternoon, this is a teaser-unveiling excerpt from a Friday File we published in late March. It has NOT been updated or revised, except to note, at the bottom, that I do now currently own shares. To my knowledge there has been no news of consequence from the company since this note was first published, their first well should be drilling for another month or so before they reach their target depth.
We’ve got a bit of a teaser to dig through — and it’s an oldie that has been brought back a couple times over the last few years, but each time the story changes a little bit.
The stock’s sure a heckuva lot cheaper than it was last time the idea was teased — and this week’s teaser pitch says there’s more by way of “real” news catalysts coming soon. So is the story worth buying now? Let’s dig in and see if we can help you make that call.
You’re my favorite people, of course (you can’t buy love, but you can buy fondness), so I won’t make you linger through the whole teaser spiel before I unveil the stock — the pitch is from Byron King for his Energy & Scarcity Investor, and he’s teasing HRT Participacoes en Petroleo, often referred to as simply “HRT” (though that’s not the ticker — stock symbol is HRP in Canada, HRTPY on the pink sheets, HRTP3 at home in Brazil). HRT is the Brazilian oil company run by the ebullient Marcio Mello, and it has been a terrible investment since it went public a few years ago in the height of Brazilian oil optimism, not long after Petrobras had discovered their offshore bounty in the huge deepwater fields (while Mello worked there, we’re told), and it has particularly been falling since they got into the Namibian exploration business in a big way by buying UNX Energy about two years ago, now down more than 90% from the highs.
If you missed our earlier pieces on UNX Energy and later on HRT when King teased them in 2010 and 2012, our article on the original pitch for UNX is here, from back in July 2010, and the March 2012 teaser unveiling when the pitch switched to acquirer HRT is here. That buyout looked good for UNX Energy shareholders at the time, since if they bought around the time of the first Byron King tease they would have seen their shares run up from $1.50 or $2 to about $6 on the takeover bid.
But the takeover was paid for with HRT shares, not with cash, so if you continued to believe in the excitement of the Namibia story (or HRT’s other assets, mostly exploration blocks in remote northern Brazil), your UNX Energy share that you bought for $2 (for example) is now worth about 50 cents (it turned into .55 HRT shares, and HRT is at about 90 cents in Canada right now). HRT has been on pretty steady downward trajectory from $8-9 at the time of the takeover to the current sub-$1 price, though it has bounced a couple times on the way down (and even almost doubled at one point, early in 2012 when King again teased them as they were approaching $4).
But that’s the past — what’s going on now? Well, let’s just take the teaser info from Byron King’s latest version of this pitch and see what he thinks is shaping up:
“Energy’s Last Great Frontier
“The Untold Story of a .91 Cent Per Share Company That Just Placed a Drill Bit Into The Deep Sea Mud…Hoping To Hit A $703 Billion Oil Jackpot
“Major News Of This Promising Play Could Come At Any Moment ….
“If this under $1 per share company hits the $703 billion jackpot, the geologist we’re about to speak to says that ‘Rockefeller riches’ could hit a few bank accounts.
“But as you’ll see, this isn’t a situation for the faint of heart. We’re talking about a penny stock play here with news that could break any moment.”
And then we get the story from Byron King about the urgency of this expected news:
“… this past Monday night, after dinner, here in Pittsburgh.
“As I was getting ready to call it a night, I received an urgent message….
” It was one of my contacts at an oil company I’ve been following for three years.
“This moment is a milestone in the history of our company,” he told me. He went on to proudly announce the “spud-in of the first offshore well.”
“The spud in basically means that the drill bit has hit the earth’s floor.
“What does this mean? Well, it’s do or die time for this low-priced, penny share sort of company.
“We’re at the point where all the talking, arm-waving and speculation stops. It’s time to make or break things.
“You see, this drill bit is aimed about 12,000 feet under that seafloor — in about 3,700 feet of water, by the way. We’re looking for a massive, oil reservoir that looks much like one of those ‘reef’ structures that you find in West Texas, in the great Permian Basin.
“This is the first of several planned wells, in a locale where this one company’s acreage might hold as much as 7.4 billion barrels of oil.”
And he makes the “lottery ticket” argument — that it might be risky, it’s an exploration well and they might get disappointing results, but ….
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“Would you risk a few bucks on this kind of play? Heck, the guy that won the Powerball Lottery, last week, scored over $300 million, out of odds like 150 million to one.
“But this oil play? We’re looking at something like even odds of finding something, or not with just this one well. And after this well, there are three more….
“If the drilling finds what I believe is down there, I could see the share price going to $5 when the results are announced. And then, over time, I wouldn’t rule out $15-$20 per share.”
OK, so would you play the lottery if the odds are maybe 50/50 and your payoff for a $1 investment is $5? Maybe, but it might not get your heart racing … particularly because you probably don’t plunk down $1,000 or $10,000 (or more) on lottery tickets as you might on an enticing little penny stock speculation.
The stock might end up doing well if they discover a good quantity of commercial oil, but to make life-changing amounts of money on the stock, unlike with a $1 lottery ticket, you’d have to risk a meaningful amount of money. So get the lottery ticket idea out of your head, think instead about option trading — HRT Participacoes is more like a call option on oil exploration offshore Namibia. It might go to zero, the last two years teaches us that it might drop gradually over a long period of time and frustrate you, or it might go up several hundred percent quickly if good news comes. And if you know which of the three is most likely, well, then you’re better at predicting what’s under two miles of water and a mile of dirt, rock and salt than I am.
Byron King is not infallible, of course, but he definitely knows more about oil and drilling than I do, and he certainly says he’s excited about it …
“… the ‘oil kitchen’ play that I’ve been tracking isn’t on anyone’s radar… not yet.
“The discovery site is 7,267 miles away from Wall Street… 4,999 miles away from Europe… and 3,808 miles away from Saudi Arabia…
“It’s completely new. And now that the drill bit’s in the seafloor, the news could break at any moment. This is the real deal. No vaporware. The rig is there. It’s drilling the well.
“Look…. I know I‘m pounding the table here, but this oil kitchen is the… next… big… discovery… in… the… world.”
When people say that, you almost can’t help but get a little excited about it — even if you know that they’re prone to say these kinds of things about the potential of exploration stocks far more often than these huge discoveries are actually made. And, of course, if you need someone to cool your jets a bit for you — he sounded like he was equally excited about it back when the stock was trading for $4 about a year ago.
So now the news is that HRT has spudded their first exploratory well offshore Namibia, in search of the kinds of oil formations that have been found offshore Brazil (by their CEO Marcio Mello and others, when he was working at Petrobras), with a big part of the theory that they’re working on being that the oil reservoirs probably developed similarly offshore Namibia to how they developed offshore Brazil in the years before and after those continents separated.
That’s not unlike the theory feeding into the success (so far) of Africa Oil’s exploration in East Africa (AOI.V AOIFF), where they theorized that the rift patterns present in Yemen and Saudi Arabia would probably be echoed in Somalia and Kenya and Ethiopia, across the Red Sea, because they were formed before the land split to open up that sea (though of course, it’s on a much grander scale — the formation of the Atlantic Ocean instead of the formation of the Red Sea — and we’re also talking about much deeper, more complex formations underwater than are found in and near the Arabian peninsula).
And it’s not just a theory, of course, they’ve been investing in seismic data collection and think they’ve found some attractive drilling targets, and they do have outside analysts who have a good reputation and who’ve backed up the claim that there might be billions of barrels of oil (equivalent) under the ocean there… and there is at least some kind of an active hydrocarbon system in the area, since we already know that there’s one significant gas field — part of the pitch from King is that the “oil kitchen” that’s percolating deep underground is the source of the large Kudu gas field. Though it’s also notable that this gas field was discovered almost 40 years ago and is still not really producing gas, despite the fact that they think there’s more than a trillion cubic feet of natural gas in Kudu — no one has wanted to cough up for the investment infrastructure, it appears. The current lead operator is Tullow, and the current plan is to build a big power plant and a pipeline to South Africa, but as far as I can tell nothing is happening and other partnerships with the Russians and others seem to lead nowhere. So be forewarned that if HRT finds gas instead of oil, as they did in much of their Amazon drilling, there won’t be nearly as much enthusiasm.
To spud a well just means you’ve driven the drill bit into the earth, though, so what does that mean for us?
Well, it means they’re going to get actual drilling results for the first time fairly soon, so analysts will have some more real data to which they can attach probabilities and dollar figures to try to get to a reasonable valuation that’s based on something other then seismic data and speculation. The spud was a couple days ago, which anyone could have discovered whether or not they got a call from Byron King’s contact, and they have projected that the drilling time should be about 60 days, so we should have some indication of what’s going on by the end of May — though there’s certainly the possibility, if not the likelihood, for all I know, that they won’t say anything very specific about the drilling results until they do further testing of the hole. You can bet that if they find no commercial hydrocarbons, the stock will fall further … if they find natural gas, it may go up a bit … if they find large intervals of oil, the stock should go up rapidly. Just drilling the well has not increased investor enthusiasm at all — the stock has fallen another few percent just since the drilling began on Tuesday.
They have a four-well program planned, with three firm targets from what I can tell from their presentation (you can see their recent investor presentation and their last quarterly report here) — this first one is the Wingate prospect in block PEL-23, which they believe is both the biggest and the most oil-prospective of the targets, so they’re shooting for the best one first. This block is home to their estimated 2.8 billion barrels of oil equivalent, which is more than a third of the total 7.4 billion barrels of potential for their four blocks.
This block and the other three initial drill targets are expected to have a drilling cost of about $250 million altogether — though this first one is also the least expensive, at $78 million for a dry hole cost (DHC — what you have to invest in the hole to drill and test it, and therefore the amount you’ve wasted if it turns out to be a “dry hole”). These three blocks are partnered in a farm-down with GALP, the Portuguese oil company, which bought in for 14% and will cover some of the expenses up to a cap amount (I haven’t seen what that cap amount is). HRT wants to partner more of their Namibian blocks — it sounds like the level of partnering they’d like is more than a quarter, less than a third. Not sure why that level specifically, but that’s their goal and they say they’re in negotiations. They do have the semisubmersible rig (from Transocean) under contract for pretty much the rest of the year, which sounds like it ought to cover getting at least those first three wells drilled and moving the rig as long as there aren’t real delays along the way.
And in terms of finances, HRT looks like it is in fine shape, at least for now. They have a market cap of about a billion Brazilian Real, which translates into about $500 million. And from what I can tell by looking through their books quickly, they have about $500 million in net cash and short-term inevstments, too. They’re spending a lot of money in exploring the Solimaes basin in Brazil, which has so far been a disappointment because their finds have been natural gas, not oil (that’s an onshore basin in the Amazon — they have partnered it with Russian TNK-BP, and they have found gas, but they are currently doing studies on how to turn that remote gas into money and what the infrastructure costs would be), and they’re also, of course, spending a lot in Namibia — so that money is going to be spent and it doesn’t represent a value for shareholders unless they find something … but at least they have they money and don’t need to raise it in this environment and with this low share price. They’re also selling their air logistics business, which is basically a cargo airline they’ve used to move equipment to their Brazilian exploration sites, to raise cash, all of which points to the company making a bet almost entirely on Namibia.
And, as the head of HRT’s Africa division said recently, “The prospects are beautiful, what we need now is a little bit of luck.”
The stock is a little more expensive here in the US (or Canada) than it is in Brazil — most of the trading takes place in Brazil, where the shares last traded for BR$3.33 and where you’d have to say that the fair value is probably set. Each Canadian GDR or US pink sheets share represents half of one Brazilian share, so that should mean that the US shares trade for about 82.5 cents and the Canadian shares about 83.5 cents. The actual trading closed on thursday at 87 and 89 cents, respectively, so do note that if you’re buying here you’re paying a little bit of a premium for the privilege and convenience. That’s not necessarily unusual, but it can mean additional volatility and some additional friction — if things turn South for HRT again as drilling results come in, it wouldn’t be shocking if it turned the other way and these global depository receipts (GDRs) began trading at a discount just as you wanted to sell ’em.
So it’s not million-to-one returning lottery ticket, even if they do great, but it is a levered call option on potential commercial oil discoveries in HRT’s three blocks in Namibia this year — with the biggest impact probably coming from the initial results that we could hear about either as they’re drilling, if there’s something really notable, or at some point after they reach their target depth around the end of May. This is a company that folks were treating as an up-and-coming multibillion-dollar oil producer with pedigreed management just a few years ago, with some early excitement about their onshore blocks in Brazil, and now it’s basically a small junior oil explorer that investors don’t trust at all … it seems that they’re now being valued just at their cash on the books and we’re in “show me” territory. For good reason, you might argue, but at least they’re not trading at an inflated price.
I certainly don’t know how it will turn out — but you know what? I’m going to place an order this weekend if I can get them for near the closing price of 90 cents or so, maybe even a little more since I expect the boost of attention from Agora Financial will help drive the shares up over the weekend. This is just a small gamble with far less than 1% of my portfolio, to be clear. I’m curious to see how this works out and I haven’t been at the blackjack table in a while, so I guess I’ve got a bit of a gambling jones. If the price spikes up because of King’s attention and goes over a dollar at the open on Monday, my order will just sit there unfilled — so we’ll have to see how Easter treats the market. Since I”m writing this for you today, I won’t either change the order or, assuming the order is filled, sell those shares for at least three days. This is just a personal wager I’m making and I have no particular insight or expertise on this company beyond what I’ve shared with you above, I wouldn’t urge anyone else to follow me.
Updated disclosure: My order for this stock was filled and I do currently own shares, I will not sell them for at least three days per my trading rules.