by Aaron Levitt | December 6, 2013 1:48 pm
Offering both promise and fortune, Africa is certainly one of the last frontiers in investing. But it can be a pretty cruel mistress as well. Investors in independent oil and gas producer Cobalt International Energy, (CIE) are finding that out the hard way.
Despite discovering more oil and natural gas than previously thought in fields of the coast of Angola, CIE stock has plummeted — to the tune of 17% on the news. While that seems difficult to comprehend — a small producer hitting a big field — there some risks with those massive elephant finds. And those risks need to be understood.
However, it seems like the market is going overboard with regards to understanding the news and the risks. For investors willing to take the gamble, CIE stock could be a huge bargain after the big drop.
While CIE does hold interests in offshore wells in the Gulf of Mexico, Cobalt’s growth prospects lie in offshore Africa — namely, Angola and Gabon. The small E&P firm has done pretty well in discovering oil and natural gas in deep waters of their coasts, and its latest find was a doozy. Angola’s geology is very similar to the per-salt flats in offshore Brazil. The discoveries there have been massive, and CIE’s recent well shows Angola’s potential.
A test well in Cobalt’s Lontra field managed to produce roughly 2,500 barrels of gas condensate and 39 million cubic feet of gas per day. According to CIE, the flow rate at Lontra was actually a reduced amount based on testing equipment malfunctions. Overall, the well should flow about 30,000 barrels of oil equivalent per day when fully operational. That’s substantially more than CIE and partner BP (BP) had expected. And at that flow rate, Lontra is a “discovery on a global scale.” This find is now the third massive oil/gas field that Cobalt has discovered in Angola’s Kwanza pre-salt basin.
You would think that a smaller producer’s shares would surge at the announcement. But for CIE, it’s not so simple. The problem is twofold.
First, the Kwanza basin is known to have high volumes of natural gas. That in and of itself isn’t a problem. After all, worldwide demand for natural gas is growing by leaps and bounds.
The issue is Angola’s rules on exporting and marketing that bounty. Under the country’s production-sharing contracts, foreign investors are restricted from sending natural gas production overseas without sending royalties and concessions to the Angolan government. That means, any natural gas that CIE produces from the field will need to be used in Angola first. This fact could hurt profitability at the field considering that it is more than 55% natural gas.
The second issue for CIE and Lontra is that there is a lack of infrastructure in Angola to even consider using gas from the field. Oil majors like ConocoPhillips (COP) and Norway’s Statoil (STO) are looking at building liquefied natural gas (LNG) transportation facilities in the nation. However, these projects could take years to develop. At the same time, getting the gas from Lontra to these facilities would take plenty of infrastructure muscle — something that doesn’t exist yet. So, CIE’s field could be dead in the water.
While those two factors are big risks to consider, they don’t necessitate a 17% drop CIE stock. Especially when there are plenty of long term positives at Cobalt.
On the call announcing the find, CIE management suggested that the government of Angola is looking to develop gas and NGLs/oil at similar paces. To do this, Cobalt would need to be granted a contract change to monetize the Lontra. Management seemed pretty positive about getting that change in the near future.
The Angolan government also seemed very keen about getting its resources out on the market and have been fast tracking LNG facility approvals.
The potential to monetize its Angolan properties is huge for CIE. Overall, Cobalt has a vast network of acreage in the nation — 1,360,000 acres’ worth. So far, initial estimates of Cobalt’s acreage show that up to 5 trillion cubic feet (Tcf) of gas has been discovered in Lontra as well as its other wells in Cameia and Mavinga. That’s a lot of gas and good mean big bucks for CIE and its shareholders down the road.
Then there is the buyout angle to consider. Already, rumors have circulated that CIE — given its huge acreage in Angola could be a buyout for larger oil majors like BP or Exxon Mobil (XOM). The potential is there as the public owns roughly 71% of shares outstanding. And with the recent discovery at Lontra and its recent drop in CIE stock, that buyout could come sooner than expected.
All in all, CIE stock is risky given the company’s operating environment. However, after the recent huge drop, investors now have an opportunity and margin of safety with CIE shares.
Those with higher risk tolerances should consider adding Cobalt to their E&P portfolio.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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