Nostra Terra - where is it heading?

Nostra Terra has been pushing out news with amazing regularity recently. It all started midway through the year when the company acquired a new CEO, Matt Lofgran.

Since then, it's changed its strategy completely. Having started out with an oil field in Ukraine, it's now moved to invest in US oil fields instead - looking for areas where the exploration and operational risk, but also political and currency risk, is much lower. While it retains the Ukrainian asset for the time being, it might well try to sell it - on the other hand it's developing its US assets fast, bringing its fields into production and looking for further investments of a similar type.

So far, Nostra Terra has been working exclusively in the US with its joint venture partner,  the privately held Hewitt Petroleum Inc. (HPI), which serves as operator on the leases in which NTOG has acquired an interest. Utah-based HPI's speciality is the identification, acquisition and management of older oil and gas fields that have either been abandoned, or are producing well below capacity, as they have passed their peak of production.

HPI uses modern technology to recover additional hydrocarbons from these old reservoirs, at low cost - management claims to be able to produce at less than USD 11 a barrel operating cost [ref] HPI website, http://hewittpetroleum.com/ [/ref] , which is well below the 2006  average US onshore production cost of USD 19.46 [ref] EIA report quoted on Jim Kingsdale's Energy Investment Strategies, http://www.energyinvestmentstrategies.com/2008/02/03/global-oil-production-costs/ [/ref] - and costs have presumably increased for most producers in the past three years.

HPI also has an enviable success rate in discovering additional commercial reserves. It has built up a massive database of leases in target oilfields, and is looking to acquire further assets. It is likely that Nostra Terra will be able to participate in some of these leases. It's also worth noting the speed with which HPI has been able to bring the joint venture assets into production - whether that's a feature of HPI operations generally, or simply the fact that NTOG's participation has freed up cash for investment.

NTOG holds a number of assets in partnership with HPI: the Boxberger prospect, Bloom prospect, and Hoffman property. All of them are in Kansas, and have gas as well as oil reserves.

Recent months have seen newsflow on all these assets. At the start of November, the company announced new, upgraded reserves estimates for the Bloom prospect. The shares rose 15% on the news - seemingly a grudging recognition of an announcement that doubled the company's total reserves position. Bloom has 2.26m bbls of gross proved reserves (50% attributable to NTOG) and 1,096 mmcf of natural gas proved reserves, with an attributable net present value to NTOG of USD 23.8m. Bloom has nine production wells, which are being deepened and reworked.

At Boxberger, the company has announced that well A#5 is commercially viable, and will be put into production. However, flow rates haven't yet been announced - these will obviously be crucial to establishing the value of production. This will be NTOG's first production well on the property, and the cash flow should assist NTOG in developing the other ten wells at Boxberger.

This announcement got the market really excited-  the shares rose 30% on the news, and though they slipped back a little on profit taking, they still ended October as the week's top risers on AIM.

NTOG has a 75% working interest in Boxberger pre-payout, and 50% thereafter. This is one of the largest fields in Kansas - discovered in the 1920s  and producing for years. Boxberger has 1.66m bbls oil proven and 804 mmcf gas, with an estimated NPV of USD 18.5m [ref] Interim report, http://www.ntog.co.uk/media/pdf/int_2009.pdf [/ref] .

NTOG's working interest in the Hoffman property is smaller, at 25%. This field has 834,000 bbls proven oil reserves, and 404,490 mmcf gas, with a present value attributable to NTOG of USD 3.3m (based on a USD 60/bbl oil price) [ref] Interim report, http://www.ntog.co.uk/media/pdf/int_2009.pdf [/ref] . NTOG's most recent announcement stated that work was now starting on this property, with 5 wells to come into production.

So that's quite a lot of action in just a few months! The difficulty is working out what it all means for the company's finances. As of the interim results, the company was debt free, with a small loss being made, and having reduced head office costs so cash burn was minimal [ref] Interim results statement [/ref] .

But part of the deal with HPI is that NTOG finances much of the new development of the fields - for instance on Hoffman it's already paid USD 125,000, with a further USD 275,000 to come. So it looks likely that there will be some fairly chunky capital expenditure outflow over the next year, till the first wells into production are generating enough cash flow to pay for the rest. I'm sure an analyst somewhere has worked on the numbers, but the publicly available information doesn't give me enough to go on to feel at all confident in coming up with a cash flow forecast.

The only thing we have to go on, then, is asset value. Now this does look interesting. If you take the NPV of the assets as stated by the company, they add up to nearly USD 46m. The market capitalisation of the company is just under £17m.

That leaves the other assets in there for nothing. One is an option on a 50% working interest in the Koelsch field in Kansas. The other, of course, is the Ukrainian onshore oil field, Oktyabrskoe. That might well be sold - it's been mothballed, since the severe devaluation of the Hryvnia leaves Nostra Terra responsible for high royalties but selling at a price around half the current oil price.

Unfortunately, Oktyabrskoe had other problems besides the economic environment. While well #24 looked good at first, with encouraging initial results, reservoir pressure quickly dropped and the well encountered water from both above and below the target zone. Well #24 was abandoned - and so were plans to complete well #10, which had a similar geology to #24 and was likely to experience exactly the same problem. That left only well #1 producing up to scratch - not a great record [ref] Annual report, http://www.ntog.co.uk/media/pdf/ar_2008.pdf [/ref] . The company couldn't find finance or a partner last year, and even though investors' appetite for risk seems to have returned, I can't see that the asset has got any more attractive. So although Okyabrskoe is in there for free, I wonder if it's just going to stay in there for the same price.

And of course we don't have a real operating record in the US at the moment. There's no reason to distrust the management, but though we have the reserve estimates and initial production on a few wells, we don't have the flow rates, and we don't have a history of production. So there's still some risk - will Boxberger end up looking like Oktyabrskoe?

Besides, although the company has a diverse portfolio of assets, they are all held with a single US partner. That introduces another element of risk - if HPI can't access sufficient finance to develop its portfolio, will NTOG find itself having to take up the slack? And will NTOG be able to find assets elsewhere to enable itself to grow?

I'm also a little concerned that the new CEO is quite a young chap, who is still taking his MBA, and though he's been employed in business development in the energy industry, has no geological or operational experience. I wouldn't mind that so much if he weren't the only executive director - both the other directors are non-execs.

The shares have shot up from 0.25p as recently as September to 1.77p now, peaking at 2.79p. It's a tough call, given the run of good news recently, but I'm going to sit this one out. There are just too many risk factors -  and the shares seem to have kept well up with events.