Victoria Oil & Gas - three buses at once?

Some oil and gas companies seem to go for ages without any developments - then, a bit like London buses, three come along at once.

I know Victoria didn't exactly have a news moratorium, but it seems that recently there's been a spate of good news flow on both its main assets after a frustrating year during which nothing seemed to be happening.

That's particularly good news as VOG is a former star of AIM which fell from a great height after Russian prospects failed to materialise (take a look at the share chart - the price hit 250p in 2006 and the company is now trading as a penny stock). This has been a trader's joy and an investor's nightmare with its volatile share price.

It came to AIM in 2004, with an initial focus on Russia and Central Asia, where CEO Kevin Foo and his team all had managerial experience in oil and gas. More recently though it's been transformed, buying 75% of Severgazx-Invest (which held the West Medvezhye licence) and 100% of Bramlin.

Now, the  company's principal assets are the Logbaba gas and condensate project in Cameroon(of which it owns 60%), and West Medvezhye gas field in Siberia (100% owned).  In 2007, the company changed its strategy from pretty much pure exploration, to prioritise production and cash flow. That may not have been the obvious move at the time but it looks pretty good in hindsight. It's now moving to develop Logbaba rapidly, and that should give the company high cash flow generation from a captive market.

Let's get the latest results out of the way first. They showed a £42.4m loss - but £35.5m of that represents a writeoff of the Kemerkol project in Kazakhstan, which is currently the subject of a court case. On a cash basis, the company's loss was £6.8m, and that's a reduction on the previous year's £10.8m [ref] Fox-Davies newsflash, http://www.proactiveinvestors.co.uk/companies/news/10564/fox-davies-capital-newsflash-including-victoria-oil-gas-mantra-petroleum-strategic-natural-resources-and-central-rand-gold-10564.html [/ref] . My guess is the group isn't going to make money this year, either, as Logbaba won't be onstream till the second half of the year.

Logbaba is located close to Douala, the economic capital of Cameroon. One of the good things about Cameroon is that it's one of the more stable economies of sub-Saharan Africa; largely agricultural, with industry and trade focused on Douala. One of its major problems? Chronic power shortages. So the news that Hyundai is going to invest in a new 232 MW gas-fired power plant [ref] Moneybiz, 24 July 2009: http://www.moneybiz.co.za/business_in_africa/Cameroon_Hyundai_Eng_sign_$162_mln_power_deal.asp [/ref] means there's going to be a requirement for gas, and plenty of it - which is what VOG aims to provide.

The Logbaba field was actually discovered in the 1950s by Elf, with four exploration wells all flowing gas at rates up to 62Mmcf/d. Of course at the time Elf was looking for oil, and there was no real market for the gas - so the field was abandoned. VOG bought it in 2008 when it acquired Bramlin plc.

At the time of the acquisition, no new data had been acquired since 2007. VOG has been active in improving the data - the company has already drilled a new well, La-105, which has encountered 90 feet of gas pay. This gas bearing zone appears to correlate to the gas sands encountered by Elf's La-103 well, which flowed at 4.5m cu ft (800 boe) [ref] Reuters, November 16, 1009: http://www.reuters.com/article/energySector/idUSBNG52254220091116 [/ref] . A second well, La-106, is now to be drilled.

The 2008 survey puts Logbaba's potential at 106 bn cu ft, proven and probable; right now, GeoDynamics Research is conducting a passive seismic survey over the entire licence area, which could increase the size of reserves.  At the same time VOG will be applying for a 35 year exploitation licence.

If all goes according to plan, the first gas sales are expected in Q3 2010. letters of intent for sales are already signed. However there's a fair amount of work that needs to happen first - including 15 kilometres of pipeline.

Logbaba is undoubtedly the biggest and shortest term prospect for VOG. Fox-Davies gives the field an unrisked value of USD 81.7m, and a 75% chance of success, adding up to a prevent value of USD 61.3m, or 5p a share [ref] Fox Davies note, August 2009: http://www.victoriaoilandgas.com/investors/VictoriaOil_GasInitiatingCoverageAugust12th2009.pdf [/ref] . That's pretty much the current share price.

VOG's other main prospect is West Medvezhye, situated in the Yamal-Nenetsk region of Siberia. An independent reserve audit estimated prospective resources for West Med of over 1.1 bn boe of gas, condensate and light oil, and it's next door to the super-giant Medvezhye field, and about 120 km away from the huge Urengoy condensate field. But the resources so far are only in Russian categories C1 and C2, which don't take commerciality into account, so they count as contingent resources from the point of view of UK investors [ref] Fox Davies note, August 2009, p 7: http://www.victoriaoilandgas.com/investors/VictoriaOil_GasInitiatingCoverageAugust12th2009.pdf [/ref] .

Fox Davies gives this field a 67% chance of success; only one of the three wells drilled ahs been successful, but the  two unsuccessful wells were targeting a shallower play than the classical Medvezhye prospect - so they should not necessarily be taken as an indication of higher risk on the main field. With an unrisked value of USD 28-57m, that gives a risked valuation only USD 27m - less than half that of Logbaba. And it's got high drilling costs owing to very extreme environmental conditions.

However if you see the current share price as covered by the Logbaba field, then you'd say West Medvezhye is in there for free - which doesn't look bad. (Of course you also need to take some account of financing and administration costs, but even after that, my feeling is you have 1.5p - 2p a share 'free' value.)

Now for the other little bits. In September 2008,  VOG acquired an option over Falcon Petroleum, which has exploration acreage in Mali and Ethiopia.  However, the option has now expired, and though VOG is negotiating an extension, you can't really give it any value.

As for the Kemerkol oilfield project in Kazakhstan, that's pretty much been written off. The company is appealing against a 'fraudulent' local challenge to its ownership and has been supported by the Kazakh general prosecutor, but it's difficult to foresee the outcome of the case. Management has clearly acted to ring-fence the impact of the Kazakh operations and will be focusing on Logbaba over the next year. So while there's a possible windfall gain to investors - and there is little downside from here - it's not really something you'd base your investment case on.

It's Logbaba that will be the real driver of the turnaround. VOG claims that once Logbaba is up and running, it will become profitable, though that won't be till the second half of next year. There's a good prospect of increasing the reserves in the near future, since the current estimates only refer to a small part of the total acreage, and the hit rate has been excellent - every single well drilled on the Logbaba prospect has found multiple reservoirs of gas with high flow rates [ref] April 2009 presentation to Oilbarrel [/ref] .

There is still some risk on Logbaba. There's not been an extended production run, so the total extent of the reservoir isn't known. And there's some execution and commercial risk, getting the facilities up and running, and signing the final gas contracts. Still, that's nothing compared to the exploration risk you'll see at most oil and gas juniors.

So what is the company worth? The current share price appears well supported, and Fox Davies believes fundamentals justify a target price of 7p. Fox Davies in particular likes the fact that the company has “proven hydrocarbon-bearing assets close to production” - not blue sky exploration prospects. The broker also suggests there is an extra upside from derisking Russia, which is still in an early stage of appraisal; that, it says, could justify a share price of 14p. [ref] Fox Davies initiation of coverage: http://www.victoriaoilandgas.com/investors/VictoriaOil_GasInitiatingCoverageAugust12th2009.pdf [/ref]

With a net asset value of 6.6p, investors should be well protected from downside. However, I find it hard to get excited about the upside. Victoria should become a nicely profitable little business, but will it ever become a big business? I might rather save my ammunition for other West African ideas that have the potential to become rather larger.