Hardy Oil – A Speculative play in promising geography

If you are kicking yourself for not picking any stock in the March meltdown of 2009, and are a little bit adventurous, you might just want to take a look at Hardy Oil.

The Pluses

1. Strong Partnership

In India, Hardy is partnered with Reliance Industries Limited, one of India’s largest business firms with interests ranging from upstream energy to grocery stores. Reliance has gained significant experience in the upstream energy space with Niko Resources by bringing the D6 gas find on stream.

2. Strong Geography

The D6 gas find lies very close to acreage of the D9 and D3 blocks that Hardy and Reliance have the right for. Hardy has a 10% interest in both and Reliance holds the rest.

Please see image attached.

Source: http://www.hardyoil.com/Assests/nelpiii/nelpiii_main.htm

3. The Timing

The first well drilled in the D9 acreage ahs turned out to be a dud - http://in.reuters.com/article/businessNews/idINIndia-43388320091023. This has caused the share price to fall.

Decision

Another three wells are to be drilled in D9 - http://www.gulfoilandgas.com/webpro1/MAIN/Mainnews.asp?id=9500

Minuses

This is purely a speculative play and the risks are high. So are the potential rewards.

Hardy Oil trades in the UK markets - http://uk.finance.yahoo.com/q?s=HDY.L

Two Potential Sources for Google’s Next Big Leg up In Revenues

This article may appear off topic as it does not have to do anything with an India focused investment. However, given my professional background in online marketing, it is an on-topic article and I wanted to share with it with everyone.




Everyone seems to agree that the next step change in Google’s earnings are not likely to come from search marketing. Google has a commanding market share and has made “Googling” a tough habit to break. But there is a limit to the amount of growth that can come from “search marketing”.

I believe that there are two areas of earnings within the online advertising pie that Google could grow reasonably strongly in the near future viz. Display advertising and Classifieds.

After “search marketing”, “display” and “classifieds” form the next big chunks that Google can go after.

Please see image title IMG1 above.

Source: http://www.mediapost.com/publications/index.cfm?fa=Articles.showArticle&art_aid=103113

Display Advertising

So far Yahoo has been the clear market leader in this space. The banner market has been the prerogative of the big brands or cheap guys right at the bottom of the heap out to make a quick buck.

Apart from opening a new ad exchange (http://tech.yahoo.com/news/pcworld/20090918/tc_pcworld/googlegoesafteryahoowithmarketplacefordisplayads), I believe that the introduction of the “View Through Conversions” (http://adwords.blogspot.com/2009/09/announcing-view-through-conversion.html) could make display advertising to the vast numbers of businesses (small and medium) that currently use Google mainly for “search marketing”.

In tough economic times, which are only going go to away, very slowly, this new metric helps measure conversions (users that took an action and were exposed to the banner) better and therefore provide a better handle on a more accurate reporting of Return on Advertising Spend (ROAS).

I tried a display campaign and was amazed at the results using this new metric. I was able to generate/report 10 times the number of people that clicked on the banner and completed a sale as View Through Conversions. There is some controversy on how best to report these conversions. Regardless, the use of View Through Conversions, should create a large opportunity for incremental sales at Google.

It was the ability to measure that created “search marketing” out of thin air a few years ago. If my experience with View Through Conversions is eve somewhat typical of others, Google should see be able to harness a lot of net new advertising dollars to its Content Network, using the View Through Conversion.

Classifieds

Google has made two changes that I think might make it more of a player in this space.

A. Google Product Ads

Within the existing adwords ads, Google is making room for ads which occupy a larger piece of real estate on the screen. These product ads will presumably be shown against shopping oriented queries alone so that the overall Google experience is not disturbed. I suspect that if these ads gain traction, they will likely help raise CPC (Cost Per Click) fees.

Please see image 2 titled IMG2 at the top of the article.

Source: http://www.seroundtable.com/archives/020583.html

B. Google Merchant Centre http://googlebase.blogspot.com/2009/09/introducing-google-merchant-center.html)

Google has recently broken up its Google Base product into two separate products. All users of Google Base (a program to feed products/data to Google) that submit products have now been provided access to the new Google Merchant Centre.

My suspicion is that once the migration is complete, service providers that provide hard goods and soft goods (data or services) could be offered bells and whistles that correspond better to each demographic. In both cases, given Google’s large reach, I would say Google could become a player in the classifieds space with enhancements to both, the existing Google Base for service/data providers and the new Merchant Center for product catalog providers.

I believe that these two potential revenue streams will materialize before any revenues from Android and allied activities materialize for Google.

Opportuity Beckons - Niko Resources

The Company:

Niko Resources, based in Canada is an independent and frontier exploration company. Like Cairn Energy, my other pick, they typically go into countries and regions that regions that Big Oil has overlooked. They are a pure play in terms of oil and gas exploration as they are not into owning or running gas stations or refineries.

The Assets:

1. Near Term Trigger

The most significant asset that Niko has is its 10% stake in the gas field of D6, in the Krishna Godavari (KG) basin off the east cost of India.
D6 is a global phenomenal gas field by any standards. At its peak production, the D6 KG filed will produce the equivalent of 550,000 barrels of oil a day (that more than half a million barrels a day!!). http://www.arcweb.com/Regions/India/Lists/Posts/Post.aspx?List=5ca2e668-8692-44a9-81cd-147593ce461c&ID=104

With most of the base infrastructure in place and initial gas already being captured, this is a major impetus, both to the country and the company (Reliance Industries & Niko, the 10% partner) http://www.arcweb.com/Regions/India/Lists/Posts/Post.aspx?List=5ca2e668-8692-44a9-81cd-147593ce461c&ID=104

D6 will have knock on downstream benefits for the Indian economy as reported by Goldman Sachs http://www.livemint.com/2009/03/24165730/KG-basin-D6-field-gas-to-lowe.html

2. Exploring outside of D6

Niko is also exploring other blocks in D6 and elsewhere in India, Pakistan, Bangladesh, Indonesia, Kurdistan, Pakistan, Trinidad and Madagascar.
With cash flows that will be flowing from the D6 field soon, Niko will be in a great position to bid for better blocks and undertake better exploration in the acreage that it already has access to.

Risks:

1. The brother on brother dispute in the Reliance Family (owners of the 90% stake of D6).

Apart from the usual risks of delayed production and other technical risks associated with deepwater exploration, there hangs a more serious cloud over the revenues that could accrue courtesy of D6.

90% of D6 is held by Reliance Industries Limited (RIL) controlled by Mukesh Ambani, the elder of the two Ambani brothers. When the two brothers split from each other in 2005, they signed an agreement on how to divvy up the empire that their father legendary Dhirubhai Ambani had created (and the boys had helped grow). Anil Ambani, the younger brother has contended in court that as per a settlement agreement, he has rights to buy a certain amount of gas (28 million cubic metres of gas per day) from the D6 fields at a “friendly” price (50% of the price set by the government). http://www.telegraphindia.com/1090731/jsp/business/story_11304165.jsp

With Anil’s part of Reliance making investment in generating electricity for a country that desperately needs energy, access to low priced gas is a key competitive advantage.

Current Status of the dispute:

A. The dispute now lies before the Supreme Court of India.

B. The government of India has stepped in and wants the gas sold at full price so that its own revenues do not get hit. The governments’ contention is that the natural resources are a national asset and that the folks that discover and sell the resource are just companies that are leasing the land/asset.
http://www.ft.com/cms/s/0/77ca7444-74c4-11de-8ad5-00144feabdc0.html

2. The low price of the gas versus international price

The gas from D6 is not sold as per free market prices but at prices set by the state. At a set price of USD 4.2 mm/BTU, the will of the state may be tested if natural gas prices move up globally. What happens if and when the global prices of natural gas shoots up? I dont know.

Keeping in mind that India has yet to attract “Big Oil” to explore, it is hard to imagine that the state will be able play the role of a paternalistic parent in perpetuity. India’s energy needs require a few more D6 kind of discoveries and global players are required to generate competition and accelerate the pace of exploration. An awakened India cannot allow the discovery of additional deposits to be put off.

There have been other less significant discoveries adjacent to the D6 already - http://www.business-standard.com/india/news/reliance-strikes-oil-in-kg-basin/229691/

Valuation:

Niko states that once D6 hits the targeted 2800 MMcf/day target which is expected before calendar year end 2009, shareholders can look forward to $ 10 as cash flow from operations. http://www.nikoresources.com/nikopr.htm

I am making an assumption or a leap of faith, that much of $10 will flow directly to the bottom line in the hope that interest and taxes will be met by some income from the non D6 fields. If some one has additional information on this, please share it with the readers using the comment form at the end of the article.

In the worst case scenario of a quarter of the production of the natural gas from D6 has to go to Anil Ambani’s group, it will be interesting to see if it is taken out solely from the 90% that Reliance Industries owns (as should be the case and Niko’s stake should not be impacted). Niko after all was not party to the family agreement between the Ambani brothers.

With an expect field life of 11 years (http://in.biz.yahoo.com/090402/50/bateb6.html), an investor may pay upto 5 times of these earnings on a conservative basis for an independent oil exploration company (http://biz.yahoo.com/ic/123.html 9.1 PE for Independent Oil & Gas producers).

That establishes a base of $ 50 for the Niko stock and throws in all the other exploration assets and potential at zero cost.

How to best play Niko India?

Niko Resources trades on the Toronto Stock Exchange (http://ca.finance.yahoo.com/q?s=nko.to). At $ 80 the stock may feel expensive given $ 50 as a base price, but please note that the independent oil and gas companies trade at 9 times earnings. I have chosen to go with 5 as an extreme caution.

Long investors are expecting the cash register to ring soon as we are not far from the moment when Niko will begin to lock half a billion dollars in sale every quarter. http://www.nikoresources.com/nikopr.htm

Recommendation:

You may choose to wait before buying Niko at your own risk. If there is a weakness between now and end 2009, definitely load up on this stock and wait till the cash flows start rolling in. I don’t think a long term investor will be disappointed.

You will also find that Joseph Schacter on April 6, appearing on BNN (Business News Network in Canada) has Niko as a top pick (he has had this in his radar for a long time) http://www.bnn.ca/marketcall.aspx

The Case For Cairn

The Company:

Cairn Energy, based in Scotland is an independent and frontier exploration company. They typically go into countries and regions that regions that Big Oil has overlooked. They are a pure play in terms of oil and gas exploration as they are not into owning or running gas stations or refineries.

Cairn Energy has two distinct subsidiaries:

A. Cairn India and

B. Capricorn Energy

The Assets:

1. Near Term Trigger

The most significant asset that Cairn India has is the oilfields in Rajasthan India. The oilfields of Mangala, Aishwariya, Saraswati and Raageshwari in Rajasthan have an estimated 3.7 billion barrels of oil. Cairn owns 70% of these oil fields (ONGC, one of the Indian national petroleum companies owns the other 30% and not all the oil is extractable).

Cairn expects to start production at 30,000 barrels a day in the second half of this year and ramping it up to a peak production of 125,000 barrels a day by 2011. The 125,000 barrels per day is expected from the MBA fields (Mangala, Bhagyam and Aishwarya). These figures do not take into account any other oil finds that Cairn may find and exploit elsewhere in India.

2. Exploring outside of Rajasthan

A. Sri Lanka – In the Sri Lankan waters close the Krishna Godavari basin (where India has discovered its biggest gas find ever), Cairn has rights to explore hydrocarbons in a 1,500 square km. Cairn India owns 100% of this field.

B. North India – The Ganga Valley sedimentary basin is one of the most under explored basins in India. Cairn India owns 50% of the rights to explore acreage in Uttar Pradesh and Bihar.

C. Eastern India – Cairn’s focus in the East is based on the Ravaa oilfield in the KG basin (Krishna Godavri basin). In partnership with 2 other companies, Cairn India is producing 50,000 barrels a day from this field and can process 70,000 barrels per day, 95 mmscfd of natural gas and 110,000 barrels per day of injection water.

D. Western India – In partnership with 2 other firms, Cairn has been producing gas from the Lakshmi gas fields in the Cambay basin.

E. Greenland – Cairn is exploring 3 different basins in Greenland that are suited to oil and gas deposits with a total of 72,000 sq km under license for exploration.

F. Mediterranean – Cairn is also bidding and exploring for oil in Tunisia, Spain & Albania.

G. Capricorn – All of the non Indian assets that Cairn Energy holds are owned via a subsidiary called Capricon Energy. Capricorn Energy Limited (“Capricorn”), a subsidiary of Cairn is the exploration focused arm. Capricorn now has assets in Bangladesh, Nepal, Northern India, Greenland, Tunisia, Peru, UK (West of Shetlands), Albania, Australia, and pending licence awards in Spain and Sicily.
Cairn Energy holds 90% of Capricorn, an unlisted subsidiary.

Risks:

1. Oil prices fall and stay there for a while

My perspective is that even if this happens, usage of petroleum in India will continue to remain strong. At the end of the day, we are talking about a commodity that is depleting and that we will eventually run out of. Sooner or later prices will go back up and stay there.

2. Taxation

The state of Rajasthan goes back on its word and decides to tax Cairn heavily for the oil it draws out of the ground. The Chief Minister has already hinted at raising taxes on Cairn and others.

Again, if this does happen, Cairn has shown in the past that is not afraid of going to court and fighting for its rights. The federal government in India understands that after many years, the oil majors are slowly looking to India for exploration. With a Congress government both in Rajasthan and the Centre (federal level), I think it is unlikely that the Rajasthan government will tax Cairn to death.

3. Low quality Oil

When the GOI (Government of India) forced the state owned oil companies to firm up buying of the waxy crude that is produced by Cairn India, there was confusion about pricing the crude given its high viscosity.
However, those concerns have been laid to rest and Cairn has now signed deals that ensure that the crude will be sold and they have ready customers - http://www.thehindubusinessline.com/2009/07/20/stories/2009072051570100.htm

4. No additional oil is found

Usually where some oil is found, there are chances of finding some more oil. But investors should consider the possibility that despite promising seismic surveys and geology, Cairn may not find any major discoveries in its other explorations.

Valuation:

Here is how I have valued the MBA fields, Cairn India’s most promising asset.

Please click on the graphic at the top of this post to expand and view the excel table. I have yet to figure out how to paste tables from Word or Excel into blogger.


At $ 40 a barrel, Cairn India has an enterprise value of $ 10.5 billion.

A. Reserves have been taken at a conservative 500 million recoverable barrels versus the company aiming for 685 million - http://www.livemint.com/2008/03/31142600/Cairn-India-raises-projection.html

B. Average net margins have been taken at a conservative 15% compared to the 40% plus in the valuation done by IndiaBulls - http://www.business-standard.com/pdf/tu953%20cairn%20india%20090701.pdf

C. Assumed a conservative PE ratio of 5 for Cairn. Comparatives can be viewed at http://biz.yahoo.com/ic/123.html (9.1 PE for Independent Oil & Gas producers)

D. Current price on July 21, 2009 is Rs 245 or - http://www.business-standard.com/stockpage/stock_details.php?bs_code=11204 and http://in.finance.yahoo.com/currency/convert?from=USD&to=INR&amt=1&t=1y
How to best play Cairn India?
Cairn Energy, the parent company trades in the UK markets and owns 69.5% of Cairn India. To follow stock movements of Cairn Energy, used this http://uk.finance.yahoo.com/q?s=CNE.L

Recommendation:

At a conservative $ 40 a barrel, Cairn India has an enterprise value of $ 10.5 billion. The market cap of the company on the Indian markets is at USD 9.3 billion and too far off from the $ 10.5 billion I have calculated/estimated.

Cairn Energy stock on the UK markets has a market cap of 3.32 billion sterling. At an exchange rate of 1 sterling being 1.64 USD, that translates into a market cap of USD 5.45 billion. Theoretically speaking the 69% of Cairn India should translate into USD 7.3 billion.

In light of the above, I would propose that at current prices Cairn Energy stock represents an opportunity to buy into the MBA fields at a discount and get exposure to all of the other exploration that Cairn Energy has lined up at zero cost.
If you wish to buy Cairn and wait till 2011/2012 (my suggested hold period), I would suggest buying it on the UK markets.

Investment Theme 1

Source: http://www.climate-policy-map.econsense.de/factsheets_download/factsheet-energy-efficiency.pdf

If a picture is worth a thousand words, then the graph above should clearly shows huge $$ signs. All the 3 major BRIC nations are at the bottom of the heap in terms of per capita consumption of "Primary Energy".

Imagine a life without gasoline, electricity and all that these vital inputs provide and help produce.

In terms of power plants, transmission grids, electrical transformers etc, clearly there remains a massive amount of money and investment that will be required. But in the case of India, I believe that primary hydrocarbon exploration represents a major multi-billion opportunity.

Allow me to list my reasons:

1. Under Explored Terrain - India is an under-explored country (seismically speaking). It is only recently that overseas companies have been allowed to explore for oil and gas. Google the phrase "NELP exploration policy" and see what you find. India's hydrocarbon czars have some what awakended from their slumber and are reacting to what is a strategic shortage and choke point.

2. Geology - Geologically the prospect seem good with oil discoveries having been made in Rajasthan in recent years and massive gas deposits having been found off the Eastern coast in India.

A map of all the major basins can be viewed at http://www.iypeinsa.org/updates-09/art-45.pdf (looks like a 2004 document)

3. Captive Market – India imports something like 75% of its crude requirement. With the rising middle class and the ambition/dream of every family owning an automobile or two, India is a long way away from suffering from a glut of crude oil and gas.

Source: http://timesofindia.indiatimes.com/Business/India-Business/Inflation-to-average-5-in-FY10-Assocham/articleshow/4725571.cms

With most purchases of electricity being done by bankrupt State Electricity Boards, for now, I believe the singular theme as far as a energy is concerned should be E&P (Exploration & Production) plays with an India focus.

Investing Philosophy

I am a regular guy just like who. Perhaps like you I have lost 40% of what I invested in the market meltdown of 2008 and 2009.

But I have also made significant profits on stocks that I bought and held as a 20 something old in India. I am thankful to my father for teaching the values of frugality and clear thinking on what to buy and why.

After the recent carnage, surely every one realizes that investing for the long terms, the next 5 to 10 year horizon, can only be done by investing in the developing countries. Any one read or heard about the concept of Marketing to Bottom of the Pyramid. Those familiar with the web economy, think of micro-payments applied at a massive scale. That is what the developing nations represent.

When it comes to developing nations, India is probably the country that I know best having lived and grown up there and having a connection to that society.

Since I live outside of India, I will try and list stocks that overseas residents can buy.

I will not be suggesting prices you buy stocks at but will list stocks that I believe will strongly rise over the long term (5+ years).

I have deliberately titled the blog "Investing With India" as I believe that is the best way to make money. As India invests in her own future, being a participant in that process will yield, good, solid and yes, stable returns.

Happy reading

Harmit Singh Kamboe