Sunday, September 30, 2007

New Position: Harvest Natural Resources

I'm going to keep this write-up short because frankly, I still have only a basic understanding of the company and I have many more questions that I hope to uncover as time goes on. But based on the numbers and the story, it seems clear that Harvest represents a compelling valuation at current prices.

Harvest Natural Resources is an American company with oil production in Venezuela. Over the past few years, the stock price has been hit because of fears over the possibility of nationalization. Today however, the revised contract is very near implementation on the terms that the Venezuelan government has wanted. The terms were very stiff: 33% royalties, reduced ownership in the properties to 40%, and 50% tax rate. But if we accept this as final, then the risk reward situation as follows:

Price: 12.21
Market Cap: 460 million
At end of 2nd Quarter, 115 million in net cash.
Reimbursement payment: 60 million cash(*)
= approximately 175 million adjusted net cash.

The company also provides you with a discounted valuation of their reserves, after-tax and at 10%, as follows:
Proved reserves: 308 million
Probable reserves: 158 million
Possible Reserves: 396 million

Play around with the scenarios and you can see the range of values can be exciting, at 175 million - 1037 million. A few things to note:

*First, with regards to the reimbursement payment- this is the money the company is supposed to get reimbursed for operating their oil wells during the past year and a half without a contract. I believe the number I came up with is approximately right based on the terms in the new contract, although I will be double checking my methodology some more. See the comments below for further discussion.

Second, with regards to the valuation of the properties. These NPV's were done using a recovery rate(the amount of oil you recover out of the total in the field) of 13% on their reserves. The company showed how they have historically done much better than this, and they see their new fields having the same characteristics as their past successes. So, if you assume their 13% recovery rate is conservative, that means you would value the properties all the way to 3P (Possible), because that would be 13% recovery. Every subsequent 1% improvement in rate adds about 100-125 million in value to HNR, implying another huge upside in the stock based on exploration potential.

With regards to the fears over Venezuela, it seems like Venezuela has already "done its worst", so to speak. They have gotten the terms they have wanted, and to ask for anything stiffer would send the companies packing. Harvest and the other companies have shown how they can add plenty of value by exploring and operating these oil assets, so Venezuela doesn't want to see them go. So I think it might be fair for now to consider these terms as final.

I do have plenty of questions; (for example, what is the price of oil used in the NPV calculations?) Plus, I have also always been sort of an oil bear, thinking that most the rise in oil prices has been due to speculation rather than fundamentals. But add up the numbers for Harvest and you have a stock price backed by a lot of cash, along with a high quality oil asset with very low operating costs (Currently about $5-6 per barrel of oil). It was enough for me to buy a position today. Look forward to more on this in the future.

Update on 10/4/07


This blog is intended to be a reservoir for my thoughts on investing and a dumping ground for my ideas and mistakes. said...

Actually, the potential reimbursement from VZ govt is more like $1/share.

Check out this blog for the exact calculation:

I used a back-of-napkin model to value HNR reserve:
- A $12 per barrel multiple
- Multiplying by a recovery factor (90% for proved, 50% for probable, nil for possible)
- A 50% haircut for country-specific risk
This gives me $9.49/share in reserve. Perhaps too conservative but stock right now is still selling at a slight discount to my bear-case intrinsic value estimate.

Nnejad said...

Okay, you are mostly right. The source of confusion for me was this statement:

"Since signing the MOU, CVP has designated Petrodelta’s board members, a General Manager and President, each of whom influence Harvest Vinccler’s operations and staffing. Harvest Vinccler continues in the day-to-day operations of its properties in Venezuela, and since April 1, 2006, it has accrued cash advances of $58.0 million to fund operations. At the request of PDVSA, Harvest Vinccler invoiced PDVSA for these costs and as of July 12, 2007, $42.6 million, representing April 2006 through February 2007 advances, have been reimbursed."

I took that to mean that on July 12, they received 42.6 million in cash plus they needed to be reimbursed for 15.4 million more. In reality, the balance sheet at the end of Q2 already reflected the 42.6 million cash, but still had a receivable of 15.4 million.

Otherwise, your number is pretty similar. I would take your 34 million, add the 15.4 million remaining receivable, plus an additional 10 million estimate for further cash advances that will be necessary from April 1st to the day the contract is implemented. That would be about 60 million. I believe that to be reasonable, but feel free to dispute anything there.

Also, I would say that you discount to deeply for recovery factors, given that management expects in two years to more than double their proved reserves by shifting probable and possible over. But this is the part I wish to do more research into, and you can look forward for more postings on the valuation of their oil assets.


Anonymous said...

Thanks for the analysis Nick. I would like to see more in depth analysis of their reserves etc.

This blog is intended to be a reservoir for my thoughts on investing and a dumping ground for my ideas and mistakes. said...

That's about right.

I don't consider myself an expert in estimating future oil prices so that conservatism does give me some extra margin of safety. But if Jim Rogers is right then oil may still have a long way to go.

I look forward to your further analysis.

Anonymous said...


Approximetely how much of the reserves would go to the Vz government via royalty payments and taxes if/when realized?

Nnejad said...

To summarize the change of terms:
1. Ownership of the corporate entity went from 80% to a net 32%.
2. There is now a 33.3% royalty on production.
3.Tax Rate increased from 34% to 50%.
4. Price realized increased from 47% of WTI to 70% of WTI.
5. They kept their original oil fields, and also received 3 new fields.