Thursday, October 04, 2007

More Info on Harvest Natural Resources

As I mentioned in my original posting a few days ago, there was going to be more research into Harvest Natural Resources. Here is some more analysis and some key notes.

First, to briefly go over the contract details:
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.

Now, if you look from the viewpoint of the Venezuelan government, before this change foreign companies(in general, not just Harvest) were receiving 66% of the profits from Venezuelan oil profits, while the government took only its 34% in taxes. Now, after the new royalty, foreign ownership restrictions, and tax rate, the ratio is about 13% to 87%. So the incentive to impose even stiffer terms seems to have become significantly reduced.

Second thing I wanted to mention regards the reimbursement fee. Unfortunately, most of it should not be included in our intrinsic value calculations. The reimbursement fee is supposed to make up for Harvest's costs and profits from April 1st, 2006 to the date the contract is signed. But, the NPV calculations we have been using for analyzing the oil assets are also based off of April 1st, 2006. So, this would be double counting the profits in our value calculation. We can still include the operating cost portion of the fee to Harvest though, which I estimated at approximately 25 million. Also, since it is now October 2007, there was been some increase in time value in the NPV of the oil assets, but I'm choosing to ignore that. So it is nice that we will be getting a hefty reimbursement soon, but the appropriate net cash number to use seems to be 140 million.

Now, Oil Assets. One thing I found interesting was that the Ryder Scott valuation report said it conformed to SPE/WPC reserve definitions for proved, probable, and possible. So, I looked that up and found this link. Basically, the summary of the definitions are:

Proved: "If probabilistic methods are used, there should be at least a 90% probability that the actual quantities recovered will equal or exceed the estimate."
Probable: "In this context, when probabilistic methods are used, there should be at least a 50% probability that the quantities recovered will equal or exceed the proved reserves plus the probable reserves."
Possible: "In this context, when probabilistic methods are used, there should be at least a 10% probability that the actual quantities recovered equal or exceed the proved plus probable plus possible reserves estimates."

Now this is interesting because we can use this to come up with an average based on strict interpretation of the definitions. The calculation is as follows:
(Note: I used 100% for proved instead of 90% to simplify, and just because I think that's fair)
(.50)(308) + (.40)(466) + (.10)(862) = 427 million

So interpreting those definitions strictly comes up with an average value of 427 million. Note also that in this and all the other NPV calculations mentioned, the net price used was $45.81, while the price today would be about 53.24, a 17% increase.

Now, using the net cash of 140 million plus this 427 million calculation gives us 567 million, compared to a purchase price of 460 million. And, there is a 17% safety margin in the oil price not taken into account. And this is not taking into account what appears to be management's sincere beliefs that they can recognize a lot of the probable and possible reserves, based on what they have done historically with their three fields.

Now I'm going to conclude by throwing out one question that has been bothering me: In the reserve estimates in the valuation report, Ryder Scott attributes zero reserves for probable and possible for the original SMU fields. But if you look at the production and reserve numbers in the chart I provided here, you can see that Harvest has clearly been successful at expanding their proved reserves at their traditional SMU oil fields. So my question is, why is there no probable or possible reserves for the SMU oil fields?

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