Canoel International Energy (CIL.V) - building a portfolio in undervalued Italian gas

Full Report by Will Purcell , Jan 15, 2013 download full report
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Key Points:

• Canoel is acquiring several more producing gas assets in Italy
  In September, Canoel agreed to acquire 13 onshore production and exploration natural gas assets from Mediterranean Oil and Gas plc. Of these, six are operated producing concessions and three nonoperated producing concessions. The other four concessions are exploration projects. Canoel will pay a token cash sum to MOG and will assume liability for all future plug and remediation costs. Further, MOG will pay Canoel C$1.56m as a partial contribution to these costs and will provide Canoel with all revenue earned subsequent to August 24, 2012, net of allowable costs.
   
  Management currently projects its existing Italian gas fields, Torrente Vulgano and Canaldente, will commence production late this year. When last in production during the late 1990s, Torrente Vulgano yielded nearly 280,000 standard cubic feet of gas per day.

• For now, Argentinean oil production remains Canoel’s primary source of revenue
  Canoel’s first production acquisition occurred in 2011, when it purchased the Don Alberto and Don Ernesto oil fields in Patagonia, Argentina, for C$2.85m plus future royalties estimated at C$0.56m.
   
  Canoel achieved production of 40,695 barrels of sweet, non-paraffinic, crude oil (18.5° API) during the company’s fiscal year ended March 31, 2012, lower than its eventual target of 60,000 barrels per annum, but an improvement over the prior year. During the subsequent quarter, production dropped to 7,422 barrels from 11,819 barrels a year earlier, the result of unusually severe weather conditions. Our production estimate for the current year is 40,000 barrels. We expect Canoel will achieve 60,000 barrels of oil per annum in subsequent years, and we model an eventual increase to 120,000 barrels per year, assuming the company will enhance production from its two fields. It is worthy of mention that Canoel’s Argentinean assets have been assessed with a net present value of US$52m.
   
  During the past year Canoel has substantially increased its oil reserves at Don Alberto and Don Ernesto, to a current two million barrels from an earlier estimate of 679,000 barrels. The price for domestic Argentinean oil increased during the year as predicted, but remains, and is likely to remain, substantially below the prevailing world price. This arbitrary price is sufficiently high to provide Canoel with significant cash flow, but it does result in increased risk for Argentinean oil producers.

• Nevertheless, Canoel continues to seek opportunities in Africa and elsewhere
  Canoel had an agreement to assist and advise a Zambian company, Mafula Energy, in its petroleum activities in Zambia. Although no discoveries have yet been made in the land-locked nation in south-central Africa, Mafula believes the area to be prospective for oil and gas and has already been awarded one exploration permit. Mafula awarded Canoel 400,000 shares for its assistance. The company also has an agreement with Oren Oil of Norway which may provide modest remuneration for services.
   
  Canoel is actively pursuing the acquisition of other oil and gas producing properties, targeting Italy and African nations, with the goal of generating sufficient cash flow to fund its operations, exploration prospects elsewhere in the world and to provide financing for future acquisitions.
   
  At this stage, management believes Italy to be a particularly promising region for acquisition and development of petroleum opportunities. In regard to new exploration and development activities in Africa, Canoel now intends to focus its efforts in Libya and Nigeria, because of their advanced petroleum sectors.
   
  In this regard, the company has just established a representative office in Libya with the intention of setting up a local company to explore and develop oil resource projects as they arise.

• Canoel’s expansion strategy is not without risk
  Like all exploration and development companies, Canoel is expanding operations in an uncertain economic climate. The most recent Italian acquisition will help remedy the company’s cash shortfall, through the introduction of new production and the up-front payment of plug costs by MOG, however Canoel will still face significant capital expenditures to bring its new assets on stream. Indeed, the requirement for cash has resulted in significant shareholder dilution over the past year, with a substantial number of new shares issued at low prices.

• Our valuation for Canoel continues to show the company is undervalued, albeit with some risk
  We view the company’s Italian gas assets as capable of enhancing Canoel’s revenues considerably. Assuming current probabilities for success in both Argentina and Italy, we place a base-case valuation on Canoel of C$0.27 per share, with a more optimistic valuation, given higher probabilities of success, of C$0.44 per share. Assuming success through all stages of work leading to full production, we derive a base-case valuation of C$0.31 per share, with an optimistic valuation of C$0.49 per share given higher confidences in existing reserves, resources and exploration potential.