Description

Long International Petroleum Corporation

At the current valuation, IPCO is a clear long.

A little more than a year ago, a previous write-up of IPCO was done by om730. Since then, not so much has changed, but the valuation has become even more attractive. This write-up will try to accentuate a somewhat different aspect about the company.

IPCO came into existence when the international oil and gas assets were spun-off from Lundin Petroleum in 2017. This way, Lundin Petroleum became a pure-play Norway company.

These 3 assets were a Malaysian oil field named Bertram, a few French oil fields, where the Aquitaine basin assets are co-owned with Vermillion Energy and a gas asset in Holland (which has since been sold for a nice profit on a limited reserves asset).

The most profitable of these two is the 75% owned Malaysian Bertam field (the other 25% is owned by Petronas). Bertam is a small field offshore Malaysia which went into development under the marginal field program. The field started production in 2015 with an estimated field life of between 8 and 10 years. At the time it started production, it’s reserves were estimated to be 12.5 million barrels. After 5 years of production, the reserves stand at around 7.5 million barrels. The plan here, since the operation has a pretty much fixed cost structure, is to keep production high enough to more than cover the 90 million a year in fixed costs (of which just a third is opex). They are now having a third infill drilling campaign to maintain production and to increase reserves. This new infill drilling campaign will somewhat increase production this year and thus increase the gross profit. Given this setup, I expect the field to be productive for about 5 more years, with maybe a few years of upside left, but that is more optionality. Bertam was probably their best asset, but in the long run it will be one of their lesser ones due to the limited reserve life. Still, the cash-flows from Bertam have enabled IPCO to diversify away into long reserve, low cost assets.

The second asset are the relatively low cost and long-life French oil fields. These fields in France have a pretty good track record in replacing production, and even some possible upside in the future. The fields are in general pretty large OOIP fields with relatively low decline rates (around 8%). Infill drilling, EOR, workovers and some exploration of different zones in the field have been the way they worked these fields for the past decades. Their 2 largest fields are fully owned, namely Villeperdue and Vert-La-Gravelle. In Vert-La-Gravelle there has been some recent success where horizontal wells have been drilled in a new zone of the field that came into production at more than 1000 barrels a well. Given that France is responsible for around 3000 barrels a day to IPCO (6% of total production), these wells could provide some upside in the years to come. The reserve life of this segment is around 17 years, with quite some contingent resources to extend this for at least a decade or 2. However, don’t start imagining France will become a growth engine for the company, since that would require too much capex to expand production. Besides, what is wrong with a low cost, long life base to build on, like they did since listing?

Good capital Allocation

IPCO has used the cash-flow from the above-mentioned assets to diversify away into low cost, long reserve life assets. These acquisitions were done are very good prices. And even when there were no good assets to buy, they just went out and bought back their shares at attractive prices (more on that later).

Probably IPCO’s best acquisition to date was in September 2017 when they acquired, using all debt, the Suffield asset from Cenovus Energy (a spin-off with the heavy oil assets from Encana). Cenovus had to sell their conventional assets to lower debt after their 50% acquisition of the ConocoPhillips oil sands (they owned the other 50% interest). This forced selling created a giant opportunity for IPCO

They acquired 100 million barrels of 2P reserves and 46 million barrels of 2C resources for 512 million CAD, or about 4 USD per barrel and about 18.000 USD per flowing barrel. These assets have a reserve life of at least 11 years

Suffield is a combination of conventional gas assets (about 75% of reserves) and conventional oil assets (the remaining 25%) where EOR techniques are used to increase recoveries. Since the acquisition, I estimate between 20 to 30% has already been returned to the company with free cash flow.

Cenovus neglected these assets and drilled no oil wells there in almost 3 years and no gas wells for more than 7 years. Since the acquisition by IPCO, they have drilled around 20 oil wells (which has modestly increased oil production) and have only done recompletions and swabbing of the gas wells, which sustained gas production over that 2-year period. These measures are very capital efficient and manage to maintain production and increase reserves.

To give an idea about the attractiveness of these assets. The break-even price of gas production is between 0.2 and 1.6 CAD/mscf. The breakeven price for new oil wells in these formations is around 23 USD per barrel WCS price.

There are however many more drilling opportunities left in the gas acreage, which will be developed at a time when gas prices are more favorable. But it is safe to say that IPCO will still be producing here in 10 years’ time, and very likely in 15 years as well.

In October 2018, IPCO merged with another Lundin owned listed company named BlackPearl resources, a heavy (and bituminous) Canadian oil producer. This was a nice match since BlackPearl has a really large resource base, but too little free cashflow to develop it all by themselves.

Initially, I was somewhat skeptical about this acquisition. I thought that it was a convenient way for the Lundin family to combine 2 Lundin companies. I thought the asset quality from IPCO was better than the BlackPearl asset quality. Since then these conventional heavy oil assets have proven their worth and gave IPCO some more optionality when it comes to growth while adding a large amount of reserves and resources (more than x2). Since then, I have changed my mind.

The conventional steam flooded heavy oil assets that BlackPearl owns produce oil at a breakeven CAD 27 per barrel WCS price. There is ample opportunity to expand Onion Lake (and Mooney for that matter) thermal production to 20,000 barrels per day and probably even more, but IPCO is cautious about more capex given the low oil price scenario. So given the low breakeven price, these assets have produced some meaningful FCF since the acquisition and are expected to produce FCF for many years to come.

An added bonus in the acquisition was a 800 Million barrel Contingent resource of SAGD developable Bitumen. Last year IPCO did a neighboring land acquisition to increase this resource to 1 Billion barrels. Management has given very little information of the way forward for this giant resource and is cautious and patient. I get the opinion they are just fulfilling their minimum duties to maintain these licenses and wait for the export pipeline situation and the crude price to become more reasonable again. While this can be material in the future, this is mostly an optional value going forward.

In January 2020, IPCO announced the acquisition of Granite Oil, a Canadian listed oil company. The acquisition metric of price/2P reserves is again salivating at 5.5 CAD per barrel. And I assume after a few years this deal will look even better.

With Granite Oil they are acquiring a very large conventional oilfield with almost 200 million barrels OOIP but with a low recovery factor. The oil recovery rate to date has been about 3%. The opportunity here is to increase the recovery factor using all sorts of EOR-techniques like gas injection and CO2 injection.

Granite oil was split-off from DeeThree exploration in 2015 to be a growth and dividend paying company. In the spin-off Granite was burdened with a small amount of debt and paying out almost all free cashflow in the form of dividends, they never really managed to develop this asset to its full potential.

With the acquisition of Granite by IPCO, I’m quite comfortable they will manage to develop this asset to its fullest potential but I think the market is underestimating the potential here.

Valuation

As I tried to explain above, IPCO is a combination of mostly long-life, low cost conventional fields. And since these fields are conventional, the decline rates are very acceptable and Free-cash-Flow generation is pretty impressive.

Currently they are producing close to 50,000 barrels per day. Try to find any oil company producing 50,000 barrels a day with a 17 year reserve life at an enterprise value of 750 million USD, and I will tell you, you won’t find it. Not only is this company cheap, it is also high margin. The last 2 years the after-tax margin of IPCO, after some one-offs both positive and negative, was 25%. The EBITDA margin has been between 55 and 60% over the last 3 years.

The coming 5 years, IPCO guided to keeping production flat, and producing plenty of Free-Cash-Flow because maintenance capex should be 5 dollars per barrel on average for the coming 5 years.

What will IPCO do with the cashflow?

I assume some more interesting acquisitions, more buybacks will be done and maybe they will initiate a dividend.

In November 2019 IPCO started a share buyback for 10% of its shares outstanding. The buyback is management’s response to a 65% undervaluation of IPCO to its own calculated NAV. Since then the undervaluation has widened to almost 75%. The company has already repurchased 5% of their shares outstanding during the last 4 months. More repurchases will come, whether by open market buybacks (which are limited to 10% of the public float, or 7% of shares outstanding) or by tender offer. And these buybacks are all very accretive to shareholders.

Catalyst

* Rising Oil Price

* More value-accretive acquisitions

* More buybacks

* More FCF