Macro Tsimmis

intelligently hedged investment

BUY Transmeridian (TMY)—black gold in Kazakhstan

Posted by intelledgement on Wed, 03 Jan 07

We making Transmeridian Exploration (TMY) our inaugural investment in our speculative portfolio. TMY’s cardinal asset is their license to develop Kazakhstan’s South Alibek field. There are 72.9MM BBLS of proven reserves there, and TMY has a market cap of $322MM, which means that the company’s oil is being valued at $4.42/barrel…a more reasonable valuation with the price of oil around $60/barrel would be between $10 and $15/barrel. How can this be?

The main problem is that it doesn’t seem to be that easy to get the oil out of the ground. The Soviets drilled a couple of dozen exploratory wells back when Kazakhstan was part of the USSR but never found anything compelling enough to develop immediately. More to the point, TMY have been trying for several years to pump just a few thousand barrels a day and failing. The geology is apparently quite challenging, and consequently, it seems likely that the field may not have been economic back in the days of $10 and $20 oil.

TMY need to produce at least 4000 bpd to breakeven on operations, and 6000-to-8000 bpd to be able to service their considerable debt and continue their drilling program. (They have developed only 8% of their proven reserves, so drilling more holes is most definitely a necessity.) In 2005, they only produced 1100 bpd, but as most of that was being sold to the Kazakhstani government at $8/barrel, investors did not fret much over the lost production. We are expecting production for 2006 to at least double to north of 2000 bpd, and for income to improve even more with a significant portion of that production now reaching the world market (we will know for sure when TMY release their 4Q06 results in March).

But 2007 could be the year that Transmeridian achieve a breakthrough. There are currently a record six drilling rigs either creating new holes or (hopefully) improving production from existing wells. We anticipate that production should attain 4000 bdp by the end of 1Q07, and exceed that level in 2Q07. In addition, we expect in 2007 that the company should be able to transport their oil via pipeline instead of truck/rail, thus cutting expenses, and that with the completion of their storage facility by mid-year, they should be able to sell all production on the world market (lack of storage forced them to sell a significant proportion into the local market at steep discounts in 2006). If they can ratchet production up to the 6000-to-8000 bpd range, they should be able to service their debt and afford additional drilling without the need to raise additional capital (which would require issuing more stock thus diluting the value of the stock already out there, obviously an undesirable result for current shareholders).

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