Macro Tsimmis

intelligently hedged investment

BUY BPZ Resources (BZP)

Posted by intelledgement on Mon, 19 Nov 07

We have been watching this stock closely since mid-summer, hoping for a pullback, and today’s announcement of a potentially dilutive shelf registration has done the trick, with shares selling below $10 for the first time in a month. (Of course, we would have been better off buying it right away in August in the fives, but hindsight is always 20-20.)

BPZ Resources is a Texas-based late early-stage E&P, who have been methodically developing properties in Peru for the last six years. BPZ Resources was formed in 2001 by the principals of the former energy consulting firm, BPZ & Associates. BZP president/CEO Manuel Pablo Zúñiga Pflücker—the “Z” in BPZ & Associates—has spent the past 20 years in the international oil and gas business, and has been involved in projects throughout Latin America and other areas of the world ranging from exploitation of marginal oil and gas fields to frontier exploration projects. His father and chairman of the BPZ Resources board of directors, Dr. Fernando Zúñiga y Rivero, was Energy Division project officer of The World Bank, where he planned and implemented exploration promotion projects in 58 countries, ranging from East and West Africa, Eastern Europe and Southeast Asia to Latin America, from 1979 to 1996. Dr. Zúñiga y Rivero has fifty years of experience in the international energy industry starting as an exploration geologist, biostratigrapher, and exploration head of an Exxon affiliate in Peru and continuing as exploration production manager, integrated operations manager, general manager, and ultimately serving as Chairman and CEO of Petróleos del Peru, the national oil company of Peru. So these guys know as much or more about the oil business in Peru as anyone alive and they are also well-connected. And insider stock ownership is running about 20% so the interests of these really smart, knowledgeable, and connected folks are well aligned with ours.

So, what have these smart guys put together for us? Oodles of potentially good stuff, and a substantial dollop of potentially great stuff, as it happens. The company holds licenses to explore and produce oil and natural gas over 1.7 million acres of Peru (on shore) plus another 700 thousand acres offshore within Peruvian national water. For the most part, these are properties previously licensed to large oil companies which are known to have oil and gas but were not economical to develop at then-current prices.

BZP signed a contract for their offshore acreage, known as Block Z-1, in November 2001. Tenneco and Belco Oil & Gas drilled 18 wells within this property in the 70s and 80s. They were looking for oil but found mostly natural gas; as there was no market for NG at the time, they gave up. BZP acquired four offshore platforms constructed by Tenneco and Belco in connection with its Block Z-1 property, and completed the refurbishment of one of the offshore platforms—CX-11 in the Corvina field—and intends to maintain all of the platforms for use throughout the life of the Block Z-1 contract. These platforms revert back to the Government of Peru at the end of the contract, provided they are in good working condition, with no further obligation to BZP to dismantle or remove them. To date, BZP have drilled three wells, all near CX-11, two of which appear to be capable of producing both natural gas and oil in commercially viable quantities and the third of which appears viable as a NG producer. The Block Z-1 contract runs up to 30 years for oil and 40 years for NG.

The company signed a second contract for Block XIX (500 thousand acres) in December 2003. If their exploration efforts are successful, this contract can also be extended for up to 30 years for oil and 40 years for natural gas. Earlier this year, the company completed shooting 200 kilometers of 2-D seismic in Block XIX. Based on the results of the 2-D seismic survey and in order to comply with the requirements under the next phase of the license contract, BZP expect to begin drilling operations (one well) in Block XIX in late 2008.

BZP expect to sign two more contracts for, respectively, Block XXII (900 thousand acres) and Block XXIII (200 thousand acres) later this month

The company’s master plan is to finance the development of the natural gas in Block Z-1 and construction of a NG-fired power plant (160 megawatts) to sell electricity, primarily to Peru and, secondarily, to Ecuador. Peru has growing demand for electricity and is primarily dependent on hydropower, which supply vulnerable is vulnerable to the vagaries of the weather. Supplemental power generation is currently supplied by diesel- or fuel oil-fired plants, which are much more expensive than natural gas would be. The power plant is to be financed with a $160MM loan from the International Finance Corporation, which is a The World Bank member—thank you, Dr. Zúñiga y Rivero—and owns 9% of BZP. The plant will be constructed at Nueva Esparanza near a substation with transmission capability to both Peru and Ecuador (180 megawatts each), so the output of the BZP plant could theoretically be doubled—and there is room to do this—should demand warrant it. At 160 megawatts, the plant will need 14 bcf of NG/year—which, easily transported from BZP’s nearby fields—a ten-mile pipeline from the CX-11 platform to the power plant is on the drawing boards—would enable the plant to be profitable presuming 80%+ utilization.

This plan is good, but things got complicated (and potentially great) a year ago when the first well spudded at Corvina (21XD) in pursuit of the natural gas everyone knew was there surprisingly produced 6000 BBLS/day of oil! (In addition to the 60MM cf/day of NG that was expected, that is.) Apparently the Tenneco and Belco folks missed something.

At this point, the company has not published any proven reserves estimates. However, that is likely to change in 2008 as production from Corvina (Block Z-1) ramps up and drilling starts in Block XIX. There is now no doubt that the properties contain oil and natural gas, but at this point, how much is commercially obtainable is anybody’s guess. But with respect to guesses about Peruvian geology as it relates to energy matters, putting our money on Zúñiga Pflücker and his troops seems like a good bet.

The savvy management here reminds us of another of our speculative early-stage E&P plays, BQI. And, as with BQI, BPZ Resources has yet to book their first dollar of revenue. However, that is about to change: last month, the company leased two tankers from the Peruvian navy and expects to begin selling 2500 BBLS/day as early as this month (ahead of the originally planned early-2008).

The immediate prospect of revenue begs the question of taxes. Virtually all of BZP’s eggs are in the Peruvian basket (there is one small project in Ecuador where the company has a 10% non-working interest). The government in Peru has been reasonably stable by Latin American standards for the last quarter century. In 2006, Alan Garcia was elected president and—benefiting from the experience of his tumultuous pre-Fujimoro first term—has so far proven to be a mainstream moderate (which in Latin America is to say, left of center but pro-trade). As things stand now, Peru’s taxes on prospective oil and natural gas sales by BZP would be relatively moderate compared to many other countries.

Peru stands to benefit significantly by virtue of the work BPZ Resources has undertaken. First, of course, there is the prospect of cheaper, reliable electricity. Also, Peru is a net importer of oil and insofar as BZP develop internal resources and cut into that outflow of funds, it’s all good.

Again, as with BQI, one major shareholder concern is dilution. The development of these properties is going to take a lot of money, and while the company’s debt levels are low and they should be able to borrow some of the needed funds, no doubt there will be additional sales of stock. As of 30 September, dilution over the trailing twelve months amounted to 25%…and that was before this latest shelf registration. So this remains an area to watch. The good news is that management are in the same boat we are, as shareholders, so they have a big incentive to watch out for our mutual interests.

Bottom line: BPZ Resources, a seller in a seller’s market, appear to be a $600MM company on the road to becoming a $3B+ company a few years down the road. A solid, macro-consistent play.


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