Bahamas Petroleum - Brief Respite

http://www.bpcplc.com/


Bahamas Petroleum (LSE:BPC) has rallied in recent days after investors took kindly to a couple of high-profile director appointments. Starting from lows around 1.50p it was not surprising to see the recovery be both swift and exaggerated, as investors sought to profit from the move off historic lows. However, the fundamental picture at Bahamas Petroleum ('Bahamas') remains very unclear, and there is the risk of a reversal as hot money flows out of the company. Bahamas is currently trading at 3.78p, and with 1.23 billion shares in issue, the company is valued at £46.45m. This is comfortably below previous valuations, but I reckon this valuation is too high, and the previous decline in the share price over the start of the year probably more accurately reflects the general market sentiment towards the group. The recent rally simply looks to be a brief respite.


The technical position of Bahamas epitomises why I reckon the recent rise is no more than a brief respite. It has come on the back of months of rapid downtrend, over which time the shares more than halved. That halving was on the back of a lack of operational progress, a negative operational update, and a major technical breakdown of the 4p level. The rise from 1.5p has been exaggerated because of the steepness of the prior downtrend as investors saw the share price as 'cheap' and as an opportunity to buy the shares at a large discount to levels at which the share price has traded during 2013. The rise has therefore comfortably exceeded 100%, when the actual news itself probably didn't warrant a rise of that magnitude. The shares have now risen into overbought levels, and the rise has been halted by substantial resistance at 4p. That resistance was formed by the 200-day moving average, which is declining, and round-number resistance. On a side note, the company is working on a Bahamian securities exchange listing in order to boost its regional credibility. Many investors point out that Bahamas was trading at nearly 25p a few years back. Whilst that is true, the oil and gas market was in a complete bubble at the time, and the share price was driven up to those levels on the back of a placing, and 2D seismic results - that simply would not happen nowadays. Sentiment has changed.

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The shareholding structure of Bahamas is pretty simple. TD Waterhouse, Hargreaves Lansdown and numerous other stockbrokers hold roughly a third of the total shares in issue, whilst Majedie and HSBC hold a further ~6% between them. The board of directors have a disappointingly low uptake of shares with CEO Simon Potter only holding 0.08% of the total shares in issue. At current prices that translates into ~£38,000 worth of shares. Most of the board's shares were acquired back in Q2 2012 - the only relatively recent buy was in September 2013 when a non-executive director purchased 200,000 shares at just over 4.5p. A lack of board backing is often a bad sign in oil and gas companies, but that is made worse when you compare CEO Simon Potter's salary to that lack of backing.

Admittedly, he performed well at Hardman Resources after directing the company to a takeover by Tullow Oil at historic highs almost 4 times the lows, but that does mean that he is likely to have large personal cash holdings. Presiding over a share price fall in 2012, he took home a basic salary of $1 million and $121k in pension benefits plus charged $301,000 in local housing and travel costs to the company. The basic salary itself is extortionately high, especially in relation to the company's size and performance and combined with the lack of equity interest does lead investors to question where his motivations lie. This is a side issue in the grand scheme of the company, but it does raise the question - how can such a high salary be justified?

As per the name, Bahamas is an oil and gas exploration company in the Bahamas, which is a massive group of islands located South of Florida and North of Cuba. The company has 5 primary offshore licences within Bahamian waters, 1 to the North (Miami) and 4 to the South (Bain, Cooper, Donaldson and Eneas). Each of these is 100% owned by the company. Bahamas also has a series of applications elsewhere in the country albeit these are in their early stages. In this sense, the company is a very one-dimensional play and is exposed to the inherent geographic and political risks. The former include the hurricane season, which spans the third and fourth quarters of each year. Of course, that does not mean that there will be a hurricane that affects the country each year, but drilling is scheduled around that season as a precaution.

The company has already had a dose of the political risks involved. The Bahamian oil and gas legislation is out of date and the government has been planning to re-evaluate the laws. That has caused delays for the company, albeit a half-solution was found. The referendum on the oil and gas laws is being postponed until the company has completed its first exploration well. Whilst that hardly provides comfort for Bahamas, it's an improvement on a straight delay or worse. The government would ultimately benefit from an oil discovery, and probably welcome it given that they would take away between 12.5% and 25% in royalties, but they are being careful to manage it against their other objectives. One of those objectives is to safeguard the environment in and around the Bahamas, as the tourism industry is a major economic driver. Aside from those points, the country has attractive taxation levels as there is 0% income tax, corporation tax, capital gains tax, wealth tax and VAT.

Looking back at the asset, the main activity is being undertaken in the four southern licences. Both 2D and 3D seismic has been collected across a section of the four licences and an independent Competent Person's Report (CPR) has led to "Multiple billion barrel [oil] potential" being talked about. Whilst the CPR was only based on the lower quality 2D seismic, it gives multiple prospects with recoverable resources of over 1 billion barrels. The chances of success (COS) range from 9% to 35% across the inventory, which is poor at the lower end, to excellent at the higher end. Of course though, the COS does not account for commerciality (which is linked to flow rates).

It's perhaps a little surprising to see that a further CPR has not been commissioned after the integration of the 3D seismic. After all, the CPR based on the 2D seismic commented that the 2D data set 'worsens noticeably' below the top cretaceous horizon. In other words, there is probably still material uncertainty as to the geological structure of the deeper horizons, and that can only be cleared up through drilling. Positively, the seal potential of some areas within the four licence areas are enhanced by a mudstone cap. It's important to recognise that any drill within these licences can only be considered to be very high risk, despite what the COS says. Yes, extensive technical analysis has been done over the key areas, but only a real up-to-date well can validate the geological model.

The licence play is looking for an extension of the lucrative North Cuban oil system, which has producing wells within it. Combined with a series of nearby oil shows (albeit not commercial), there is plenty of evidence to suggest that there is a working oil mechanism within the region - the question is whether it lies within Bahamas' licences, and if its in commercial quantities. That will be dependent upon the presence and quality of a capable source rock. The company does have one well to work off - that well is called Doubloon Saxon-1, and was the last well drilled in the Bahamas, back in 1986. The well was drilled in the Southern part of the Donaldson licence. Unfortunately, the well was unsuccessful in that the drill stem tests returned formation water as opposed to hydrocarbons. The overall porosity of the rock observed was of mixed quality with an average of just 4% -> 6%.

There has however, been recent drilling further away from the licence in the North Cuban basin. That well has also been unsuccessful to date as the well encountered mechanical plus geological issues and is currently suspended at a depth of around 2000 metres.

So what's the deal with Bahamas Petroleum - It has huge upside potential (albeit very high risk and the figures are largely irrelevant)? That is true, except that the real risks are inherent in the business model. The company is obliged to commence drilling a well by April 2015. That well is estimated to cost a massive $120m, will take 120 days to drill and will be drilled to a depth of ~6,860m. Therein lies the issue. The company cannot fund the drill, let alone a minority share of it, plus there is a moderate risk of the drill running into technical issues given the length of the drill plus the drill depth. With a cost of roughly $1m a day, that's simply a huge risk for any company to adhere to. Yet, the potential resources are supposedly mouth-watering and that is the attraction.

The problem is that the company only had circa $15m in cash at year-end. Subtract cash burn, and the company is probably down to around £8m in cash. That would only be sufficient to fund a working interest of approximately 11% and even that would be severely uncomfortable given that Bahamas would then require cash for administrative expenses, and there is no leeway in the case of cost overruns. Of course the company have realised this, and have been pursuing a farm-out agreement with a larger partner for a period of time - that process has taken years and has not reached a conclusion. Unfortunately that says a lot about the asset itself. Admittedly more geophysical studies and work has been done on the asset (to the tune of $50m), and various political barriers have been removed, but if the company has failed to farm-out for that period of time then it really does call into question the risk/reward profile of any drill. Add in the time constraint on the drill spudding, the fact that the company has not fully received drilling clearance from the government, and the political environment itself, I can't see the overwhelming attraction of farming-in. It's essentially extremely high risk (in more dimensions that one) and that is why the share price has slumped over the past year.

The fact that the government have suspended the referendum until the exploration is completed hardly provides comfort, as the parties involved could still be liable to experience a drastic change in legislation post-drilling. That creates uncertainty, and that uncertainty is a deterrent. If you are an oil company evaluating farm-in prospects, why would you choose Bahamas Petroleum's prospect over any other in the world? The potential partners don't have oil operations in the Bahamas, so there's a geographic disconnect, plus the political risks are very real, so why take the risk? The answer simply lies in the huge potential resources. One company, or a handful, may be tempted to take a gamble on the huge potential upside on the premise that the rewards in the event of success greatly cover the risks in the event of failure. That is true, but the sheer cost of the well closes the door on smaller companies so it's essentially down to companies who have cash to risk (i.e. the £2 billion+ companies).

The next point is to be realistic about what sort of farm-out can be achieved. Towards the smaller end of the larger companies, perhaps a farm-out involving 1-2 other parties is the way forward given that then not one company is forced to adhere to too much financial risk, yet the upside remains in place. The problem with that is you then get have to decide who will be operator, and how the funding structure is derived. Let's consider the case where the asset is only farmed out to one party. Ultimately, Bahamas Petroleum needs to be fully carried for its first well. It cannot afford to sacrifice the cash it has on its balance sheet, as it would then require a working capital fundraising. However, if it needs to be fully funded, it will need to give away a majority stake of the licences (probably 60%+). In the case of success, Bahamas benefits massively. In the case of failure (which is more likely), the company has lost a large proportion of its asset, plus would be required to fund the following well, which needs to be spudded by April 2017.

Essentially, there is no easy answer, and any investment in Bahamas is very one-dimensional - there is no asset to fall back upon. That means the company is exceptionally high risk, and there is a severe funding issue. Why would a company want to fully fund Bahamas Petroleum when Bahamas is in a poor financial state? It was not long ago that the share price was at 1.5p, and the market cap £18.5m. That's an extremely weak negotiating position to work from. If the company is going to be fully funded, then the farm-in partner(s) would be required to stump up the full £71.4m cost of the well. In such a scenario, it makes zero sense to farm-in and complete sense to simply buy out Bahamas and take the 100% equity stake. But that won't happen because Bahamas' assets are too high risk politically, environmentally and geologically (as it stands).

On the other hand, if a company does farm-in but refuses to carry Bahamas, then it's an equally poor scenario. Why? Because the farm-in company would not want to commit to a drill programme when it knows that BPC will struggle to fund its own stake. In such a scenario, there simply would not be a farm-out. The problem is clearly deep-rooted and there is unlikely to be an easy answer. The best case for shareholders in the short-run would be to take a free carry and bet on success, but it is just that, a bet with the odds stacked against Bahamas. The risks are such that a two-well carry is almost certainly out of the picture as a company is unlikely to want to risk drilling before the new oil and gas legislation is created. That risk would be easier to take if the well cost was substantially lower - a £71.4m cost will deter many companies. I think it's justified to be sceptical over: a) whether a farm-out deal will be completed, but especially, b) whether the farm-out deal will be attractive for shareholders.

Just as a further point, whilst appreciating that many hurdles have been removed with respect to the farm-out, the same statements seem to be coming from the company every time. Indeed, the company has been commenting about a farm-out of one variety or another since late 2011.

April 2012: "Bahamas Petroleum Company continues to seek third-party farminees to share the costs of future exploration activities and remains in active negotiations with a number of companies. As these negotiations remain commercial in confidence, no update or announcement is anticipated until a successful outcome has been achieved, nominally expected in the summer of 2012."
September 2012: The Company opened a data room for May and has received a number of offers to farm into its licences, none of which have been accepted. Farm-out discussions remain on-going with a number of interested parties with this recent communication from the Government providing additional clarity for potential farm-in partners."
March 2013: "Farm-out discussions remain on-going with a number of interested parties and this clarification of the consultation process provides significant impetus and clarity for potential farm-in partners."
April 2013: "This recent clarification of the exploration process and timetable has already re-energised farm-in negotiations which hitherto have suffered from these commercial uncertainties notwithstanding the significant interest expressed by numerous parties over the Company's technical prospects. The farm-in process is live, active and on-going."
August 2013: "Now armed with clear direction associated with the renewal of the licences, strengthening of regulations, and the amendment to the previously proposed referendum, the Company has a clear mandate to proceed with exploration drilling by 2015. This clarification gives BPC further impetus to focus on the ongoing farm out process and bolsters the commercial basis for discussions with a significant number of potential farm-in partners."
April 2014: "The Board changes come at a time when the Company is seeing increased activity in its data room as part of ongoing farm-out discussions."

As noted earlier, aside from the core 4 southern licences, the company had a number of applications. Some of these were part of a joint licence development agreement with Statoil. In January, Statoil exited that agreement and the licences reverted back to Bahamas Petroleum. The loss of such a highly credible and heavily financially backed company such as Statoil is a major loss and hints that they have bigger fish to fry. The company attempted to put a positive spin on the development talking about a higher working interest being more attractive to other companies, but ultimately that is a side point. Statoil is one of the mostly highly respected companies in the oil and gas space, so to expect a better result is probably misplaced. Moreover, it perhaps says more about their stance on the Bahamian oil and gas industry.

The one ray of light was shone to investors in April when the company announced two high-profile appointments. Firstly, Bill Schrader joined the board as a non-executive Chairman. Bill was formed COO of TNK-BP and is a non-executive director of Hess Corporation and London listed Ophir Energy. All of these past jobs surely provide Bill with extensive industry connections. In addition, it suggests that Bahamas does have a future ahead of it. On the other hand, this is simple a management appointment, and that is unlikely to cause a company to pursue a farm-out. A company pursues a farm-out on the basis of the asset, and this appointment does little to alleviate the risks. The second appointment was James Smith who has had numerous reputable roles within the Bahamian government. Despite the good credentials of the duo, it probably should not have had the impact of more than doubling the share price and the market cap rising to over £45m. Bear in mind that the short update on the farm-out (as noted earlier) was likely only an attempt to arrest the share price fall given that it added nothing material to previous comments.

As followers of the site will know, I rarely put out sell tags and only do if the company reviewed offers a poor risk/reward rating over the chosen timeframe. The timeframe with Bahamas is 0-2 months, over which I would expect the share price to drop back considerably. The shares have risen on little real premise - admittedly the management appointments look promising, but the underlying condition of the company still looks relatively weak, and that is unlikely to change in the very short-term. There are a lot of questions that need to be answered, and until those are, a market cap of almost £50m looks unjustified, and the market looks to have been right to walk the shares down during Q1, albeit perhaps 1.5p was too low.

Sentiment within the exploration oil and gas market remains weak, with the exception of a couple of cases, which include Tower Resources (LSE:TRP). Tower Resource does prove that investor appetite is there, should funding be sorted and the well, set into motion. Unfortunately, Bahamas' investment proposition remains weak. There is yet to be a farm-out, and the risks of the company's fundamental assets will probably inhibit value creation for shareholders. In the case that the asset is farmed-out, Bahamas will lose a large chunk of its working interest and become a binary bet on the result of one well. On that premise, the fact that operational progress has been slow, and the fact that investing into new Bahamian oil ventures is probably unattractive (at the moment), means that the company still faces a tricky 2014 in convincing a farm-in partner to take the risk. The odds of success are currently stacked against Bahamas Petroleum. I have therefore attached a Sell tag to BPC at 3.78p.

UPDATE (06/08/14) - I have moved Bahamas Petroleum from Sell to No Rating at 2.15p after a significant 43% decline from the original call price. 2p has acted as support in the interim so I have removed it as part of additional portfolio management

16 comments:

  1. I will sit on the fence with Bahamas Petroleum COmpany. I am not 100% sure its a sell but I will write another comment on Wednesday next week so we can see how it has done :)

    CraigJ

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  2. 'Bahamas which is an island' Semantics I know but Bahamas comprises several hundred islands. Otherwise a great bit of work as usual Elite.

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    1. Good point - duly changed. Thanks

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  3. Hi El1te,

    This article is spot on and like so many other oil companies this one is washing shareholder money down the drain. There is no reason why such a CEO should get such a stupidly high payout. Seems like a lifestyle company.

    Solooiler

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  4. Amid all the ramping on bulletin boards, i think this is a very truthful assessment of the real Bahamas Petroleum (BPC) situation. I encourage everyone to understand the company and its problems. God only knows why SP was paid so much. it is an outrage

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    1. The ii board is especially awash with inane comments and 'analysis' this evening, though admittedly from the faithful.

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  5. Possibly the most comprehensive and well-considered article on the situation that I have read in my years of tracking BPC.

    (Dubed)

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  6. Just shows what can happen to the price here. Global economic recovery should see a strengthening oil price and a move back towards risk on investing in O&G. The farm in news should make the recent rise look minor in comparison.

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    1. Interesting to note that the company was in active negotiations on April 2012, now downgraded to 'on-going' discussions - sounds a weakening of the prospect of a farm-in?

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  7. I suppose those active negotiations are ongoing. Not something to get silly about with semantics.

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    1. My experience is that it's to read and understand very carefully what words a company uses in its investor communications. Do we know who the company was in negotiations with in April 2012 and where these got to?

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    2. My experience is pretty substantial as well especially in the oil industry

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    3. So, do you know why the negotiations failed, or else are taking so long to conclude? Which company were they negotiating with 2012? Is this the same company?

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  8. It seems rather convenient for a lone blogger/trader like El1te to suddenly post up his views now after months of a falling price and based on past delays. Tell us something we didn't know on that subject. The new additions to the board would also have known that and better placed for where the company's going.

    You don't get quality personnel like that unless something big was in the immediate pipeline.

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  9. Some mug called Yoda thinks it costs $500k a day to drill when the company's own documents from April say $1m a day. LOL

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