The Australian-headquartered oil & gas company has undergone a major transformation from starting life as an investment fund in the 1960s. Under the leadership of Terrence Fern, Petsec moved into the resource space in gold and oil & gas in the 1980s before finally setting its sights on liquids in the Middle East and North Africa (MENA) following a strategic review conducted in 2013-14.
Petsec Energy (ASX: PSA) (OTC: PSJEY) established itself as an oil and gas business with assets in the United States, principally gas production in the Gulf of Mexico. Petsec was in an enviable position prior to the global financial crisis with a market cap exceeding hundreds of millions of dollars. Following the GFC the company was forced to sell assets, while the associated US gas price crash saw Petsec’s stock price fall to around AUS$0.09 per share.
Current Petsec Energy (Middle Eastern) Limited CEO Maki Petkovski joined the company in 2015 as part of chairman and managing director Terry Fern’s strategic review. Petkovski said he joined at a turning point for the company.
“We had a series of discussions about where to next for Petsec – what was the appropriate strategy to restore Petsec’s fortunes, to return the company to its historical mid-tier capitalisation. We are aiming to become a mid-cap company again, certainly on the ASX and if possible on a global scale.”
Petkovski has vast experience in the Middle East through his previous employment at Oil Search Limited, successfully operating oil & gas projects in the region over the past 16 years. Through this experience the strategic conclusion was to focus on the Middle East where low cost/high reward opportunities could be secured.
“Firstly the decision was made to focus on the acquisition of liquids, to invest in oil assets in preference to gas reserves, and to move to onshore activity, with a particular focus on development and producing assets” Petkovski explains. “Offshore is very expensive, especially for a small-cap company and it’s risky as well, not only for geological risk but also operational risk.”
Petkovski says that the ultimate opportunity for Petsec to restore its fortunes is to build a portfolio of assets in the Middle East and North Africa (MENA) region where material opportunities are available. He said at the time that although exploration and production costs are generally the same around the world, in particular the required expertise of geologists, geophysicists, and engineers – MENA would provide unique benefits to a small cap company like Petsec.
“You want to operate in a production base where the ‘prize’, reward is significantly greater than that of some of the mature areas in the United States, such as the onshore Gulf of Mexico.
“The MENA region is still lightly explored and developed in comparison to places like the United States where it is a very mature industry and where people are now chasing unconventional targets at great expense.”
In terms of an overall glance at the oil & gas industry, Petkovski frames the industry as having three key components with associated risks, some that may be managed, others that are out of Petsec’s
Subsurface: the geological potential for accumulated hydrocarbons.
Engineering: operations; drilling, completions, facilities, installations, manufacturing.
Surface Conditions – Operational Environment: the ‘licence’ to operate; relationship with local communities; villages, tribes, towns, local and national authorities, governments.
Petsec’s strategy and approach to their operations is to assuage subsurface risk through judicious acquisition of assets that contain proven reserves with significant exploration upside while focusing their resources on improving or alleviating the associated risks of the other two elements. Petsec want to operate within areas of very limited geological risk. Petkovski says the main reason behind this strategy is that one can apply huge sums of capital to exploration, use all of the available technology to understand the rocks, the subsurface, and yet after such expenditure can still fail to find a drop of oil.
“All that money is spent to ‘have a look’, you cannot change the results, you cannot change the subsurface and that is the biggest risk in the industry from my perspective. That’s a very major risk for a small-cap company like us, with limited capital.”
The geological risk and previous operational experience was the key driver behind targeting the Yemen asset acquisitions. These assets have tested hydrocarbons and have been operational and produced oil previously. They are all onshore so do not incur the increased risks and costs associated with offshore exploration and production, and there is existing infrastructure for viable commercial operations.
The second component, engineering, is an area where Petkovski feels the assets can be improved through capital investment. He says that if Petsec put money into improving facilities or production in wells through the application of technology, for example; horizontal drilling or installing multi-completions or down-hole pumps one can expect tangible results delivering improved field performance.
The third component, operational environment, can often have the biggest impact on the value of assets, particularly the licence to operate in the host country as a consequence of relationships with local stakeholders. It is often an area that requires a modest investment in terms of capital but can yield significant gains in terms of value. There are many factors to consider when dealing with the local community, population, and local administrative authority.
“My previous experiences have given me a very good understanding of how best to operate in areas of challenging environments in respect of competing expectations between our hosts and that of a commercial enterprise. Papua New Guinea was a great proving ground where tribal expectations needed to be managed and social services were often delivered by the contractor operating in the area.
“I’ve been working in MENA for the last 17 years and that’s been a key part of doing business, ensuring we have a ‘licence’ to operate. It’s an area where you can apply modest low-cost resources to actually gain significant results, to improve the situation and de-risk projects.”
Petkovski admits that the political situation in Yemen is challenging – even though the local stakeholders are very supportive and in favour of the restart of operations.
“Local staff have been out of work for over a year because of the political situation in Yemen. We’ve been invited to come back and restart activities as soon as possible by our hosts, as soon as we are comfortable to do so. I believe we have the support of the local community, we have secured a licence to operate.”
Petkovski explains that by purchasing oil and gas fields some way through their lifecycle Petsec are mitigating most of the associated risks of the three key components.
“Most of the engineering issues have been resolved; the wells are drilled, production facilities have been built, and transport infrastructure is in place. The subsurface and engineering risk is almost zero.
“Beyond this, by applying additional capital to these assets we have the opportunity to improve productivity by reworking wells and possibly drilling some infill wells, this should increase the return on our investment.”
Petsec has put together a team with extensive local knowledge to manage the MENA operations. Alongside Petkovski there is chief operating officer Murray Hawkes who has spent 13 years working in Yemen and the region for Oil Search and the head of technical sub-surface, John Rees, who has worked in the region since the mid-90s.
By entering the MENA region through their Yemen acquisitions, Petsec are operating on a counter-cycle as other companies look to leave the country and the region. Petkovski outlines why it is such an attractive proposition.
“We recognise the geology is world class, the basins we are working in; the Shabwa and Masila Basins are world class. They contain exceptional petroleum systems that are every bit as good as any other petroleum system in the world. We are acquiring oilfields that have been discovered and have been producing and we know the potential is there.
“Realising this potential is a matter of when, when peace comes, and not a question of if there is potential. The UN and the international community is working hard with the Yemenis to find a peaceful solution to the conflict. The news that 3 million barrels of crude has been recently lifted from the Ash Shihr Terminal in the Gulf of Aden is very promising news and suggests that Yemen may be restarting production soon. With this positive activity we hope to be in production early next year, if not by year’s end.”
Petsec acquired the Block 7, Al Barqa Permit in Yemen in 2015 as their entry point in the region signalling its expansion into MENA. Al Barqa contains the undeveloped Al Meashar oil discovery made in 2010 by Oil Search and includes a number of prospects with significant oil potential ranging from 2-900MMbbls. Petsec currently hold a 35% working interest in Block 7, however, it also has an agreement with Oil Search Limited to acquire all the shares of its subsidiary Oil Search (ROY) Limited, which will take Petsec’s working interest to 75% and the company is expected to assume operational control of this asset at completion.
The primary focus in Yemen is currently on the Damis Block S-1 Permit. This is Petsec’s second asset in Yemen, acquired in February 2016, in which Petsec has a 100% working interest. Damis is situated 80km southwest of Block 7 and contains five significant oil and gas fields; firstly, there is the developed and producing An Nagyah Oilfield which has produced 24.9 million barrels of oil and has a further 22.1 million barrels of remaining 2P reserves as estimated by DeGolyer and MacNaughton Canada Limited. Further to that there are four undeveloped fields which hold ‘substantial’ oil and gas resources within the permit: Osaylan, An Naeem, Wadi Bayhan and Harmel.
“We’ve now started to focus on the re-start of production through the Marib Export Pipeline in the west of the Yemen, through the Ras Isa Terminal in the Red Sea. In addition to restarting production we are looking at opportunities to increase productivity from the existing wells which will ultimately increase recovery from the oilfield. This will dramatically improve the economics for the An Nagyah Oilfield.”
The Harmel field is the next big opportunity for Petsec, having in production in the early days of the Block S-1 evaluation by oil major Occidental. Petkovski sees an innovative way to monetise Harmel by utilising the gas in the An Naeem gas-condensate field.
“One can foresee a gas-cycling and combined gas-flooding project where gas from An Naeem is injected into Harmel, which recovers the condensate at An Naeem and also improves the recovery of liquids from Harmel, ultimately improving the economics for both An Naeem and Harmel. This would result in a significant increase to the currently recognised reserves at Harmel.”
Putting all of the factors together Petsec has made a swift transformation into a ‘sleeping giant’ on the Australian Stock Exchange according to Petkovski. He joined in March 2015 when Petsec did not have a Middle East subsidiary, there was no office in Dubai, they didn’t have Block S-1, and there were no material reserves early last year. The situation has changed dramatically since then.
“We’ve had a 3,000% increase in our 2P reserves (net), we’ve got half a billion dollars’ worth of facilities that we now operate and we’ve got over 12 million barrels of oil (gross) from at least one oilfield and significantly more if you add up all the other fields across the Damis block, waiting to be produced.”
“We don’t have any imminent exploration work to do. Our immediate investment and capital work is all about turning the ‘taps’ on at An Nagyah and looking at the engineering requirements to develop Harmel.”
The oil industry has faced a global slump in the last two years or so in terms of benchmark pricing and hence valuations have been conservative on the fear of further drops in crude pricing, the NPV10 valuation conducted by the auditors used a price deck starting at $30 per barrel for the MENA assets.
At today’s price point these valuations increase significantly. Petkovski says that if oil returns to $60-70 per barrel the NPV will easily double.
“The profitability increases dramatically when oil prices increase. Getting $70 oil could get us to the level of half a billion dollar NPV very easily,” remarks the CEO. “The reason the return on investment is significant to Petsec is that the infrastructure is already in place so there is no capex investment required by us. The largest cost to us is staffing, production costs; Opex – that is the fundamental difference between having to develop a brand new discovery, spending hundreds of millions of dollars on facilities and drilling, and our situation where none of this is required by us.”
Looking forward Petkovski is very positive about having the opportunity to provide local jobs and contracts to local suppliers. He wants to show Petsec to be a part of the local community and to be seen as a company that is contributing to their host countries, not solely profiting from them.
“We would like to work with as many Yemenis and Yemini companies, sub-contractors, and service providers as possible. We see ourselves partnering with local industry, the local community, the local population. It is a key aspect of how we do business globally, not only in Yemen.
“We would like to be viewed as a company utilising local resources as much as possible. We are looking to invest in the region and with our investments we look forward to utilising the local expertise and hopefully further developing that knowledge and expertise.”
Yemen is the starting point for Petsec in the MENA region because of the existing level of experience, knowledge and friends the management team have in the area. Petkovski says the company is looking at other nations in MENA and hopes to expand out of Yemen in the ‘near future’.