Sculpin now covering MMT with a target of $2.50
(Thanks to OJ on IV)
Breaking New Ground In Nigerian
Marginal Fields
We are initiating coverage on Mart Resources Inc. with an
Outperform rating and a one-year target price of $2.50.
Our investment thesis is based on the following:
• Low-exploration risk, operating a marginal field in
Nigeria with long-established discovery and proven
reserves.
• Local knowledge and expertise, with the CEO of the
company having long involvement in the west African
oil and gas industry; strong local partnerships and a
competent on-the-ground team provide operational
and regulatory advantage.
• Adequately financed with ~$50.0 million in cash
currently and large operating cashflow, Mart is well
positioned to continue its dividend payment and
continue its current capital program.
• Significant growth opportunity resulting from
completed and upcoming development drilling, as well
as facilities and pipeline upgrades. Further growth is
expected from stepped-out exploration drilling and the
acquisition of new marginal fields.
Valuation
We are initiating coverage on Mart Resources Inc. with an
Outperform rating and a one-year target price of $2.50.
This target price is derived by calculating the company’s
risked NAV and implies a 3.8x 2013E cashflow and
$64,389 per 2013E flowing bbl. If achieved, this target
price would provide an attractive 50% total return
including an 11% dividend yield.
Conclusion
Mart has developed an effective strategy to manage
Nigeria-specific risks. The company has taken full
advantage of the favorable conditions by growing
production, cashflow and reserves in the past two years.
Mart is one of the highest dividend paying stocks among
the junior oil and gas companies.
Executive Summary
Mart Resources is a TSX Venture-listed oil and gas company with assets in Nigeria.
Although Nigeria evokes a perception of heightened geopolitical and operational risk,
Mart has developed an effective strategy to manage Nigeria-specific risks.
Mart currently produces over 12,000 bbl of light crude from a marginal field in Nigeria
jointly operated with local partners. The following attributes make Mart an attractive
investment as an international E&P company:
• Mart has close to 18.0 mm bbl of proved and probable reserve supported by an
independent evaluation by RPS Energy Canada Ltd.
• There is a potential for substantial reserve growth from exploration drilling in the
extensions of the currently producing field;
• Significant near-term growth in production with the availability of alternative
pipeline system;
• Further growth opportunity through new partnership for other marginal fields and
through acquisition of assets divested by majors
• Good working relationship with Nigerian partners and local communities, resulting
in an effective marginal field operation;
• Established infrastructure and access to two of the five Nigerian crude export
terminals;
• Capable management with a broad experience in Nigeria dating back over two
decades;
• Realizes Brass river pricing, which is slightly higher than Brent;
• Over 11% dividend yield; a strong commitment by management to return capital to
shareholders.
Assets
Since inception, Mart held interests in four marginal fields in Nigeria with various
partners. Over the years, Mart gave up its interests in two fields in order to focus on
the Umusadege field.
Acquisition of oil and gas interests
Mart’s initial foray into West Africa started in 2003 with the pursuit of oil and gas
interests in the DRC and in Nigeria. Mart later discontinued its activities in the DRC.
Mart stepped into Nigeria in 2003 by acquiring a 100% interest in Oil Prospecting
License 310 (OPL 310), located offshore Nigeria. The interest was acquired through a
joint venture agreement with Optimum Petroleum Development Limited, a Nigerian
company. The license expired in 2004.
In between 2004 and 2006, Mart significantly stepped up its activities in Nigeria by
acquiring rights to participate in the development of three marginal fields in Nigeria. To
that effect, Mart entered into agreements with local Nigerian companies that were
initially awarded the operatorship of the marginal fields:
• Umusadege field with Midwestern Oil and Gas and Suntrust Oil;
• Eremor field with Excel Exploration and Production Company; and
• Qua Ibo with Network Exploration and Production
In 2006, Mart entered into another agreement for the joint development of the Ke
marginal field with Del-Sigma Petroleum. Between 2009 and 2012, Mart terminated its
rights to the Ke, Eremor and Qua Ibo fields and focused exclusively on the
development of the Umusadege field. Currently Umusadege is Mart’s only oil and gas
asset.
Umusadege field
The Umusadge field was discovered in 1974. Three wells were drilled and cased in the
field between 1974 and 1980. A 3D seismic survey covering the field was acquired in
the early 1990s. The field is a multiple-horizon hydrocarbon reservoir situated in the
north central part of the Niger Delta basin. It covers a 3,771-acre area and contains 16
known reservoirs. Originally permitted to Elf Petroleum Nigeria as part of a larger
concession, it was later farmed out as part of Nigeria’s Marginal Field Program to two
indigenous companies, Midwestern Oil and Gas and Suntrust Oil (at a 70:30 ratio).
These two companies are Mart’s joint venture (JV) partners for the field.
Although the marginal field was awarded in 2003, final development approval was not
received until 2006.
Service agreements with partners
Mart entered into a Finance and Production Sharing Agreement (FPSA) with the
Umusadege field JV partners in 2006. Under the agreement, Mart would contribute to
developing the field by providing 100% funding, operational and technical assistance
and receive an allocation of the oil produced from the field. The allocation followed a
sliding scale allowing an accelerated repayment of costs and moving to a stepped
down schedule after cost recovery. Under the original terms of the FPSA, Mart was
entitled to receive up to 97.5% of the production revenues remaining after deduction of
royalties, income taxes, community development contributions, operating costs and
abandonment obligations during the cost recovery phase.
In 2010, Mart and its partners revised the FPSA and entered into a Risk Service
Agreement (RSA). Under the RSA, the recovery rate was restricted to a maximum of
82.5% from October 2010. Once Mart recovers all of its capital costs, production
revenue after expenses are shared 50% to Mart and 50% to its partners. As the field is
constantly under various degrees of development, Mart’s share of the production
revenue varies between 50% and 82.5%.
Reserves
Mart’s entitlement of the reserves in the Umusadege field is based upon its right to
participate in the development of the field, guaranteed by the RSA. Although Mart
publishes annual NI 51-101 reports at the end of financial year, it published a special
reserve report (prepared by RPS Energy Canada Ltd.) as of the first quarter of 2012 to
reflect an extension of the field and a new pool discovery. In the last three years, Mart
has increased its reserves by 26% annually.
Field development
A total of 10 wells have been drilled on the Umusadege field at a depth between 8,000
to 12,000 feet. Six of these wells are currently producing. The first well drilled in the
Umusadege Field was Umusadege #1 (Umu-1), drilled in 1974. It encountered oil pay
in 13 zones between 6,520 feet and 8,000 feet. Umu-1 was followed by two other
wells. Umusadege #N1 well (Umu-2) produced water and Umusadege #N2 well
(Umu-3) identified two additional deep hydrocarbon zones. After forming a joint
venture, Mart and its partners reentered two old wells and drilled seven new wells. A
number of other development and exploration wells are planned for 2012 and 2013.
Producing wells
Umu-4 well was drilled in December 2006 to a total depth of 8,818 feet. Light oil of
38-44° API was recovered from three good quality sandstone reservoirs, encountered
between 7,730 feet and 8,276 feet. This well is suspended for possible future use.
Umu-1 well was reentered in June 2007 and tested two of the 13 oil bearing sands.
These two zones flowed light oil (~40° API) at ~3,000 bpd each. This well has been
continuously producing since April 2008 with minor decline.
Umu-3 well was reentered and tested in November 2007. The well flowed light oil at
~1,000 bpd. This well with high gas/oil ratio (GOR) is currently suspended.
Umu-5 well was drilled as a twin well to Umu-1 in March 2009 to produce from two
zones encountered by Umu-1. The well tested these two zones and flowed light oil
(~48° API) at 3,200 bpd and 725 bpd, respectively. The well has been continuously
producing since April 2009.
Umu-6 well was drilled from a multi-well pad (for Umu-6, 7 and 8) between September
and October 2010. It was drilled to 9,000 feet targeting formations deeper than
previously intersected. The well tested at four different zones with initial flow rates of
3,100, 3,400, 4,200 and 3,600 bpd of ~40° API oil. This well has been continuously
producing since December 2010.
Umu-7 well was drilled in February-March 2011 to a depth of 8,700 feet targeting the
sands first intersected by Umu-6. The well tested at four different zones with initial flow
rates of 2,450, 2,600, 4,000 and 1,240 bpd of ~40° API oil. This well has been
continuously producing since May 2011.
Umu-8 well was drilled in June-July 2011 to a depth of 8,600. The well was tested at
four different zones with combined flow rate of 7,661 bpd. The well has been
continuously producing since October 2011.
the Umusadege field production. All three wells tested successfully at multiple zones.
In order to maximize production, these wells were completed using dual tubing
completion technology, thus allowing production from two zones at a time without
commingling production.
Umu-9 well was drilled in November-December 2011 as the first well drilled on the
eastern extension of the Umusadege field. Umu-9 was a very successful well as it
confirmed an eastern extension of the field. With a deviated section extending to a
subsurface location one kilometer east of the UMU-6, 7 and 8 wells, it appraised the
extension of the zones discovered by existing wells. Drilled vertically to a depth of
8,300 feet and in a deviated section to 10,848 feet, the well resulted in 430 feet of
gross pay in 20 sands. The well encountered six new sands not intersected by existing
wells. Five sands tested in this well produced at a combined flow rate of 11,718 bpd.
Umu-10 well was drilled from July-October 2012 from the same pad as Umu-9. Drilled
to a total depth of 9,700 feet, the well targeted the five new zones identified in the
deeper section of the Umu-9 well. Up to four of these sands could be completed in
UMU-10. This well is currently undergoing well logging, pressure surveys on
prospective zones and acquisition of fluid samples.
Completion of multiple zones with dual tubing
Starting with Umu-6, all new wells in the Umusadege field have been completed in
multiple zones using dual tubing (3 1/2 inch and 2 7/8 inch) with sliding sleeves. In
addition, some wells were completed by comingling zones to maximize production
from multiple oil bearing zones. While this completion method may not be the most
optimum method for faster drainage, it allows simultaneous production from multiple
zones and allows move to a higher zone when a lower zone waters out, Success of
this method indicates the potential for production growth using infill wells.
Operating environment and infrastructure
Pipeline and processing infrastructure are available for the Umusadege field, but their
capacity is only catching up with the fast growing production in the field. A recurring
problem for Mart and its partners is pipeline loss (theft of crude during transportation),
which denies the company of significant revenue. Another related problem is field shutin
or closure of production due to pipeline disruptions.
Mart has initiated a number of measures to add capacity, remove constraints and
achieve field production consistency. These measures, scheduled to be completed
during 2013, are expected to significantly increase production and revenue.
Field infrastructure
Mart and its partners installed a 10,000 bpd early production system during 2007-08 in
preparation for the start of regular production in 2008. A permanent central production
facility (CPF) with a 15,000-20,000 bpd capacity replaced the EPF in 2009 to handle
higher crude production. This facility is currently being further expanded.
Pipeline
Crude is transported from the Umusadege field to the Brass River terminal on the Gulf
of Guinea through two pipeline systems. First, crude from the production facility is
transported to Nigeria Agip Oil Company’s (Agip) Kwale station by a 20 km pipeline run
by Ase River Transport Company. Agip transports stabilized crude from its plant in
Kwale to its Brass Terminal for storage and Export. Agip is a subsidiary of ENI. ENI
takes delivery of the oil at the Brass Export Terminal.
Pipeline losses and field shut-in
A common problem for Nigerian producers is the theft of crude during transportation
through pipeline. This happens through hot-tapping or bunkering, siphoning off crude
from live pipelines. Under the crude handling agreement with AGIP, the pipeline
company is allowed to recover pipeline losses at the actual rate of loss. This rate was
historically estimated to be 8.0%. In 2011, AGIP notified of further losses of about
5.5% of total volume during the year, for a total of 13.5%. Pipeline losses remained at
a heightened level in 2012 at 8% and 18%, respectively, in the first two quarters.
Pipeline disruption also cause field shutdown, which results in lost production and
revenue. Mart estimates a 60-day production loss each year.
Planned development for the future
After proving the prospects of the centre part of the field, Mart and its partners are now
focusing on increasing production through development drilling and new resource
discovery through exploration drilling. Mart has also made significant progresses in
expanding processing and pipeline capacities in order to support increased production.
Development and exploration wells
After completion of Umu-10, Mart plans to continue its development drilling with
vertical and horizontal wells. During 2013, the company is expected to drill two vertical
development wells and at least one horizontal development well.
Parallel to the development drilling in the main field, Mart plans to drill exploration wells
in the eastern and the western parts of the field. These exploration areas are
considered to be oil or gas/condensate in up to 33 stacked sands. Presence of
hydrocarbon has been supported by strong geophysical interpretations tied to
interpretation from the main field.
Central processing facility
Mart is currently expanding the capacity of the central processing facility to
35,000 bpd. Full capacity is expected to be available by the end of 2012.
New pipeline
To remove the constraints of the AGIP pipeline, Mart and its JV partners reached an
agreement with an affiliate of Royal Dutch Shell to provide a second independent
export pipeline. To that effect, construction of a new 54 km pipeline has been
proposed, which would connect Umusadege to a Shell affiliate’s export pipeline in
Eriemu. In order to construct a pipeline, transport it to Shell’s facilities in Eriemeu and
sell the crude to Shell, Mart and its partners have negotiated two contracts with Shell
affiliates to: 1) purchase the oil; and to 2) handle the oil. The first of these two contracts
have been signed, FEED has been completed and long-lead items have been ordered
for this pipeline. Pipeline construction has an anticipated completion date of 3Q13. The
pipeline would be owned and operated by Mart and its partners, and would be equity
and project financed (Mart’s share of equity is about $5.0 million).
Shell is expected to allocate a 35,000-40,000 bpd capacity on its pipeline connecting
Eriemu to its Focados export terminal. This alternative pipeline will not only supply
much needed extra capacity, but also provide redundancy and safety, reducing
pipeline losses and field shut-ins.
Estimated future production
Current field production at Umusadege averages about 12,500 bpd. The field achieved
considerable production growth in early 2012 with the completion of Umu-6, 7 and 8
and 9 wells. We expect another step-up in production capacity in the short-term to
16,000 – 18,000 bpd with the help of continuous production from Umu- 10, fullfunctioning
of the CSF and availability of new capacity on the AGIP pipeline. However,
actual field production would still be limited by pipeline loss and field shut-in.
Another major step up in production is expected in late 2013 when the planned
development wells are completed and the additional capacity at the alternative pipeline
is available.
Capital requirement
We estimate Mart’s total capital expenditure to be ~$64.0 million in 2012 and
~$75.0 million in 2013. With no expected dividend increase in 2013, dividend payment
should be capped at ~$70 million.
Mart is adequately funded for this capital expenditure with current cash and expected
future cashflow.
Production Economics
Mart and its partners sell oil to Ente Nazionale Idrocaburi (ENI) under a Crude Sale
and Purchase Agreement. Umusadege field crude realizes a Brass River price, which
is slightly higher than Brent because of its lighter gravity and low sulfur content.
ENI takes delivery and title of the oil at the time of a lifting (at least once a month) at
the Brass River terminal. Each month Mart and its JV partners nominate the quantity of
oil to be delivered to ENI in the following month. ENI pays JV the price for the
nominated oil, whether or not the same quantity was delivered. A delivered quantity
higher (underlift) or lower (overlift) than the nomination creates accounts receivable or
an account payable.
Production allocation
Mart’s share of the Umusadege field production after royalties, taxes and expenses
varies between 82.5% and 50%, depending on the size of capital expenditure during
the period. With ongoing exploration and development expenditure, we have estimated
a 65% allocation of field production.
Royalties and taxes
Marginal Field operators pay two types of production royalties: 1) government royalties
are payable to the Nigerian government; and 2) a “Farmout Royalty” is payable to the
original owners who released the particular field to the marginal field program. Both
royalties are based on a sliding scale formula whereby increasing production from the
field escalates royalty rates. At current level of production, Mart’s effective royalty rate
is ~10% of gross crude oil sales.
Oil and gas companies in Nigeria are subjected to two types of taxes. The Petroleum
Profit Tax (PPT) rate is generally 85%, but applies at a 65.75% rate for marginal field
producers. Income taxes are payable at 32%. Corporate income tax (CIT) on the risk
service fees is payable at 30% (a further 2% education tax is applied to all taxable
income (both in the PPT and CIT domains).
Although Mart receives its allocation of revenue after payment of PPT, this tax is in
reality payable by the operator (Midwestern/Suntrust). The advantage to the operator
of an FPSA or an RSA contract is that payment to the service contractor such as Mart
is deductible for PPT purposes, which reduces the effective rate.
Mart and its partners have been awarded a Pioneer Status Incentive whereby they are
entitled to a waiver of PPT for the 2009-2013 period. Currently Mart only pays
corporate and education tax at an effective rate of 32%.
Netback
Mart’s current field netback is ~$75, which we expect to continue before a step up of
royalty rates during 2014.
Nigeria Country Profile
Nigeria is located in western Africa and is the largest country in the continent according
to population size (160 million). It has a total area of about 1.0 mm km2. It is bordered
in the southwest by the Gulf of Guinea in the Atlantic and in the east, north and south
by Benin, Niger, Chad and Cameroon. With the largest population in Africa, Nigeria is
one of the largest and most important economies in the continent. With a per capita
income of $2,600 per annum, it is a middle-income country considered among the
most promising frontier markets.
Before the British colonial rules, Nigeria was comprised of a number of separate
independent regions and ethnic groups. The country was colonized in the late 19th and
early 20th century and the three separate regions in the north, east and west were
brought under the same colonial administration under the name, Nigeria. The country
gained independence from the British colonial rulers in 1960. The country has had a
tumultuous 50 years of independence, including a separatist war and a number of
military dictatorships. Nigeria currently enjoys relative political stability as a result of
successive democratic elections at the federal and the 36 state levels. However,
tensions remain between various ethnic groups, and the northern part of the country is
often rocked by religious militancy. A large section of people is alienated because of
inequitable distribution of oil-wealth.
Nigeria as a Petroleum Producer
Nigeria’s oil and gas resources are the mainstay of the country’s economy, contributing
to 95% of its foreign trade and 80% of the government’s revenue. Nigeria has the
largest oil & gas reserve in Sub-Saharan Africa with an estimated 30.0 billion bbls of oil
and 180.0 Tcf of Gas natural gas reserve. Nigeria is an OPEC member and is the 12th
largest producer in the world with production of 2.5 mm bbl of oil and ~3.0 Bcf of gas
per day. Most of this production is concentrated among international majors such as
Shell. Nigeria is the fourth largest exporter to the U.S., contributing to ~10% of its oil
import. Nigerian oil is mostly light and sweet, selling close to Brent prices. Nigeria has
well-established upstream infrastructure terminating into five export terminals.
Challenges facing the industry
Despite ownership of such a large reserve and a 50-year production history, Nigeria
has not been able to fully develop a domestic petroleum industry. Over 1,000 fields
have been discovered with only 35% producing. Nigerian crude oil output has declined
from a high of 2.6 mm bpd in 2005. Nigeria currently produces well under its full
capacity of 3.0 mm bbl. Compared to its large natural gas reserve, gas production is
low because of limited infrastructure. Most of the associated gas is flared.
Development of the petroleum industry has been constrained by the need for large
capital investments, lack of policy support and widespread corruption.
New Petroleum Industry Bill
A new petroleum industry bill (PIB) is expected to outline the regulatory framework and
clarify the investment uncertainties in Nigeria. The PIB was initially introduced in 2008
with the purpose of restructuring the oil and gas sector, clarifying regulatory and
operational rules of Nigerian energy institutions and increasing government take and
local content requirements. The IOCs opposed the bill as the possibility of higher
royalties and higher local content requirements did not appeal to them. However, the
IOCs seem more favorably disposed to the bill with several rounds of revisions.
Some provisions of the new PIB are viewed as negative by the majors because of
higher proposed government take and the requirement for higher local content.
However, the proposed PIB also attempts to favor marginal fields, indigenous
companies and local talent with lower royalty rates and various tax advantages.
Niger delta
Mart’s Umusadege field is situated in the Niger delta, as are most of Nigeria’s onshore
and shallow offshore fields. Niger delta is a geologic province in western Nigeria with a
single petroleum system – the Tertiary Niger Delta Petroleum System. This petroleum
system is estimated to contain as much as 34.5 mm bbl of recoverable oil and 94 Tcf
of natural gas at origin. This is not a single gigantic field, but is composed of numerous
individual reservoirs formed by sandstone pockets trapped within oil-rich shale. The
Niger delta petroleum system is so prolific that some have compared finding oil there
to “shooting fish in a barrel”.
The Niger delta is also a densely populated region with 31 million people. More than
40 ethnic groups live there speaking 250 different dialects. This diversity makes it all
the more complex to maintain a working relationship between the oil companies and
the local community. Historically E&P companies, especially international majors,
generated a lot of animosity by following a heavy-handed approach toward the local
population in collaboration with the military regimes. With escalating conflicts and
pipeline theft, the majors found it safer to move and operate from deep offshore in the
Gulf of Guinea, leaving the smaller onshore and shallow-water fields to the marginal
field operators.
Marginal fields
The Nigerian government introduced the Nigerian Marginal Field Allocation Program in
1996. Under the program, marginal fields could only be allocated to indigenous
Nigerian companies, defined as having at least 60% Nigerian ownership. These
companies were free to enter into financial and technical partnerships with foreign
partners. A total of 116 proven but undeveloped fields were designated as “marginal”
under certain criteria, including a 10-year period of inactivity after discovery. In order to
improve the economics of these proven fields and encourage indigenous participation,
the government granted a number of fiscal incentives under the program including
lower “sliding scale royalties” and taxes.
The Nigerian government offered 24 marginal fields in 2001 in the first bidding round.
These fields containing as much as 2.0 billion bbl of reserves were held by Nigerian
National Petrloleum Corporation (NNPC), the Nigerian state oil company and a number
of multinational oil companies. In 2003, 24 fields were allocated to indigenous Nigerian
companies. Mart operates as a technical service partner in such a marginal field with
the original awardees.
Mart has expressed interest to participate in another upcoming marginal field bidding
round. Significant upside potential exists in the marginal fields as the majority of the
wells were drilled in the 1970s and 1980s on the basis of 2D seismic. The fields in
which Mart expects to participate are covered by modern 3D seismic, which shows the
presence of significant upside potential. Mart expects to develop the fields in
partnership with other financial and technical companies.
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