Strain Consultants, Inc.
RESEARCH REPORT
Analysts:
Charles M. Strain, CFA
Michael V. Strain
Parkcrest Explorations Ltd.
Common Stock -- (Alberta Exchange-PKC) May 1, 1998
#300-1530 56th Street, Delta, British Columbia V4L 2A8 (800) 661-3788
(ALL MONETARY VALUES ARE IN CANADIAN DOLLARS)
RECOMMENDATION
We are initiating coverage of Parkcrest Explorations Ltd. with a recommendation to purchase the common shares for capital appreciation by investors for whom the risks inherent in a small oil exploration company are appropriate.
We are recommending Parkcrest for two main reasons: 1) the common stock price is at a discount when compared to its peer group and 2) the exploration and development program in Colombia has the potential to add meaningful reserves on a per share basis.
We calculate that the adjusted break-up value, or net asset value, of Parkcrest is C$1.34 per share (see Exhibit I). The common stock is currently selling at only 83.43% of this adjusted break-up value. For comparison, we calculate that the common stock for the peer group sells at a median value of 94% of the adjusted break-up value. By this valuation method, Parkcrest common stock is selling at a discount to the peer group. In addition, we calculate that the potential break-up value for Parkcrest on a risk-adjusted and fully diluted basis is C$3.81 per share. This figure reflects the potential impact that the current exploration and development program in Colombia could have on the company.
Preliminary results from two recent wells drilled and completed in Colombia, the Estero #3 and the Canacabare #1, look more promising than we originally anticipated. Therefore, the valuations shown above could prove to be conservative. It is important to note that we assume that Parkcrest will meet any short-term obligations accrued through its loan agreement with Harken Energy this year. See a more detailed discussion about the break-up value calculations in the financial section below.
Not only do we consider Parkcrest stock to be currently undervalued, but we also view this company as possessing upside potential through possible future reserve additions. Keep in mind that the oil and gas business is inherently risky and there are no assurances of future success.
SUMMARY
Parkcrest Exploration Ltd. is a junior oil and gas exploration company that is focused on exploration and production in Colombia. Historically, the company's strategy has been to become partners with operating companies, which have established technical and managerial capabilities. Parkcrest and its partners, Harken Energy (HEC: AMEX) and International Rochester Energy (ROH: TSE), are participating in an active exploration and development program in the Alcaravan association contract area of the Llanos Basin.
Recent events worth noting are:
The Palo Blanco discovery well, the Estero #1, tested at a rate of over 4000 barrels of oil per day (BOPD). This rate was restricted by the capacity of the submersible pump and storage facilities used for the test. Well logs indicate that two other zones, the Mirador and Guadelupe, above the Ubaque look promising.
A development well at Palo Blanco, the Estero #3, has been completed and is undergoing production testing. These tests not only include the Mirador and Guadelupe formations, but additional zones found in the Ubaque formation.
An apparent discovery at Anteojos, the Canacabare #1 has been drilled and is awaiting a completion rig for further testing. Preliminary indications from the well logs indicate that the Mirador, Gacheta, and Ubaque are all potential zones worthy of testing.
Pipeline construction for Palo Blanco is underway and will hopefully be completed in the third quarter of 1998.
Future leads and prospects in the Alcaravan acreage are being evaluated and further defined. Additional 2-D seismic data was acquired in certain areas of the block to help in this endeavor. In addition, 3-D seismic survey is underway at Palo Blanco to further delineate that new field discovery.
Harken has provided Parkcrest with a loan agreement to advance the company up to 2.6 million US dollars to cover any cash calls made on Parkcrest regarding its interest in the Alcaravan and Miradores Blocks. The funds loaned are secured by one half of the 25% beneficial interest Parkcrest has in the Palo Blanco prospect.
In summary, the exploration and development drilling program at Alcaravan has resulted in recent wells that could add important reserves and improve the net asset value of Parkcrest significantly.
COMPANY BACKGROUND
Parkcrest was established in 1984 as a mineral exploration company. It was first listed on the Alberta Stock Exchange in 1987 and began to become involved in the oil business in 1989, when it farmed into some very small interests in Alberta. The company was effectively dormant when it was refinanced in 1995 by Vancouver-based investors, who are still involved with its management. In early 1996, Parkcrest entered into a letter agreement with Cupet to explore for hydrocarbons in Block 3, in western Cuba, but the company formally withdrew from this arrangement in June 1996. At the end of 1996, the company entered into negotiations with the Colombian subsidiary of Harken Energy Corporation, which led to its entry into that country.
COLOMBIAN ACTIVITIES
In March 1997, Parkcrest participated in its first Colombian well through the joint venture agreement with Harken covering the 210,000 acre Alcaravan Block, located in the Llanos Basin. Under the agreement, Parkcrest earned a 25% beneficial interest in the Palo Blanco Prospect by paying 33.334% of the costs of the Estero #1. This well proved to be a discovery, testing 4,116 barrels of oil per day from 37 feet of net pay in the Ubaque formation. Additional pays may be present in the Mirador and Guadelupe Formations, located above the Ubaque. These two zones are productive in other wells in the region and will be tested at a later date. Estimates for the Palo Blanco discovery have been put in the range of 20 to 50 million barrels of recoverable oil and the discovery is thought to have an areal extent of 1,200 to 1,500 acres. The Ubaque reservoir has excellent porosity and permeability characteristics and it appears this zone could produce at higher rates than those achieved in the initial tests by utilizing a larger downhole pump. The oil is a low gravity 16.4 0 API crude and will require special treatment for export. There is existing infrastructure in the area and initial plans will likely be to mix the Ubaque crude with nearby lighter crudes so that it can be exported through a small existing pipeline, which is only 8 kilometers from the Estero #1 site. In the meantime, trucking of oil from Estero #1 is planned to begin as soon as the second well drilled at Palo Blanco, the Estero #3, is finished testing. Estimates are that trucking could support production in the 1000 BOPD range. Transportation by pipeline should improve this production rate several fold. Construction of a spur connection to the existing pipeline is underway and will hopefully be finished late this summer.
Unfortunately, the area in which the Alcaravan Block is subject to extensive flooding during the rainy season, which generally occurs between May and November each year. Because of the flooding, operations can only take place during the rainy season if adequate roads and drilling sites are established. The current dry season has been very active and productive: two wells were drilled, 2-D and 3-D seismic data was acquired, and pipeline construction for Palo Blanco began.
The Estero #3 development well was drilled and completed and is currently undergoing production testing. Well logs indicate that not only is the Ubaque prospective, but so are the Mirador and Guadelupe. Testing of the Estero #3 has taken longer than anticipated due to the number of intervals being evaluated, delays in obtaining a completion rig, and some minor mechanical problems.
A second discovery on the Alcaravan Block appears to have been made at the Anteojos prospect with the Canacabare #1 well. The well has been drilled, logged, and cased and is waiting for a completion rig. Well logs indicate that there are several zones worth testing including the Ubaque, Gacheta, and Mirador formations. This is an exciting new discovery for Parkcrest and its partners. As it is currently mapped, it appears that Anteojos has a larger areal extent than Palo Blanco does. The actual size of any possible reservoir will have to be confirmed through further delineation with more wells and possibly seismic data. The Canacabare #1 well is to the northeast of Palo Blanco and only about 15 kilometers from a point where it can be tied into the planned pipeline system.
In addition to Anteojos, there are several other prospects in Alcaravan at various stages of interpretation. Harken has acquired a small 2-D seismic survey to help delineate another exploration prospect and a 3-D seismic survey over the Palo Blanco area. Engineering studies are also under way to determine the best way to develop the field and establish long-term pipeline export.
Through its joint venture agreement, Parkcrest has the option to participate in all prospects generated by Harken on the Alcaravan acreage. In each case, Parkcrest pays for 33.334% of the costs of the initial well, plus a prospect generation fee, in order to earn a 25% beneficial interest, held through Harken. The Colombian national oil company (Ecopetrol) has the right to back in to any commercial discovery for a 50% working interest by reimbursing the existing partners for half of the relevant exploration costs. Once the cumulative production exceeds 60 million barrels, Ecopetrol's working interest increases in stages, to a maximum of 75%. A 20% royalty is paid to the Colombian Government from any production.
In November 1997, Parkcrest announced that it made an agreement with Colombian Hydrocarbons Ltd. to study certain areas of Colombia to try to obtain additional contract areas for exploration. An application has been made for a 496,000 acre block in the Lower Magdalena Valley and it is hoped that the award of an association contract will be made in early 1998. Parkcrest will operate this contract.
In summary, Parkcrest is well positioned to achieve substantial growth through its participation in the development of the Palo Blanco Field, evaluation of the apparent discovery at Anteojos, and continued exploration on several remaining prospects at Alcaravan.
FINANCIAL
Harken has provided Parkcrest with a loan agreement to advance the company up to 2.6 million US dollars until November 30, 1998. These funds will bear interest payable monthly at an annual rate of six percent. The funds advanced will be to cover any cash calls or management fees made with respect to Parkcrest's interest in the activities on the Alcaravan and Miradores Blocks. One half of the 25% beneficial interest earned by Parkcrest in the Palo Blanco prospect secures the funds loaned by Harken. Therefore, the company's interest will be lowered to 12.5% if this obligation is not meet by November 30, 1998.
For our break-up value calculations (discussed below), we assume that Parkcrest will be able to meet any current liabilities and not have its beneficial interests in Colombia lowered. We assume that these obligations will be adequately covered by funds brought in to the treasury through the conversion of warrants and options, which have conversion prices, lower than the current stock price or our adjusted break-up value per share.
Exhibit I shows our calculation of the break-up value, or net market value, of the assets of the Parkcrest Explorations Ltd. For year-end 1997, we calculate the break-up value to be C$0.46 per share. This value takes into consideration only the pertinent financial items from the year-end financial statements.
The second portion of the model makes adjustments for changes in the break-up value not accounted for by the year end 1997 financial statements. These adjustments are anticipated for 1998 and include, several equity transactions, the draw down of debt with Harken, and Parkcrest's interest in an estimated 25 MMBO of gross reserve additions at Palo Blanco. As shown, warrants and options with conversion prices less than the adjusted break-up value are assumed to have been converted. We calculate the adjusted break-up value as C$1.34 per share. The common stock price can be compared to this calculated value; the median for our group of forty peer companies is usually near the adjusted break-up value.
The next portion of Exhibit I makes adjustments for the potential Parkcrest has for adding reserves with its exploration and development program. We have separated these potential additions into development and exploration. These adjustments illustrate the impact that the risk adjusted reserve potential of each project could have. This portion of the model also calculates the full dilution to the common stock. Since the per share value of all the potential additions is greater than the conversion price of all the stock options, warrants; and convertible debentures we assume that these instruments are converted. We calculate the possible break-up value, on a fully diluted basis, as $3.81 per share.
An important point to keep in mind when evaluating Parkcrest and its potential break-up value is that the estimates of potential reserves are risk adjusted based on estimated probabilities of success. Therefore, it is possible for a single well or prospect to provide better results than these estimates. For example, we anticipate that the recoverable reserves for the Palo Blanco Field could ultimately prove to be twice as large as the combined 50 MMBO used in this model. Therefore, we show our unrisked per share values in this model to give the reader a better idea of the higher upside potential these prospects posses.
The second most important valuation method for small oil and gas companies is often a multiple of operating cash flow. At the current stage of development, cash flow multiples are not a meaningful valuation tool for the company. Parkcrest is a development stage company; therefore, the stock price should follow the value of the assets, or reserves, added through the company's exploration projects until production and revenues become meaningful.
Strain Consultants, Inc. plans to construct an earnings model for Parkcrest when the production rates from the Palo Blanco Field are better defined.
Exhibit II is a chart showing the historical sales price and volume of Parkcrest Explorations Ltd. common stock (Alberta: PKC).
Figure 1: Map of Alcaravan and Miradores Blocks
Exhibit I: Break-up Model
Exhibit II: Historical Stock Price Chart
( Copyright 1998 Strain Consultants, Inc. The study herein is not an offer to sell any securities; it does not include every material fact respecting any company, industry, or security and should not be relied upon as a sole source of information and opinion for making investment decisions. Some information in this study is opinion and the opinions expressed here should not be construed as statement of fact. Such opinions reflect the judgment of the author at this time and are subject to change. Facts have been obtained from sources considered to be reliable, but are not guaranteed. Past performance is no guarantee of future results. Strain Consultants, Inc., its officers, directors and/or employees may have an interest in the securities of the issuer(s) described herein and may purchase, sell, trade or act as a market maker while this report is in circulation. No employee of the firm is a director of this company. The subject company(ies) may pay a fee to Strain Consultants, Inc. for services including the Peer Group Analysis Service.
P.O. Box 42308 Houston, Texas 77242-2308 (713) 975-9260
Parkcrest Explorations Ltd. Strain Consultants, Inc.
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Here 'tis, in the flesh. My understanding is that Strain is very bullish on both PKC and ROH right now and believes the market is merely overreacting to the news draught. He wants to make it unequivocal that he is making a call on both of these stocks at this time.
I've been getting Strain's faxes for about 4 years now. He has certainly made some bad calls, but most of them have been due to reasons having something other than to do with the company's success or lack thereof in the field. Since in the near-term we will be finding out about the degree of PKC's success out in the field, I have immense confidence that the stock will pop once the news gets out.
This confidence is there even in spite of the knowledge that they are about to have their prospectus approved for registering millions of shares of cheap stock. I feel that now that Yorkton can solicit orders for the stock (they couldn't while the prospectus was under review), the Yorkton brokers will soak up all the paper coming on the market. |
