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Cash Flow Today in a Prolific Region with Favourable
Fiscal Terms
Investment Summary
We are increasing our coverage emphasis on Colombia by initiating on two
Colombian focused E&Ps: Pacific Rubiales Energy Corp. (PRE-T) and Gran
Tierra Energy Inc. (GTE-T, GTA-A). In Exhibit 1 we highlight our targets and
recommendations.
Exhibit 1. Targets and Recommendations
Name Ticker Price Target Price Recommendation Target Return (%)
Gran Tierra Energy Inc. GTE-T, GTE-A $3.71 $5.00 BUY 35%
Pacific Rubiales Energy Corp. PRE-T $3.09 $8.50 BUY 175%
Source: Bloomberg, TD Newcrest estimates.
Note: All figures in U.S. dollars unless otherwise specified. Report priced as of close February 9, 2009.
Despite the differences in the two companies and their projects, we find similar
reasons to own their stock, which we highlight below:
• Exposure to development projects that are currently cash flow positive.
• Potential exploration and development upside over the next 12 months that
could prove to be material.
• Excellent fiscal terms in Colombia, which, in turn, should create strong
netbacks and higher potential valuation levels.
• Colombia has shown to be very prolific in terms of new discoveries.
Our targets reflect our 2007 year-end risked NAV, based on the mid point of our
base case commodity prices (US$50 WTI for 2009E and US$75 longer term) and
the Futures strip, which includes the exploration upside in the Expected Monetary
Value (EMV) portion of our risked NAV.
Table of Contents
Investment Summary............................................................................................. 3
International Investment Thesis – Our Revised Stance ..................................... 3
Colombian Investment Thesis............................................................................... 5
Pacific Rubiales Energy Corp............................................................................... 7
Investment Summary ........................................................................................ 7
Investment Thesis .............................................................................................8
Top Three Key Catalyst Events/NAV Drivers, in Our View............................ 8
Top Three Key Risks, in Our View................................................................... 8
Valuation...........................................................................................................9
Justification of Target Price ............................................................................ 10
Management Team..........................................................................................15
Our take on Catalyst Events and NAV Drivers – Why Do I Buy This Stock? .. 16
Valuation and Sensitivity Analysis ................................................................. 20
Free Option Values ......................................................................................... 20
Technological Advancements and Opportunities............................................ 29
Llanomulsion ..................................................................................................29
STAR – Synchronized Thermal Additional Recovery.................................... 29
Key Risks to Target Price ............................................................................... 30
Overall Risk Rating: HIGH............................................................................. 30
Exploration and Operational Areas................................................................. 34
Colombia Country Overview.......................................................................... 34
Peru Country Overview................................................................................... 41
Financial Models.............................................................................................48
Gran Tierra Energy Inc. ..................................................................................... 51
Investment Summary ...................................................................................... 51
Investment Thesis ...........................................................................................52
Top Three Key Catalyst Events/NAV Drivers, in Our View.......................... 52
Top Three Key Risks, in Our View................................................................. 52
Valuation.........................................................................................................53
Justification of Target Price ............................................................................ 54
Management Team..........................................................................................59
Our Take on Catalyst Events and NAV Drivers – Why Do I Buy This Stock? ... 60
Valuation and Sensitivity Analysis ................................................................. 62
Free Option Values ......................................................................................... 62
Key Risks to Target Price ............................................................................... 70
Overall Risk Rating: HIGH............................................................................. 70
Basic E&P Risks Relevant To All Energy Producers ..................................... 70
Additional Risks to Gran Tierra...................................................................... 71
Exploration and Operational Areas................................................................. 74
Colombia Country Overview.......................................................................... 74
Argentina Country Overview.......................................................................... 80
Peru Country Overview................................................................................... 83
Financial Models.............................................................................................87
Appendix I. Glossary Of Terms.......................................................................... 90
Appendix II. Key Indicators and Comparitive Statistics ................................. 92
APPENDIX A. IMPORTANT DISCLOSURES............................................. 105
International Investment Thesis – Our Revised Stance
Our investment thesis for international E&Ps has changed slightly, given
commodity prices and the state of global equity markets today. In an environment
of rising commodity prices and relatively easy access to capital, companies in the
primary stages of the E&P Value Chain (pure play exploration and early stage
development companies, please refer to Appendix II) could potentially create more
value than later stage companies. But, the investing climate is very different today,
and gives us cause for the following concerns.
• The drop in commodity prices not only cut NAVs and equity valuations, but
has added uncertainty to future projects. CEOs (and investors) are faced with
the challenge of deciding if today’s capital costs can generate sufficient future
cash flow to warrant investment. It is our opinion that capital costs are still at
inflated levels and are inherently ‘sticky’, or have not dropped at the same rate
as commodity prices.
• Barriers to capital markets (both debt and equity products) severely limit the
ability of companies to attract required funding for projects. If funding is
available, then the question then becomes whether it is available at a rate that
allows a high enough return. The cost of equity and credit spreads remain quite
high compared to historical levels.
Companies without the balance sheet strength, access to capital, or production and
cash flow to support corporate activities are being forced to seek ‘strategic
alternatives’. Recent examples include two North Sea players, Oilexco Inc. (OILT,
not covered) and Bow Valley Energy Ltd. (BVX-T, not covered). We believe
this trend could continue, and as the ‘have nots’ look for buyers, the companies
with positive free cash flow and/or strong balance sheets may find that they have
opportunities to acquire companies at favourable prices, potentially without
significant or any M&A premiums.
Bearing this in mind, we believe that value creation (and investment return) can
still be captured in the international E&P sub sector.
• We are still convinced that international E&Ps typically exhibit higher growth
rates (production and reserves) than their domestic peers. It is the growth of
reserves and production that, in our opinion, ultimately contribute to higher
valuation levels (along with commodity prices, equity market sentiment, etc.).
• Despite the decline in commodity prices, many internationals have fared worse
than commodity prices. We highlight this in Exhibit 2, and attempt to explain
where and why divergences took place.
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