Take oil, add politics, stir for profits
Politics often spells danger for investors, but in central Asia oil and politics have produced a profitable mix, says this Canadian analyst.
It isn’t that politics and investments don’t mix.
Political events and government dictates are always with us, whether they’re dramatic upheavals in oil-producing lands or just common garden tax rulings and securities regulations.
It’s when you wander far from home that politics can play a perilous role in the investment picture.
Take Kazakhstan. Five years ago, many investors did, and most of them regretted it.
But it’s OK to go back. That’s the word we get from Mr. Randy McDuff in Investor's Digest of Canada. Not only OK, but potentially very profitable.
Mr. McDuff, who was able to retire early from the brokerage business, continues to invest very successfully, with two of the top 10 portfolios on Marketocracy.com.
And he rarely picks his stocks from the common garden. He digs up far-flung opportunities that others rarely cover.
So let’s follow him to central Asia and find “one of the most efficient producers of oil on the planet.”
Proverbial bandits
In the late 1990s, the Kazakhstan oil patch was a magnet for Canadian oil firms and Canadian investors. Calgary firm PetroKazakhstan enjoyed early success. Into the game came Nelson Resources, also successfully.
“Investors who held their noses, and jumped into these firms early, made out like proverbial bandits,” says Mr. McDuff.
But those who came in later were in for a rude surprise. In 2004, a “suddenly coercive” Kazakhstan government enforced new environmental policies. All very progressive, to be sure. But not entirely altruistic.
“The unexpressed motive was to persuade foreign firms to sell out,” explains the analyst. Foreign investors protested against “strong-arm tactics.” But the policy worked, as public shares plummeted and foreign producers sold out at what amounted to distressed prices.
Those that escaped the first round of what Mr. McDuff archly refers to as “takeunders” were hit with punitive tax measures in 2008. Thus many firms have pulled out, while a government agency has scooped up interests in long-lived, low-cost reserves.
This agency, bearing the unwieldy name of JSC National Oil Company KazMunaiGas (NC KMG) has a legal right to match any sale price for oil and gas assets in the country. It also has the right of first refusal on them.
But there’s a very bright light shining through this tunnel.
Impressive structure
Some of the longest life reserves in the country have been sold to a publicly traded company. Kazmunaigas (LSE-KMG) was created five years ago to operate mature onshore fields bought from NC KMG.
The firm’s mandate is to make the most of existing production and grow by acquisition. 61 per cent of its shares are in government hands and the other 39 per cent trade on the local exchange, the Astana.
Global depositary receipts for the stock trade on the London exchange in U.S. dollars. One receipt equals six underlying shares (and the current price is US$19.00). The market cap is $8.25 billion and the company has a cash balance of $549 million. The reported enterprise value (EV — the theoretical price for which the company would be sold) is $7.7 billion.
“Even jaded hands in the oil patch may be impressed with the structure of Kazmunaigas,” says Mr. McDuff.
Completely debt free
“Kazmunaigas is almost exclusively an oil producer and is completely debt free,” says the analyst.
Last year, 76 per cent of its 190,000 barrels per day was exported at world prices. The rest was sold domestically at steep discounts.
The reserves are impressive for a firm with such a modest enterprise value. At the end of 2008, the company reported some 702.9 million barrels of proven production, almost all of it oil. Proven and probable reserves amount to about 1.77 barrels, which means the company’s fields should be productive through 2047.
What’s more, those fields are in conventional sandstone reservoirs, while most of the country’s other producers are in hard-to-get-at carbonite formations. And it has other fields to cultivate.
In addition to its own reserves, Kazmunaigas holds 50 per cent equity in Nations Energy, Kazakhstan’s ninth largest producer, and 50 per cent in Kazgermunai LLP, its eighth largest producer.
“Join ‘em”
The company is one of the most efficient producers on the planet, states Mr. McDuff. Last year, its costs per barrel were a modest $4.10 per barrel, just 5.7 per cent of revenues.
Thanks to its conservative planning and prudent spending, the company actually saw its reserves increase slightly as oil prices plunged last year. It can hold its own when prices are low.
And, presto, the government is coming up with a more focused tax system to replace the current disastrous mishmash. While windfall profits will be taxed as the price of oil rises, corporate income taxes will shrink.
In the end, Mr. McDuff sets out four criteria for an oil firm. It must buy or find long-lived reserves cheaply. It must produce those reserves cheaply. It must increase its reserves, cheaply. And it must maintain a “pristine balance sheet.”
Kasmunaigas meets these criteria precisely, he tells his readers in Investor's Digest of Canada. “While foreign investors beat their heads against a wall with exploration, potentially accretive acquisitions are now being negotiated between Kazmunaigas and NC KMG.”
In short, it’s time to sell out politically and cash in financially, this analyst concludes. “If you can’t beat ‘em, join ‘em.”
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