This is the analysts report from "Fat Profits" dated 17 Jan 2007, that can be accessed via the IPM website:
www.incrementalpetroleum.com
(sorry i didnt know how to link this one)
Incremental Petroleum Buy IPM around $1.22
Fat Mining 60, 17 Jan, 2007
Bargain priced oil producer Market cap$82 million
With the shake out in oil markets that has occurred over recent weeks, we thought it appropriate to remind
Members about one of our favourite emerging oil plays, Incremental Petroleum. The company's share price has
been hammered by circumstances entirely out of its control, relating to underlying adverse oil price movements
and bad weather conditions in Turkey that affected production in recent weeks. Nevertheless, the fundamental
story remains outstanding and Members wanting exposure to a dynamic oil company at a bargain price, should
take note.
"With all that Incremental has achieved over the past year since listing, it has
never represented better value than it does now."
Fat Prophets initially recommended buying Incremental at 98 cents in December (Fat Mining 5). Our last review of
this stock was in October (Fat Mining 45).
IPM has experienced a disappointing six months with the shares experiencing considerable volatility. While
definitive signs of a recovery are yet to emerge, recent price action has nonetheless given cause for optimism.
After reaching a 10-month low of 1.15 cents last month, IPM has stabilised. The recent stability in the shares is
encouraging and indicates selling pressure is abating. While further near term weakness remains possible, we
believe IPM is becoming resistant to lower levels.
A break above $1.30 would be the first indication of upward momentum returning. Although the past six months
have been disappointing, we believe that a sustained recovery is probably in time.
Like most oil stocks over recent times, Incremental Petroleum has been battered from pillar to post by
circumstances totally beyond its control. In the first instance, it has suffered as the underlying price of crude oil fell
sharply to a 19-month low on the back of the warmer-than-expected North American winter.
But in the second instance and in a cruel twist of fate, record low temperatures in the region of the company's
Selmo oil field in Turkey have dramatically impacted production by disrupting power supplies. We believe such a
turn of events represents a real buying opportunity for those Members looking to gain exposure to a quality
emerging oil company, or those existing members who might be thinking of adding to their position at bargain
prices.
Members might consider us foolhardy to be analyzing investment opportunities in the oil sector at a time when it is
receiving such universally bad press. True, it is difficult to find favourable coverage of the sector at the moment, as
every story seems filled with doom and gloom for 'black gold.' Markets are apparently overflowing with the stuff,
with OPEC seemingly powerless to do anything about it.
While we accept that conditions in the oil market have conspired to soften the immediate oil price outlook, we
believe that the essential longer-term fundamental picture remains unchanged. Whatever might happen in the
short-term, Chinese consumption is going to continue to grow robustly over the next several decades, as will
demand from that other emerging giant, India. Meanwhile, the US is not going to lose its love affair with the motor
car.
At the same time, contrary to what the short-term supply data may say, oil is steadily getting more difficult and
more expensive to find and produce. Irrespective of the billions of barrels that no doubt remain to be found, these
untapped reserves will be more expensive to produce and more costly to refine. This means that we must become
accustomed to a high oil price environment.
This brings us to Incremental Petroleum. As a reminder to members, its owns 100% of the Selmo onshore oilfield,
situated in eastern Turkey. Selmo ranks as the second-largest oilfield in Turkey in historical production terms.
Mobil discovered the field in 1964 and operated the field until 1996; however, the field was not large enough in
Mobil terms to warrant the appropriate field work-over techniques to improve productivity.
Incremental saw an opportunity at Selmo because of the field's relatively low oil recovery rate of 16%, whereas the
average recovery rate for most oilfields is around 25%. Plainly speaking, if Incremental can enhance recovery
rates at Selmo to that approximating typical field averages, then it could potentially have access to an additional 45
million barrels of recoverable oil.
Incremental is utilizing modern oilfield technology to improve oil production from the field, including techniques
such acid jobs, plug-backs and pump changes.
The company estimates average cash production costs to remain at around US$18 a barrel over the next three
years, inclusive of all royalties. Assuming an Arabian Medium Oil price of US$63 a barrel over the next three
years, this means a robust operating margin of US$45 a barrel.
Using a base-case production scenario of 500,000 barrels of oil for each of calendar 2007 and 2008, we anticipate
generation of Net Profits After Tax (NPAT) of around A$15 million annually, which should enable the payment of
dividends of around 8 cents a share in each year.
Incremental has a policy of returning at least 50% of its free cashflow to shareholders via dividends and/or capital
returns. This puts the company on a solid yield of around 6.5% based on its current share price.
Incremental remains entirely debt free, with cash of $10 million and has no oil hedging in place. We therefore
retain our view that Incremental represents a cheap producing oil exposure for those investors with an appetite for
risk.
The Selmo oilfield last year received its first ever-independent estimate of its reserves. Independent experts, RPS
Energy, estimated 2P (proven and probable) reserves within the field of 12.04 million barrels. Now let us assume a
conservative net present value (NPV) of US$20 a barrel and this is worth $320 million to Incremental - or around
$4.70 a share. The company represents outstanding value at these levels.
Incremental has also enjoyed immediate exploration success with a farm-in joint venture late last year with fellow
Australia-based Turkish oil explorer, Otto Energy. Incremental is contributing $3 million towards expenses to earn
a 15% stake in Otto's Edirne licence in Turkey's Thrace Basin.
The first two wells, Koyustu-1 and Bati Umur-1, were both successful in encountering gas during drilling, with flow
testing of each well now underway to help ascertain likely reserves. The Koyustu-1 well has flowed gas at a rate of
2 million cubic feet a day from just one of the three prospective gas zones, while Bati Umur-1 awaits testing. The
partners are keen to commercialise these gas reserves as quickly as possible.
Despite all of this good news, we acknowledge that the market is applying an enormous discount to the company's
share price due to sovereign risk concerns. This helps to at least partly explains the discrepancy between the
company's share price and underlying value. We are of the view that with ongoing success both on the exploration
and development fronts, this gap will disappear rapidly over time.
Incremental Petroleum will remain Held in the Fat Prophets Mining & Resources portfolio, but for Members
with no current exposure we recommend the stock as a Buy around $1.22.
Fat Prophets Mining & Resources Pty Ltd (ABN 68 102 986 327) is an authorised representative (no. 277996) of Mint Financial Group Pty Ltd.