Vaalco Energy Update

Vaalco Energy (NYSE: EGY) ended the week up over 20%, after releasing an update on its drilling program. From the release:

HOUSTON, Dec. 31 /PRNewswire-FirstCall/ -- VAALCO Energy, Inc. (NYSE: EGY - News) today provided an update on the new development well being drilled in the Ebouri field and the new appraisal well (North Ebouri) being drilled in the Etame block. VAALCO commenced drilling these wells in November with the jack-up rigs Adriatic 6 and Pride Cabinda, respectively, as previously announced.

For the development well in the Ebouri field, VAALCO announced that it has drilled one pilot hole to the south of the original Ebouri discovery and a second pilot hole to the northeast of the original discovery. Both of these pilot holes were successful in delineating additional Gamba sandstone reservoir above the oil water contact, thereby increasing the acreage and reserves of the Ebouri field. VAALCO is currently completing the development well horizontally on the same orientation as the second pilot hole. First oil production from this well is expected in January 2009.

The Company also announced that it drilled the North Ebouri appraisal well in the Etame block approximately 1.5 miles to the northeast of the Ebouri platform and found 21 feet of oil column, further expanding the Ebouri field. VAALCO is now planning a sidetrack to optimize the location for a potential second horizontal development well. In addition, the Company is planning two exploration wells (North Etame and South East Etame) on newly mapped structures. The wells will be drilled back to back using Pride Cabinda.

VAALCO continues to expect production at a rate sufficient to bring total production from the Etame license area to approximately 25,000 barrels of oil per day (bopd). The Etame license production areas currently produce approximately 20,000 bopd, of which VAALCO has a 28.1% working interest.

"Results from the Ebouri development drilling have exceeded expectations, and we are pleased with the initial results from our drilling program in the Etame block, with more wells to come," said Robert L. Gerry, III, Chairman and CEO of VAALCO. "We have substantially enlarged the productive acreage of the Ebouri field, thereby greatly enhancing the recoverable reserves. We look forward to continued success with our exploration program."

Last time EGY rose over $7, I sold 5% of my position and used those funds to buy more AYSI.OB. I may sell a little more at these prices, but I plan on holding most of my EGY for the long term, as I'm bullish on oil over the next five years, and I'm bullish on Vaalco's ability to increase its reserves through its drilling program. The image above, which shows Vaalco's Ebouri field, is from the company's website.

Vaalco Energy Update

Shares of Vaalco Energy (NYSE: EGY) are up about 33% over the last week, closing at $7.05 today, despite oil prices hitting a three-year low. I've got a limit order in to sell 5% of my Vaalco shares here to free up cash, which I may use to buy a few more shares of Alloy Steel International (OTC BB: AYSI.OB).

Vaalco Energy Reports

Vaalco Energy (NYSE: EGY) reported its Q3 earnings today. From its press release:

HOUSTON, Nov, 10 /PRNewswire-FirstCall/ -- VAALCO Energy, Inc. (NYSE: EGY - News) announced that for the third quarter of 2008, net income was $22.3 million or $0.38 per diluted share compared to $8.8 million or $0.15 per diluted share for the comparable period in 2007. Third quarter 2008 revenues were $55.5 million compared to $34.8 million in the third quarter of 2007. Discretionary cash flow was up 85% to $66.2 million for the nine months ended September 30, 2008 compared to $35.7 million in the same period of 2007. For the nine months ended September 30, 2008, net income was $37.2 million or $0.63 per diluted share compared to $17.1 million or $0.28 per diluted share in the nine months ended September 30, 2007.

"VAALCO's strong third quarter results reflect higher oil prices and crude volumes, as well as the expected benefit from a lower tax rate, attributable to increased capital expenditures during the quarter," said Robert L. Gerry, III, Chairman and CEO. "Our drilling and exploration program is continuing at one of the strongest rates in our history, with prospects in place to grow reserves and production. VAALCO's capital position remains strong, enabling us to capitalize on these opportunities."

As previously announced, VAALCO is planning seven additional development and exploration wells including a development well in the Ebouri field, three exploratory wells in the Etame block, two exploratory wells onshore Gabon in the Mutamba concession, one exploratory well in Angola, and a 25% interest in a gas prospect in the British North Sea. Together, these wells expose the Company to over 50 million net barrels, or an 8-fold potential increase to VAALCO's current 6.2 million barrels of proved reserves.

Earnings will of course be down significantly from here in Q4, as oil prices have had a steep drop, but if the company's current exploration program is even partially successful, it will be well-positioned when oil prices eventually resume their climb upward.

A Conversation with the CEO of Vaalco Energy

The CEO of Vaalco Energy (NYSE: EGY), Robert L. Gerry III, was kind enough to spend a few minutes on the phone with me today. A few notes from our conversation:

- He estimates that the per-barrel cost of production of any oil produced by Vaalco's current exploration projects will be similar to the cost of the company's current production, i.e., about $10 per barrel.

- No predictions on oil prices, but given Vaalco's low cost of production, Gerry was unconcerned. "We can make money on $20 oil," he mentioned.

- Regarding the political environment in West Africa, he said the government of Gabon had been great to deal with, and Vaalco hasn't had any problems there. He noted that Gabon is one of the more stable countries in Africa (as we mentioned in a previous post, "Vaalco Energy Reports"). Vaalco currently has an office in Angola as well, in support of its exploration there.

- Gerry estimated that the company would be able to maintain daily production rates of about 25,000 barrels through '09, but noted that its FPSO¹ would be about maxed-out at these levels. He mentioned that the rates to lease an FPSO currently average about $70,000 per day, but given the current correction in crude, these might start coming down at some point. If they do, he'd consider locking in low rates on one in advance.

¹Floating Production, Storage, and Offloading vessel -- see the image above, which comes from Vaalco's website.

Vaalco Energy Update

There have been a couple of news items on Vaalco Energy (NYSE: EGY) over the last two weeks that I hadn't gotten around to mentioning. Earlier this week, the company announced that it had hired a new CFO. Previously, Vaalco's president, Russell Scheirman, was also its CFO; as part of it settlement of a proxy fight earlier this year, Vaalco had agreed to split the roles. Last week, Vaalco released an update on its drilling and exploration program. Vaalco expects production of about 4500 barrels per day by January from its development well in the Ebouri field offshore of Gabon. That would raise Vaalco's total production per day about 22%, from 20,500 to 25,000. The company also offered these updates on its exploration program:

• Three exploratory wells in the Etame block: These wells include an appraisal well (North Ebouri) for possible expansion of the Ebouri field and two wells (North Etame and South East Etame) on newly mapped structures. Due to one of the Company's partners electing to go non-consent, VAALCO has increased its interest in the North Ebouri development well and in the South East Etame well to 44% from 30%. The jack-up drilling rig, Pride Cabinda, is now expected to be on location by November with drilling to commence shortly thereafter. The wells will be drilled back to back and have combined gross reserve potential additions in excess of 60 million barrels.

• Two exploratory wells onshore Gabon in the Mutamba concession: VAALCO remains on schedule to commence drilling the first of these two exploratory wells in December 2008, as previously announced. VAALCO has a 100% working interest in the onshore Mutamba block. Combined potential reserves for these wells are expected to be in excess of 30 million barrels.

• One exploratory well in Angola: The Company previously announced that it expected to move forward on the planning for a well on Angola Block 5 during the first half of 2009 depending upon rig availability. Due to rig demand, VAALCO now expects this to occur in the third quarter of 2009. The Company has recommended to the consortium a prospect with three objective zones, both above and below the salt layer on the block. Total potential from all three objectives is 150 million barrels. VAALCO has a 40% working interest in Block 5.
  
  
• Interest in North Sea: VAALCO has a 25% interest in a gas prospect on Block 48/25c in the British North Sea. The Company is participating with Century Exploration on the well, which is an offset to a former Shell gas discovery made in 1987. 3-D seismic data indicates the ability to get higher on the structure than the earlier well, increasing the potential reserves to 60 Bcf. VAALCO continues to expect that drilling will begin in the fourth quarter of 2008.

With about $103 million in net cash, Vaalco ought to be able to continue its exploration program without relying on external financing. Vaalco's share price has declined with the correction in oil: Vaalco closed at $4.59 today; when we last mentioned it here, in August, ("Vaalco Energy Reports"), it was trading at $5.69.

Edelheit Echoes Jim Rogers

Aaron Edelheit makes two predictions in a recent post ("Looking Out") on his blog; the second one echoes Jim Rogers:

I see two major sea changes coming due to the current financial crisis.

1) When things normalize in credit land (and it has already started normalizing, albeit very slowly), there is going to be a slew of M&A activity.

2) The next commodity bull run will be mind numbingly explosive.

[...]

The second point is based upon the printing of money and debasing of currencies from every major government in the world, combined with the fact that we are still in relatively short supply for most commodities once the world starts to grow again, I think the next run in commodities will be enormous.

[...]

The 1970s show us what can happen. Oil went from $1 to $4. Then pulled back to $2, before going to $20. Could $750 oil be in our future by 2015? I think its more likely than $20 oil.

$750 oil in 2015 seems unrealistically high to me -- I haven't heard anyone quote an estimate that high -- but I agree that oil will probably go significantly higher in the next several years. Of course, given the inherent operational leverage in commodity-producing companies, even a much more modest increase in oil prices would lead to large increases in profits. For a simplified example, consider an oil E&P with cost of production of, say, $40 per barrel (this is a lot higher than the cost of production of the E&P I own, Vaalco Energy, but it makes the arithmetic simpler). If oil prices go from $80 to $120, that would be a 50% increase in the price of oil, but that would represent a 100% increase in the (pre-tax) earnings of the E&P (assuming its cost of production and production rates held steady), since its profits per barrel would have doubled from $40 to $80.

Vaalco Energy Reports

Vaalco Energy (NYSE: EGY) reported income of $13 million per share, or 22 cents per share, for the second quarter, versus 6 cents per share in 2Q07 and 3 cents per share in 1Q08 (Vaalco's 10Q).

Vaalco is a Houston-based oil & gas E&P with most of its operations in West Africa, mainly in Gabon. Gabon, according to the CIA World Factbook, is one of the more prosperous and stable African countries, thanks to the combination of plentiful natural resources plus a small (~1.5 million) population.

In his book Untapped: The Scramble for Africa's Oil (pictured above), John Ghazvinian notes some of the attractions of West African crude: it's light and sweet (so it's cheaper to refine), and it tends to be easy to transport. The oil from Vaalco's wells off the coast of Gabon, for example, is pumped to Vaalco's FPSO (Floating Production, Storage and Offloading facility), and from there it can be taken by a tanker Northwest across the Atlantic to the U.S. No perilous journey through the Persian Gulf, or through a pipeline running through some former Soviet Republic. Another advantage, at least for the oil Vaalco is currently producing from Gabon, is low production costs. Costs averaged under $10 per barrel over the last quarter.

Vaalco has come down from its recent 52-week high of $8.99, as oil prices have declined, and at today's closing price of $5.69, it has a market cap of $336 million with about $100 million in net cash. Backing out that cash, it currently trades with an enterprise value about 7x its trailing twelve months earnings and about 6x an analyst's estimate of its '09 earnings. The company also has an exploration program expected to start this fall that could significantly increase its production and reserves.

Perritt on Micro-Caps

After a three month lag time, I received the semi-annual reports for Perritt Micro-cap Opportunities and Emerging Opportunities funds today. One statistic cited by Perritt portfolio manager Michael Corbett jumped out at me. Perritt broke down the performance of different market cap ranges within the Russell 2000 index and found that, over the 12-month period ending April 30th, 2008, the average stock in the $5 million to $295 million market cap range was down a 49.3%.

A couple of other observations from this report:

1) One of my current holdings, Vaalco Energy (EGY), was listed as one of the top ten holdings of the Perritt Micro-Cap Opportunities Fund. EGY was down today, with the pullback in oil prices.

2) One of the top ten holdings of the smaller (under $250 million market cap, if memory serves) Emerging Opportunities Fund looks interesting: Mitcham Industries, Inc. (MIND). It leases and sells seismic equipment of the sort used by oil and gas E&Ps on land and in shallow waters. The company has no debt, is trading at a little over 10x next year's earnings estimates, and has had recent insider buying, according to Yahoo! Finance. I'll have to keep an eye on this one.

What's Up Today: BPT, And a Few other Stocks

Despite the Dow moving into cyclical bear market territory today (closing at 11,346.51) and the decline of the S&P 500 and Nasdaq along with it, 15 of the 21 positions in my enterprising portfolio (my main stock portfolio; I am in the process of consolidating this into a more concentrated portfolio) are up today. I'm still down from my purchase price on many of these, especially the ones I bought last year, when I was still rigidly adhering to Joel Greenblatt's Magic Formula investing system (more on that in a later post), but the lack of correlation between this portfolio and the broader market indexes is partly a result of changes in my investment methodology over the last six months. Specifically, I began paying close attention to relevant macro trends for various stocks, and limiting my investments to those positioned to benefit from those trends. Some examples of those macro trends include the secular bull markets in energy, metals, agriculture, and the related infrastructure boom overseas, particularly in China.

One of the 15 stocks that is up today made a new all-time high, BP Prudhoe Bay Royalty Trust (BPT). Shares of this trust had been flirting with the triple-digit mark for the last few months, but finally closed above $100 per share today at $100.77. Despite the 50% total return for this trust over the last year, its stock still looks inexpensive, trading at only about 9x next year's estimated earnings. This is true, incidentally, of two other, radically different oil stocks I own: the integrated mega cap major ExxonMobil (XOM) and the small cap E&P Vaalco Energy (EGY) -- both trade with enterprise values at similarly low multiples to next year's estimated earnings. This demonstrates a point I and others have made recently, that despite the huge run-up in oil prices over the last year, the current high oil prices haven't been priced into many oil stocks yet. Perhaps this is because the biggest oil bulls have been investing in the commodity itself, via ETFs, and perhaps it's because many market participants believe oil will soon revert back to $70 or $80 per barrel.

Depletion is a concern for all American royalty trusts, of course, particularly one such as BPT that derives its royalties from a field as old as Prudhoe Bay. For detailed analysis and predictions on BPT's production and depletion rates, I recommend the occasional posts by "RoundRobinJack" on BPT's Yahoo! Finance message board. Here is a link to his latest Production/Distribution Update. More broadly, this man's posts demonstrate that although most comments on Yahoo! Finance message boards may be uninformed cheer leading, bashing, or just plain spam, occasionally you find an obviously knowledgeable poster whose comments are well worth reading. Just as with investing, sometimes you have to sift through the junk bin before finding something of value.

Of these three oil stocks, I currently have a GTC limit sell order on XOM. As Daniel Wahl has pointed out in correspondence with me, and in a post on his blog, integrated majors such as XOM have a few strikes against them, limiting their ability to benefit from the oil boom:

• Refining components. While the integrated majors may benefit on the exploration and production side of the business, their exposure to refining (where rising crude prices squeeze "crack spreads", i.e., profit margins on refined products) remains a liability.

• Their enormous size. This makes it difficult for new oil and gas discoveries to 'move the needle' in expanding the company's reserves.
  
• Their need (again, because of their size) to expand exploration and production in more politically unstable parts of the world, where their assets are subject to expropriation (e.g., as was the case with Exxon in Venezuela last year).
  

Despite these factors, I still think XOM is a value at these prices will probably do well over the next year. Nevertheless, I agree that there are investment opportunities in the sector with more potential, and the ideal sort of company to find would be an attractively priced small cap E&P with proven resources in a politically stable country such as the U.S. or Canada.