Tap Oil upgraded

Falling commodity prices and rising fear have seen commodity stocks, from gold and nickel to zinc and energy, mercilessly sold off. In many cases, this is entirely justified. In others, a lower share price offers an opportunity. Tap Oil is one such case.

Tap’s share price has fallen 31% in less than a month, a time during which the company has seen setbacks and progress. The hotly anticipated Tallaganda well returned inconclusive results. As reported on 24 Apr 12 (Hold - $0.78), gas was discovered but well operator BHP Billiton is yet to determine flow rates. Testing will take some months but we don’t anticipate a favourable outcome.

Tap’s asset base has changed dramatically. The company has sold its stake in the declining Harriet Joint Venture, including an attached insurance liability and shutdown costs. The company also offloaded a 10% stake in the Finucane oil discovery. With its primary producing assets now sold, fixed price gas contracts will be the sole generator of cash for the next two years.

If exploration has failed, existing assets sold and production all but halted, why buy Tap today? As always, the decision comes down to issues of price and value.

Asset valuation

Table 1 tallies up what Tap’s remaining assets might be worth. Gas contracts will generate about $30m a year for another two and a half years. We value these at around 25 cents per share. Tap’s main asset, the Manora oilfield in Thailand, should start to produce in 2014. Having established 6m barrels of proven and probable oil reserves, we value the undeveloped project at about 20 cents per share with the $90m of net cash valued at 32 cents per share.

For valuation purposes, cash should be treated with caution. It’s included in this case because we’ve valued Manora as an undeveloped asset. Over the next two years, cash will be spent developing it, depleting the current cash holding but, assuming all goes well, increasing the value of the oilfield as it starts production.

The Zola gas discovery is valued at 20 cents per share but could be worth far more. Tap and its partners will drill ‘look-a-like’ structures nearby that hold the promise of more gas. Fresh drilling in 2013 will confirm the ultimate size of the gas field, with a decent chance it could double.

If so, development options are likely to involve one of several nearby LNG projects. The cost and timing of such a development will probably mean Tap will sell its Zola stake long before it enters production. A larger Zola could be worth far more than the value ascribed to it in Table 1.

An intelligent speculation

Tap also holds promising tenements in offshore Ghana, where a string of new discoveries have been made. As a drilling partner is still needed, we won’t ascribe any value yet. Corporate costs of 16c per share also need to be deducted from the total valuation.

Totting up those assets and costs results in an estimated value of about 80 cents per share. Today’s price of 64.5 cents, then, makes a compelling case, especially considering the conservative value ascribed to Manora and Zola.

Tap remains a speculative situation. Development needs to progress successfully and some luck with the drill bit wouldn't hurt either. But at current prices, investors are being well compensated for those risks and the upside remains large. Tap offers exactly the kind of asymmetry that should delight intelligent speculators. Consider the portfolio limit of 2% but Tap Oil is once again a SPECULATIVE BUY.

Note: The Growth portfolio owns shares in Tap Oil.