Barron's: Africa's Fields of Dreams

Anadarko's West African Assets
(Click to Enlarge)

From BARRON'S (via Dow Jones Newswires), Oct. 19, 2009

Until relatively recently, big oil gave little thought to sub-Saharan Africa beyond the coast of Nigeria and Angola. That's changing rapidly after a significant find off the Atlantic coast of Sierra Leone, where both Anadarko Petroleum and U.K.-based Tullow have exploration licenses, and another strike in Uganda, where Tullow operates.

Their stocks have jumped sharply this year, mostly on the prospect of world-class fields. Tullow shares, upover 100%, have returned to 2008 highs set when crude was about twice today's $78 a barrel, but Anadarko, up 73%, remains below its 2008 high. So the questions are, how much oil is there, and is it reflected in the stock prices?

This prospect will be more definitively appraised as new wells are drilled over the next 12 months, but there is a persuasive case that the potential could top a billion barrels in West Africa. If that proves out, as bulls predict, then shares of Tullow and Anadarko remain undervalued, even after the run-up. Tullow's main trading is in London, where the stock closed Friday at GBP 12.36; Tullow's U.S.-traded shares, each equal to 10 U.K. shares, finished at 204. Anadarko closed around 67.

One of the wells generating the excitement, called Venus, hit more than 45 net feet of hydrocarbons off the coast of Sierra Leone, Anadarko said last month. It's 40%-owned by the U.S. company and 10% by Tullow. Few holes have been poked in the new West Africa prospect, so Venus' location is key, creating a possible bookend that -- with the large Jubilee field at the prospect's other end off the coast of Ghana, discovered in 2007 -- suggests the entire 1,100-kilometer coast could hold hydrocarbons. The other recent significant strike, made by Tullow, is in the Lake Albert area of Uganda.

It's difficult to estimate, but "Venus shows there is a working petroleum system and opens up the potential for more discoveries [along the Sierra Leone-Ghana coast] to be full of oil," notes Christopher Brown, the lead analyst for sub-Saharan Africa for Wood MacKenzie, an Edinburgh-based energy-and-resources consultancy. At minimum, the exploration licenses to drill in that region are more valuable than they were six months ago, he adds.

Wood MacKenzie doesn't comment on how much oil is in the entire prospect, but Anadarko and Tullow's analysis says the Jubilee field, in which they own 24% and 35% stakes, respectively, holds anywhere from 600 million to 1.8 billion barrels.

Earlier this month, that field received a big boost from ExxonMobil, which is reportedly battling China National Offshore Oil Corp., or Cnooc, to buy effectively a 23.5% stake held in Jubilee by Kosmos Energy at a price of $4 billion. The Jubilee field is expected to come online in the third quarter of 2010 and eventually produce 120,000 barrels a day.

"I don't know if you can get a better vote of confidence than that," says Oswald Clint, a London-based Sanford C. Bernstein analyst with an Outperform rating on both Tullow and Anadarko. Given Exxon's traditionally conservative approach, it suggests Jubilee is profitable at significantly less than the current oil price.

The bookended wells, says Sreejith Banerji, a Vontobel portfolio manager and former oil and gas engineer, mean "it's more than speculation [now] . . . . There is a very high chance of a significant resource." Banerji still calls Tullow's stock cheap. "It's doubled, but off very depressed levels." Vontobel, which according to Bloomberg owns about 140,000 shares, hasn't sold into the rally.

Anadarko's global head of exploration, Bob Daniels, a 25-year oil-patch veteran and geologist, says the company is looking at 30 well leads similar to Jubilee. Using the low-end estimate for Jubilee, and Anadarko's average 33% well success rate, "you can easily get to six billion barrels," he says.

It could take years to prove that number, if ever, and it isn't reflected in the stock prices. The oil majors ignored the area, so Anadarko and Tullow managed to secure "unmatched" acreage in this new play, adds Stephen Thornber, a money manager who specializes in energy for Threadneedle in London, which is maintaining an over 10 million-share stake in Tullow. Meanwhile, Tullow found oil in Uganda, where few thought there was any, he notes.

In that East African nation, Tullow has found about 700 million barrels of oil -- though the entire amount hasn't been audited -- not including the Ngassa well find announced last month. Tullow's head of exploration, Angus McCoss, says there's probably another 1.5 billion barrels to be found in Uganda and that Tullow is looking for a partner to bring its Ugandan finds into production. The company's entire drilling needs are financed through the end of 2010, and he adds Tullow's total production should grow from 60,000 barrels of oil equivalent a day to 200,000 BOE a day "in the short- medium term."

What's the potential value of this to Tullow and Anadarko? Bernstein's Clint, who holds a Ph.D. in geophysics, says Anadarko's stock is cheaper than Tullow on price-to-cash-flow metrics and multiples based on reserves. At year end 2008, Anadarko reserves were 2.3 billion BOE, compared with 314 million BOE for Tullow.

However, since Tullow is much smaller-a $16 billion market capitalization, half the size of Anadarko -- Tullow is heavily leveraged to West Africa. Should a gusher come, the U.K. stock could rise sharply again, and more than Anadarko. Conversely, Tullow is more vulnerable if and when dry holes are drilled and could fall more than Anadarko. Indeed, last Thursday brought news of a dry hole drilled off Cote d'Ivoire, and Tullow's share price duly fell 2%.

Clint estimates that wells being drilled in Ghana, Cote d'Ivoire and Sierra Leone over the next 12 months could bring 1.36 billion BOE net to Tullow and 0.92 billion BOE for Anadarko. That's 64 times Tullow's 2009 production and 4.5 times its reserves. His base-case net asset valuation is GBP 14 a share for Tullow in 12 months, which doesn't include new leads to be drilled in West Africa.

Anadarko's larger reserve base means this same success would equate to four times current production and 40% of proven reserves, says Bernstein, whose target price is 85.

Some analysts say Tullow's stock fully reflects what is known. The caveat is clear with any oil explorer: "If they drill dry holes, the stock will fall," says Threadneedle's Thornber. "If we thought the story was exhausted we would have trimmed, but there is still upside."

Political risk is another worry. The nations involved range from stable countries to fledgling democracies. Cote d'Ivoire is troubled by political tensions and violence, notes Philippe de Pontet, an analyst for political-risk consultant Eurasia Group. Even relatively stable Uganda has been hit by political turmoil recently. That can make drilling more difficult, but political uncertainty isn't unusual for oil-rich areas.

For Tullow and Anadarko, there are likely to be ups and downs, but this once-overlooked West Africa prospect should bring much more investor clamor to both over the next few years.  

Copyright (c) 2009 Dow Jones & Company, Inc.

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