2021 Special #12 - Rex International

Why it is still cheaper to drill on the stock market!

Our previous reports had always avoided too precise a calculation but for an oil producing company, we cannot run away from some “serious” number crunching here.

We had ignored Rex when our system is blinking green at SGD 0.067 and now we are heading headlong at SGD 0.185?

It is always about greed and fear and we had fell into the greed camp in the last 2 weeks.

You are hearing from us on Rex because we realised we made a serious basic mistake while evaluating the company.

We hope we have rectified it here1.


This following company is place in the Statistical Strategy.

Arbitrage:

  • Valuation

  • Optionality

Type:

  • Trading

Possible Catalyst:

  • Increase in oil prices

  • or if luck permit hitting oil in their exploration activity.

Holding Period:

  • Up to 2 years (2023)

Weighting:

  • 2.5%


Rex International (Rex):

Rex is pretty simple. It could be divided into 2 parts

  1. Their technology platform

  2. Their exploration and production assets (in Oman and Norway)

    • Masirah Oil Limited in Oman

    • Lime Petroleum Limited in Norway

We will not talk about their technology or their exploration assets here.

They are interesting but there is no way to verify their value.

For this report, we will be first covering their assets in Oman before moving to analyse their proposed acquisition in Norway from Repsol.

Finally, we will move to put up a DCF valuation together to determine what price we should have bought.

“Should” because we had loaded up on the counter too quickly and too heavily.

Yes, greed do get the better of us.


Masirah Oil Limited (MOL):

Just to recap our “initial” thesis:

Rex International can produce between 10,000 - 20,000 barrels per day (bpd) from their Block 50 Oman Field. Their operating cost for the 3 “holes” which spill out the black stuff cost them USD 80,000 per day to operate. These are light sweet and that means that they fetch good price on the market. Assuming that oil is at USD 50 per barrel with 10,000 barrels of day production, Rex is minting USD420,000 per day in gross profit. Assuming that there is 300 days of production, that is a cool USD 126m gross profit per year. Other cost (administrative, exploration and taxes) may cost them another USD 60m bringing their cashflow to be around USD 60m which is around SGD 80m.

-Week 23

There is quite a bit of error from this initial back of the envelope calculation. The 10,000 barrel is gross (before Oman’s take) and we should be using net instead. 🤦🏻‍♂️

The formula for the Oman government take is not disclosed publicly but we can make some guess from the qualified person’s report (QPR).

So using the Current Report (MMstb) and the Gross Attributable to License, the net should be around 62.9% (=5.4/8.6).

Since Rex owns 86.37% of Masirah Oil Limited (MOL) which we must account for that later in the calculation as well.

Production Estimate:

MOL has upgraded the liquid capacity of its production facilities to 30,000 barrels per day (bpd) to cater to the increased production from the three Yumna production wells. As the production capacity include oil and water, we will expect the final production capacity to be much closer to 20,000 bpd than 30,000 bpd.

The three Yumna production wells were tested steadily over a week at rates of 20,000 bpd in March 2021, and the production rate had since then been optimised for maximum recovery.

-2021 AGM

The question is what is optimised for maximum recovery?

Through corresponding with Ms Lai Siong (IR for Rex),

  • Optimised for maximum recovery meant - the appropriate extraction rate from the reservoir through the management of technical aspects such as pressure and choke size in the wells.

For the 2P estimate (base rate), 2P reserves in the Yumna Field at 9.6 million stock tank barrels (MMstb) as at 1 July 2020, after producing 1.05 MMstb up to 30 June 2020. The reservoir should be sufficient to last for 3 years.

Using the average of number of bpd of the last 3 months(12,672, 12,210, 11,858) we will use that to project the bpd produced for the next two years. It will be imprecise but sufficient.

We will be using this estimate to do our discounted cashflow (DCF).

DCF Estimate:

The exploration wells were drilled for about USD 3.5 m each. We will conservatively assume that 3 dry wells would be drilled in a year and no discovery would be made at all.

Administrative cost will run up to USD 30m per year.

Using all these, we have a DCF of the Oman production in our case scenario (when all the other wells drilled turn out to be dry),

If the current reservoir runs out and the whole Oman field turns up zero oil…. Then that is what we have when oil is at USD 50. The current reservoir should be worth around USD 144m. Since oil is at USD 70, we can value it at USD 253m, but that is a projection with zero margin of error.

Damn, the back of the envelope calculation failed because we had failed to take into account the Oman’s take on the project which is close to 40%!

{Apology… We had screwed up here.}2

On the other hand, Rex had a wonderful track record in getting the right hole drilled so there is some reassurance there. But we cannot rely on hope but just rational valuation here.

But we have to yet looked at the new acquisition and that is what we are going to do next.


Lime Petroleum Limited (LPI):

They had just announced that they are buying Repsol stake in Brage Field in Norway.

Lime Petroleum AS had on 15 June 2021, entered into a conditional sale and purchase agreement with Repsol Norge AS (“Repsol”), to acquire Repsol’s 33.8434% interests in the Brage Field and five licences on the Norwegian Continental Shelf over which the Brage Field straddles, for a post-tax consideration of US$42.6 million. The Brage Field is operated by Wintershall Dea Norge AS.

Postive 1:

The deal is nicely structured with a very attractive valuation. If not for ESG pressure and/or corporate pressure to dispose of marginal field, we doubt Rex would be getting such a deal.

In 2020, about 3,800 bpd net to Repsol at 33.8434% interest were produced from the Brage Field. Although the Brage Field has been producing for a long time, work is still ongoing to find new ways of increasing recovery from the field. New wells are being drilled.

In 2020, Repsol’s interest in the Brage Field amounted to unaudited pro forma net profit before tax for FY2020 of approximately USD 21m. That meant that Rex is basically buying the field at 2x unaudited pro forma net profit before tax. No matter how you look at it, this is very attractive financial return.

2020 is a bad year generally for all the oil producers and with 2021 prices at a high, we are pretty sure that Rex is getting the field at less than 2x unaudited pro forma net profit before tax.

The Consideration, to be fully satisfied in cash, was determined based on a willing buyer willing seller basis, after negotiations between Lime Petroleum and Repsol and taking into consideration the rationale for the Acquisition and the value of deferred tax assets that can be used to offset against near term profits to reduce tax.

In addition, there would be a deferred tax assets and tax refund receivables of a total of NOK 644 m (approximately USD 77m) as at 1 January 2021 following the completion of the Brage acquisition.

Lime Petroleum’s manager of the senior secured bond issue of up to NOK 500m (approximately USD 60m) would be secured against the deferred tax assets and tax refund receivables from the Norway government making this almost risk free for the bond holders.

Postive 2:

Looking at the investment on the field, we notice that after significant investment in the field, there is often a decrease in investment in the next few years. We ran a correlation between yearly Brent crude prices against their investment and do not see any significant correlation. The investment is more likely due to the operational need of the field rather than the crude price.

The next few years in which Rex is vested in should come with less investment needs which should translate into higher returns.

The other worry is that the oil and gas is increasingly harder to to reach as Brage Field had been in production for a long time.

Looking at the 2021 February production numbers, there may indeed be some worry on that front. But production number is usually not predictable and we can only continue to monitor further.

On an average basis, the field is definitely not as productive as its initial years.

But on that basis, there is still a good 8+ years to go before the concession ends. So this will most likely be a highly accretive investment.

Postive 3:

Separately, Repsol has agreed to pay to (or on behalf of) Lime Petroleum, a Brage decommissioning carry limited to 95% of decommissioning costs for the current Brage Field infrastructure (the “Brage Decommissioning Carry”). The Brage Decommissioning Carry will be guaranteed by Repsol Exploración S.A., the parent company of Repsol, with a guarantee granted in Lime Petroleum’s favour on completion of the Acquisition. Most of the decommissioning is expected to occur after the expiration of the licences’ validity. At the end of Brage Field’s production life, Lime Petroleum will pay an effective 1.69 per cent of the total estimated decommissioning costs for the current Brage Field infrastructure, in respect of its 33.8434% interest in the Brage Field.

Best of all, Repsol is going to foot most of the bill for the decommissioning costs of the Brage Field infrastructure. That mean that there is minimal cost required at the end and that the ROI of the investment would be even higher!

DCF Estimate:

If we are to assume that pre-tax profit of USD 21m stays the same (we believe it would be higher at oil is no longer at USD 40). The interest rate on the bond should cost Rex slightly lesser than 10%.

Since the bond will retire within 2.5 years through the returns from the field, we will just use the return from the field minus the interest rate (USD 4m).

Since they have a deferred tax assets and tax refund receivables of USD 77m, we will assume that they will not be paying tax on the transaction.

At 90% ownership, the numbers should look like the below.

Valuation:

Using the valuation of MOL existing reservoir and LPI’s new acquisition from Repsol while excluding the possibility of any new oil discovery in Block 50, any monetisation possibility from the rest of the Norwegian fields held by LPI, the base valuation would be

Currently, Rex is valued at SGD 238m/USD 176m. Using the price of oil at USD 50, the conservative valuation should be USD 190m. Our margin of safety is much smaller than what we had expected…

If we take oil at USD 60, we will…

Nah, we are not going to go there.

Reflection:

Yes, we got lucky!

If not for the Repsol acquisition, we would have “overpaid” with zero margin of safety.

Looking at the price movement (prior to the announcement of the acquisition), our gut feel told us that something is brewing and that make us jump in quickly with that initial investment with some back of the envelope calculation.

We came up with an earning which seem incredulous and it had turn out to be really so.

The supposedly huge margin of safety turns out to be insufficient…

We looked into our database and realised that we had tracked Rex since 22nd September 2014. Our system highlighted Rex again in August 2019 but I did not investigate further. The shares are trading at SGD 0.067 then…

If you believe that oil prices will stay elevated at > USD 50, then the margin of safety is more than adequate, otherwise we would say that the market is pretty correct in its valuation of Rex.

On hindsight, we should have

  • bought slowly

  • in smaller quantities

  • put in a smaller weighting than what we currently have

But overall, this is the only oil producing company that we could understand.

If oil is still in use in the next 2 years, Rex will be vehicle we will be invested in (my vehicle will still be a petrol guzzling wagon in 2 years time).


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1

The article been updated for Rex ownership of 90% of Lime, increasing the discount rate to 10% on 4th July 2021

2

We had rectified the article on the 40% take by Oman on the publication of this article.