Monday, October 25, 2010

The Absolute last post on Petrobank

This is my absolute last post regarding Petrobank to Devin on 

The second half of the post is about value investing for those who don't care for the details on Petrobank.

I quote again:

1) Mr. Graham missed two thirds of their Bakken assets. The 2P number which is all Mr. Graham used in his valuation work is derived only on wells drilled to date. Petrobakken has 1,050 drilling locations in the Bakken. The 2P number that you used is based on 348 wells drilled. That is 33% of their Bakken assets. The Bakken of course is a well known play, and these drilling locations are in the known to be in productive Bakken acreage. These are ultra low risk drilling locations. By ignoring them Mr. Graham is ignoring 67% of the value of Petrobakken’s Bakken properties.

I am going to explain this as clearly as I know possible. I will break it down.

The 2P number which is all Mr. Graham used in his valuation work is derived only on wells drilled to date.


The 2P number that you used is based on 348 wells drilled.

The 2P number I quoted includes all 384 wells you said have been drilled (I will take your word for this). Beyond, that they have booked 297 PUDs. These wells have not been drilled. This will be drilled in 2010, 2011 and 2012. Beyond that they have booked 180 probable wells. These wells have not been drilled. This will be drilled in 2010, 2011, and 2012, but more likely in the later timeframe.


348 wells already drilled + 297 PUDs (not drilled)+ 180 probables (not drilled) = 825 wells.

Please read the report and confirm this for yourself. Don't take my word for it.

I appreciate your new tone and I will try to be more civil as well. Next statement (from your last comment).

I think your valuation of this company is way off and I think that is fairly obvious to most readers. Stop trying to focus on whether the reserve report says 477 wells or 384 wells and apply common sense.

You thought my valuation was incorrect because you weren't aware that 477 undrilled wells have already been booked. Secondly, why should I stop using reason and apply common sense. I am trying to breakdown what the value is and isn't. Since the 2P reserves does include 477 undrilled wells then my analysis is the best we both have to go on. Can't you see that. You seem to imply that common sense is some sort of sixth sense where we percieve the value. Economics are economics.

I can tell that the prices I'm paying for PMG and PBN are at the worst fair and very likely a nice discounts.

Thanks for the admission of fair value. I will also go on the record and state that I believe the company is fairly valued. That said, they are trading at fairly significant premiums to the 2P reserve value so the wells they are currently drilling must perform better than what they forecasted.

You also state the Petrominerales has made a significant discover, which is why they are trading where they are. I will take your word on it, I will ready what the reserve report says next year to confirm it as so. So at best PBN & PBG are trading at fair value but are at a 50% premium to reserves value so they better deliver the goods. I just don't have that much faith in the company.

As for the heavy oil and THAI, you need to be very careful with the contingent resources. THAI is unproven and the heavy oil business is tough and in many cases borderline economic. It is very capital intensive compared to conventional wells.

With all that said, this is not a value investment by no means. A lot of expectations are already built into the prices so I don't see the value.

Back in 2001 you could buy oil and gas company's by the handful for 2P reserve value. Some could be had for just proven producing value (just the wells on production). Companies that operated in less politically unstable regions traded at steep discounts because of the additional risk. Someday they will trade at those levels again. Resources and gold have been the hot stocks lately.

Markets overshoot and then undershoot. Everyday the Market votes on the value of these companies but in the long term the Market will weigh the real value in these companies by the cash they produce. They better deliver.

The biggest reason it is hard to value the company is because PBG cannot control oil prices. Nobody knows where oil will be 3 years from now. Now for Walmart, I can reasonable guess what their earnings will be 3-4 years from now because they are very predictable. Degree of difficulty doesn't pay in investing, pick something simple and easier to value. This is what Buffett calls jumping a 1 ft bar, and recognizing what you know vs what you don't know (circle of competence).

As you know, I have already offered one original value idea on my blog. It's trading at 4x normalized earnings, and bleeds free cashflow. Hardwoods is a very simple company that has been selling wood for 70 years. I will bet on a company like that any day of the week than one that is so difficult to predict. Feel free to pick it apart. I would like to know if I am missing something.

I am moving on because I have to read the Kraft annual report. Been meaning to read it for a while.

Good luck with PBG!


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