|
This 20-cent stock could be the next Hurricane:
Buy Nelson Resources as an highly speculative play on Kazakh oil
by James Passin
If you watched or participated in Hurricane Hydrocarbons’ (HHLF:OTC) incredible recovery from US$0.25 to US$5.75, then you have learned one thing: there are fortunes to be built in Kazakhstan. Despite appreciating 20x from the 1999 low in less than 2 years, Hurricane is trading at only 2x earnings — revealing the sheer magnitude of profits available to oil operators in Kazakhstan. Despite steady growth in production, Hurricane has also grown its reserves — demonstrating, among other things, the benefits of applying Western technology to Kazakhstan’s massive hydrocarbon deposits.
One of the most important factors behind the turnaround in Hurricane was the acquisition of the Shymkent oil refinery. Central Asian Industrials Holdings (CAIH), an entity associated with Kazkommertsbank (KKB:Berlin), which is the largest bank in Kazakhstan, sold an 88% stake in the Shymkent refinery to Hurricane in exchange for 30% of the equity of the merged company. The deal resulted in huge stock market gains for both CAIH and minority investors in Hurricane.
 In July 2000, I discovered that CAIH was negotiating a reverse-merger deal with an obscure Toronto-listed gold company. The Kazakhs agreed to inject three oil fields into Nelson Resources (NLG:Toronto) in exchange for 70% of NLG’s equity. Given CAIH’s track record with Hurricane, I decided to immediately build up a position for my fund. Having just returned from a due diligence trip to Kazakhstan, I am now in a position to disclose the details of my research into NLG.
NLG currently trades around US$0.20. My twelve-month target is US$0.50, based on a US$50 million valuation for the gold operations, a simple US$1/bbl net reserves calculation, and the assumption that the company issues another 100 million shares to raise working capital. My three-year target is US$1, based on my assessment of the cash flow potentials of Alibekmola, Tenge, and the gold operation, as well as upside from future acquisitions.
National treasure
Alfred Nobel, who prospected in the Caspian region when he wasn’t filing patents in Europe, was involved with the first search for oil in what is now the Aktobinsk Oblast in Kazakhstan. The first discovery was made in 1907. The giant Zhanazhol field, which is now controlled by Chinese National Petroleum through its supermajority stake in Aktobemunaigas, was discovered in 1978. A number of other substantial fields have subsequently been delineated in Aktobinsk.
Aktobinsk is close to the Caspian Sea, where the giant Kashagan and Tengiz fields are located. Massive pipeline capacity is being constructed near Aktobinsk to provide export routes for Caspian oil. The Caspian Pipeline Consortium is expected to be online by July 2001. A pipeline already runs from Aktobinsk to the Orsk refinery in Russia. Oil is also exported via tanker through the renovated Aktau reloading facility.
Alibekmola is one of the largest fields in Aktobinsk, with an estimated half a billion barrels in recoverable reserves (for licensing purposes, the Alibekmola and Kozhasai fields are consolidated). Test wells reportedly have revealed high-quality oil with low sulfur content. Several oil majors have allegedly attempted to acquire Alibekmola, including Amoco (before the merger with BP) and Lukoil. Government officials have called Alibekmola one of Kazakhstan’s “national treasures.” I have been told that Alibekmola was the last major unclaimed hydrocarbon structure in Kazakhstan.
In February 1999, the Kazakh government decreed that Alibekmola would not be made available for foreign development, as it was considered a “strategic” state reserve. The licenses were transferred to Kazakhoil, the state-owned national oil company.
In March 2000, NLG announced that it had signed a preliminary term sheet with CAIH to acquire 50% of Alibekmola. In July, NLG announced that Korinth, an entity associated with Halyk Savings Bank, the largest savings bank in Kazakhstan, would join the deal on equal terms with CAIH. Korinth is associated with Timur Kulibaev, the president’s son-in-law. Kulibaev also controls Kaztransoil, the national oil and gas pipeline monopoly (a critical piece of the NLG puzzle).
The final deal, which was approved by shareholders, gave CAIH and Korinth each 35% of NLG on a fully diluted basis in exchange for 50% of Alibekmola, a 31% call option on the estimated 100 million barrel Tenge field, and US$15 million in cash. The deal left old shareholders with 30% of the company — a generous deal that transferred massive value into the stock.
Magic shell
Before the deal, NLG was a penny stock with a deteriorating balance sheet. I am not going to use the term “shell,” since most shells don’t own a 3 million ounce gold reserve base or mine 80,000 ounces per annum. With its large mining operations in Tajikistan, NLG is a significant junior gold company. NLG traded at US$2 in 1996 based only on its gold assets. The collapse of gold has hurt NLG’s cash flows.
As an unhedged producer with low-grade gold ore, NLG is highly leveraged to the gold price. NLG owns 44% of Zeravshan Gold Company, which holds licenses to the Jilau and Chore/Taror gold mines. As operator, NLG retains 90% of the cash flows generated from the mines.
NLG’s gold operations have just turned cash-flow positive. Since the gold mines do not consume cash, you can view them as call options with no expiration. Eventually, there will be a sustained recovery in the gold price. I personally believe we are close to a major bottom in gold. Once sentiment towards gold begins to shift, there will be a massive rerating in gold-related assets. The biggest gains will be in unhedged juniors with large, low-grade reserves and current production. If the market valued NLG’s gold reserves at only US$40/ounce, NLG’s gold operations would be worth US$120 million — the current market capitalization of the entire company.
While gold production is not currently a fashionable business, NLG is one of the gold industry’s rare Central Asian success stories. Howard Miller, the founder of NLG, will head the company’s mining operations from Almaty. NLG’s controlling shareholders are in an unrivalled position to find and secure attractive precious metal assets in Kazakhstan. It is my belief that NLG is committed to building and monetizing a massive pan-Central Asian mining business.
Caspian tide
I met with Kong Teck Soon, the new CEO and chairman, in Almaty. Mr. Kong has an outstanding reputation in the oil industry and a 35-year track record of developing successful oil projects in difficult operating environments. After meeting with Mr. Kong, I firmly believe that the interests of NLG’s management are aligned with the interests of minority shareholders.
The development of the massive offshore Kashagan field and the completion of the CPC pipeline should keep Kazakh oil in the front-page news. Bush and Cheney are eager to foster the development of oil supplies outside of the Middle East, including the Caspian. If oil prices remain reasonably robust (and, call me crazy, but I believe they will), then Western investors may look for stock market plays on Caspian oil. I anticipate that a number of triggers could ignite interest in NLG over the next twelve months.
Don’t invest if you can’t take the risk
NLG is a very, very risky stock. It is a penny stock with 600 million shares outstanding, fully diluted (I would anticipate an eventual 10:1 reverse split). The stock is utterly illiquid and may be extremely difficult to sell. NLG needs to raise several hundred million in debt or equity to begin production at Alibekmola. Kazakhs control at least 70% of the shares. The board of directors is currently controlled by Kazakhs. As a development-stage oil company, NLG is highly vulnerable to a downturn in world oil prices. Given the prominent political connections of NLG’s controlling shareholders, the stock is particularly vulnerable to any unforeseen political turmoil. There is very little detailed information about Alibekmola’s or Tenge’s geologies in the public domain.
But, for my money, the low price of NLG more than balances these risks. If you wanted to acquire a 50% interest in Alibekmola, you would have to pay far more than US$120 million in upfront cash. Unbelievably, by buying NLG at the current US$120 million market cap, you not only get a 50% interest in Alibekmola, but you get a 31% interest in Tenge and 3 million ounces of gold in Tajikistan.
While Kazakhstan-related stocks are regarded as “risky” investments, they can’t be any riskier than U.S. tech stocks, which are riddled with more corruption, incompetence, and insanity than I have ever seen in so-called emerging markets.
You should thoroughly review the company’s filings on www.sedar.com and contact the company directly with questions before trading the stock. Nelson trades under NLG on the Toronto Stock Exchange or NLRRF on the Pink Sheets. I would recommend keeping a close eye on the stock to take advantage of any exaggerated volatility in the share price.
For more information, contact Nelson Resources Ltd., 2nd Floor, 18 Maddox Street, London, W1S 1PJ, England, tel. +44-20-7496-4991, fax +44-20-7497-4992.
|
