Analysis of Tethys Oil, 2017

Tethys Oil is an oil producer and a mid-sized Swedish company, operating in Oman. The company is listed on the Stockholm Stock Exchange. In Oman, a license is held for a 29.130 square kilometers large field, where the production is approximately 12.300 barrels of oil per day (bopd). Tethys Oil has a strategy of acquiring licenses onshore, where oil has been discovered previously, but was deemed non-commercial for production. Yet, it has one of the lowest operating costs today in the business – creating a positive cash flow even in these unfavorable times of Paris Agreements and US tight oils. Tethys Oil has a megatrend working against it, but the question is:

Can it produce a significant enough cash flow to be a great investment choice, before oil becomes obsolete?

Continue reading this analysis of Tethys Oil (or scroll down to the end if you are too exited already) to get the answer!

 

Products

The business model of Tethys Oil is:

Acquisition –> Exploration –> Drilling –> Appraisal –> Development –> Production –> Acquisition

Tethys Oil owns licenses in Oman, France and Lithuania, but the primary production happens in Oman. Together with two other partners, Mitsui E&P Middle East B.V. and CC Energy Development S.A.L., it owns the rights to extract oil from a 29.130 square kilometers large field. The license was acquired in 2007 and is effective until 2040. Tethys Oil holds a 30% share.

As you can see, oil is flowing in Lithuania as well, but it’s a neglectable amount.

Oman is estimated to hold more than 5 billion barrels in reserves, and is therefore ranked as the 23rd largest oil reserve holder in the world. For Tethys Oil, the production comes from two different blocks – 3&4 – and from three different fields within those blocks – Farha South, Shahd and Saiwan East.

These fields hold a total of approximately 21,5 mmbo (million barrels of oil), in proven and probable reserves.

Farha South is the largest field (in reserves), but the Shahd field is catching up. Even though oil is constantly being produced at the fields, the reserves are continuously increasing. This is because new reserves are being discovered, both outside of current fields, but also in formations below or above existing ones. In 2016 the reserve replacement ratio was 171%, which shows how robust the fields are. Moreover, only 20% of the total license has been explored so far.

New discoveries are constantly searched for with 2D and 3D seismic surveys. Lately, 3D has been preferred over 2D as it gives a much more accurate picture of the formations. It costs 10x but gives 100x better data (yea …. roughly speaking).

There’s a difference in the quality of oil being produced at the fields, and the production also comes from different layers in the ground. The quality of oil is measured in API, and the higher the better. A higher API means that the oil is less dense. For comparison, Brent has an API of 38,3 and WTI has an API of 39,6. The price also depends on another factor – whether the oil is sweet or not. Generally, the oil in the Middle East tends to be sour, which gives a lower price.

On average, Tethys’ oil … Tethys Oil’s oil … the petroleum that Tethys Oil produces, sells for approximately the same price as the standard benchmark Brent. Since its two largest fields have a high API close to, or above that of Brent, I think we can expect this in the future as well.

Production amounts to 12.495 bopd (barrels of oil per day) in the first quarter of 2017. This is an increase of approximately 300% since Q1 2012. On a yearly basis, at this rate, the company uses 20% of its reserves.

The strong production growth has recently been haltered by the Oman Ministry of Oil and Gas, as Oman has followed the OPEC direction of cutting down oil production to increase prices. Tethys Oil’s recommended level for the first six months of 2017 has been set to 12.300 bopd. The deal has, as of 25th of May, been extended by 9 months, to March 2018.

Tethys Oil has a deal with the Omani government that allows it to recover costs up to 40% of the value of its oil production. After that, the government takes 80% of the oil produced as a tax. For Tethys Oil, the effect has been that 52% of the production belongs to the company every year, and I would expect this to continue. That is, if oil prices stay at a lower level. At USD 100+ per barrel we’ll probably see a different company/government split, but at that point it would be a luxury problem for Tethys. And for me as a shareholder too (ooops, spoiler).

There’s room for more production from existing wells, as water injection (a method for increasing production levels) hasn’t been developed for all of them. Moreover, a new well called Erfan-1, south west of Saiwan East, has been drilled successfully recently, with oil flowing from a deep structure called Khufai.

Market

According to the International Energy Agency (IEA), the demand for oil mainly comes from the transport segment – with 64,5% of the final consumption. 16,2% is from non-energy use, such as plastics, road tar and fertilizers. 8% is for industry use and 11,3% belongs to the category “others”, which means agricultural and residential energy use (among others).

IEA forecasts that oil demand will increase until 2040. The increase will be driven by usage in freight, aviation and petrochemicals, where alternatives are scarce.

OPEC thinks that (unbiased of course) demand will rise until 2040 as well, mainly driven by an increasing population and urbanization in Developing countries.

The World Bank forecasts that, by 2030, crude oil prices will be at USD 80 per barrel.

Tethys Oil has a significant advantage over its competitors in that its situated in one of the cheapest countries in the world for oil production. In 2016 the operating expenses per barrel were USD 8,2 and in 2015 they were USD 12,1 per barrel. In the US, on the other hand, production costs are usually USD 35+ per barrel, which makes a substantial difference in when oil can be produced profitable or not (hopefully, for Tethys Oil, creating a minimum price where oil basically can’t become cheaper).

The major threats for oil prices are:

Executives & Employers

The board and the executives have an insider ownership of 5% in total. This is a little bit low to me, which is a negative sign. But Jesper Alm, the CFO, recently used all his 48.000 warrants from a stock option program to acquire the same number of shares in the company. This is an increase in total insider ownership of about 2,6%, which is a positive sign. No other insider trading has occurred since the beginning of 2015.

The executive group consists of CEO Magnus Nordin, earlier mentioned CFO Jesper Alm, and the CTO, Fredrik Robellus. All of them have relevant backgrounds and experiences for their positions. And they should, as their salaries are high for a two-billion-dollar company. Magnus Nordin has about USD 500.000 yearly, while Jesper Alm and Fredrik Robellus share about USD 700.000. Regarding staff in general, a majority have graduations from colleges and universities, primarily within business, engineering and geoscience.

Valuation & Key financials

Key ratios aren’t as useful to look at for Tethys Oil as for the previous companies that we’ve analyzed – MSAB, CellaVision and BioGaia. That’s because this is primarily a bet on the oil price. P/E 18,7 or ROA 4,5% doesn’t mean too much, because if the oil price jumps, they will be on a completely different level (and the opposite will happen if oil prices shrink). It’s impressive to see that the company has been able to grow the revenue by 22% per year on average since 2012 despite the crash of the oil price though.

Some financial ratios are still interesting, in my opinion. All of them are at healthy levels. Tethys Oil is almost 100% financed by equity capital, which is a great indication. With oil prices at historical lows, licenses should be cheap to buy as well. Tethys has room for some loan-financed growth in that way, and the company has communicated recently that it is indeed looking to extend the business. The only thing in the balance sheet that isn’t great, is the small cash position of 17% of the total assets.

During 2016, a miscalculation was discovered regarding the quantity of delivered oil from Blocks 3&4. There’s been an over-report due to this, and Tethys Oil has been selling more than it has delivered. The company repaid this during 2016, which reduced the yearly revenue and profit by USD 5,9 million.

 

Risks

Tethys Oil is strongly exposed to political decisions in Oman. As of now, there’s a production restriction of 12.300 bopd, in line with the OPEC production-cut. Since the deal has been extended until March 2018, the restriction might stay for as long, or even longer. Additional discoveries on Block 3&4 should allow Tethys Oil to increase its production anyways, but not at the same pace as otherwise. Another risk is if the Omani government decides to change the current deal with the company. For now, Tethys usually receives 52% of the production (effectively), but that might not be the case in the future if regulations are changed.

Another risk, and a quite obvious one, is the dependence on the oil price. Even though Tethys Oil is in an advantageous position here, being one of the producers in the world with the lowest operational costs, it will be difficult to stay cash flow positive if the price drops below, say, USD 30 per barrel. I find this specific scenario very unlikely, but a lower oil price than today could be a possibility.

As of now, Tethys Oil’s production is approximately 20% of its reserves. Should the company not find any more oil on Block 3&4, production will stop in 5 years, which would make for a bad investment case. Considering the high replacement ratio of 171% in 2016, and that only 20% of the license has been searched with seismic surveys, it seems unlikely. Nevertheless, it should be considered a risk that Tethys Oil might have been drilling in the areas where oil is most likely to be found, and that the remaining 80% of the license is less attractive – either in the amount of reserves, or in that it will cost more to produce there.

The two partners on Block 3&4, Mitsui E&P Middle East B.V. and CC Energy Development S.A.L., are very important for Tethys Oil. Mitsui is a huge player in the world, and seems to have good financials – with positive cash flows and strong financial key ratios. The debt/equity-ratio of 1,88 might be too high, but apart from that it’s fine.

CC Energy though…

It’s a privately held company so it’s difficult to find any data on financials. Around 50% of its total production comes from Block 3&4, so 50% of the company should be performing like Tethys. The other 50% of operations is in Oman as well, so my educated guess is that CC Energy is doing fine too.

 

Invest?

Some of my assumptions for the DCF:

  • I’ve used the World Bank’s forecast for oil prices until 2030
  • Production increase of 5% yearly, which is conservative considering prior growth and the future potential of Block 3&4
  • Operational costs of USD 11 per barrel. This, I think, is also conservative, since the operational costs of 2016 were USD 8,2 per barrel.
  • Yearly decline of 5% from 2030 and onwards, which gives me quite a small “infinity value”
  • Investment costs in line with last three years average, relative to number of barrels produced

With these conservative assumptions, Tethys Oil still manages to give me a healthy safety margin for my required 15%+ in yearly returns.

The riskiest assumption is the forecast of the oil price. The World Bank could be wrong, but it might be wrong on the upside too. In my DCF, the 15% yearly return will be broken if the oil price is 17% lower than expected, on a yearly average.

It’s not possible to exclude this option. The World Bank could be wrong, most likely they will be. The question is just in what magnitude, and in which direction? Anyways, this is the reason why Tethys Oil as an investment case doesn’t get 4+ in this analysis.

My final verdict is 3,5/5 Volvo cars. Old-style, petroleum-fueled ones.

What do you think about the oil market? Will peak oil be reached way before the 2040-mark that OPEC and IEA estimates? And what did you think about this analysis of Tethys Oil? Let us know in the comments!

For more investment tips, fueled by subscriptions and shares, stay tuned!

NOTE: I own Tethys Oil as of 6/8-17, and I will buy some more (like a 25% increase) on 7/8-17. (Hopefully before this post starts to impact the stock price).

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