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13 February 2009
COMPANY STATISTICS:
Shares Out basic: 110.9
Energy -- Oil and Gas, Exploration and Production
Market Cap (M):
Ent Value (M):
C$17.2
C$5.7
INITIATION OF COVERAGE - THE VAST
52-week Range: C$0.10 - 1.40
POTENTIAL OF KURDISTAN
EARNINGS SUMMARY: We are initiating coverage on Vast Exploration Inc. with a
FYE Jan 2007A 2008A 2009E SPECULATIVE BUY rating and a 12-month target price of C$0.25.
Production (boe/d): 0 33 43
Revenue (M): C$0.285 C$0.484 C$0.855 The Asset
Income (M): C$(2.583) C$(5.965) C$(8.306)
EPS basic: C$(0.15) C$(0.14) C$(0.09) Vast Exploration completed a Production Sharing Contract (PSC) with
CFPS basic: C$(0.08) C$(0.05) C$(0.02) the Kurdistan Regional Government (KRG) in May 2008 for exploration,
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Daily Letter | 2
13 February 2009
COMPANY OVERVIEW
Vast Exploration is a Canadian-based, small cap international E&P. The company is
managed by Forbes & Manhattan Inc. (a private merchant bank operating in the U.S.,
Canada and Western Europe). Vast trades on the TSX-V under the symbol “VST”.
The company has a small production base of approximately 45 boe/d (60% natural gas)
from the Boyer area of Alberta. But Vast’s prime area of focus has shifted to Kurdistan,
Iraq. Vast entered into a Production Sharing Contract (PSC) in Kurdistan in May 2008,
following a competitive eight-month bidding process. The company is partnered with Niko
Resources (operator) and Groundstar Resources on the Qara Dagh Block. Niko is the
company’s largest single shareholder, holding approximately 19% of Vast’s shares
outstanding.
KURDISTAN
Vast Exploration completed a Production Sharing Contract (PSC) with the Kurdistan
Regional Government (KRG) in May 2008 for exploration, development, and production of
the 846 square kilometre Qara Dagh block with consortium partner Niko Resources as
operator on the block. This PSC allocates 27% net interest to both Vast and Niko
Resources, 6% net interest to Groundstar. The remaining 40% is broken into 20% direct
investment for the KRG and 20% interest reserved by the KRG to assign a third party by
January 14, 2009; however, with this deadline passed, the government is now into a 90-
day extension period upon which it still has the right to assign the remaining 20% interest.
The Qara Dagh block includes a 390 square kilometre region with existing oil seeps, is
located on tread with existing discoveries and in near proximity to the prolific Zagros Fold
Belt (which contains the significant Kirkuk field in Northern Iraq).
Commitments under the PSC are divided into an exploration period and a development
period. The exploration is sub-divided into two periods, which will be referenced to as
sub-period 1 and sub-period 2. Sub-period 1 is three years in length (set to expire on
May 14, 2011) and contains the following commitments:
b. field work comprising structural, stratigraphic and lithologic mapping and sampling;
c. acquire, process and interpret 300 line km of 2D seismic data for a minimum of
US$6 million;
After sub-period 1, the consortium can notify the government if it does not intend to
proceed. However, if it chooses to go ahead, at the end of sub-period 1, the consortium
must surrender 25% of the net area (determined by subtracting any production areas
from the initial contract area) to the Government. Sub-period 2 is two years in length (set
to expire on May 14, 2013) and has the following commitments:
Any excess work committed above the requirements of sub-period 1 can be applied to
meet the minimum commitments of sub-period 2. Following the completion of sub-
period 2, the consortium must surrender an additional 25% of the net area (determined
by subtracting any production areas from the initial contract area) to the Government
again. If there has been no commercial discovery made on the block during the five-year
exploration period, then the PSC will terminate. The caveat being that if a discovery (not
commercial) is made, an extension to the original agreement may be granted in order for
the consortium to determine if the discovery is commercial or not. Moreover, the
consortium must surrender all areas that are not deemed a production area at the end of
the exploration period.
The development period is set for 20 years following the date of announcement of
commercial discovery, with an automatic five-year extension period. This can be
extended a further five years upon the request of the consortium.
Terms of the PSC include a 10% royalty payable immediately to the KRG on oil
production in the Qara Dagh block, with the remaining net available oil subject to a
division into cost recovery oil and profit oil. The cost recovery limit of net available oil for
the consortium is 43% for expenditures incurred by the consortium including capital
expenditures, abandonment costs, operating costs as well as production and signature
bonuses. The total profit oil is then apportioned between consortium and the KRG based
on the sliding scale of 32-15% as cumulative production increases over time.
Presently, a letter of intent has been executed with Niko Resources for the acquisition of
350 kilometres of 2D seismic, with seismic surveying for the Qara Dagh block expected to
begin in early 2009. Vast is also in discussions with neighbouring operators and service
companies on potential rig availability for Q3/09.
VALUATION POTENTIAL
Vast Exploration shares are currently trading at a premium to our estimate of year-end
2008 working capital of $7.1 million or $0.06 per share. The company has no long-term
debt. The current share price premium over its working capital position represents the
option value of the reserve potential on the Qara Dagh exploration block in Kurdistan. At
its current share price, the value of this option is approximately $12.3 million. We
estimate that expenditures to-date for Vast to be approximately $27 million.
Vast Implied value - simple ratio of relative working interest in an exploration Block
Vast's 27% relative to Talisman's 40% - USD 108.5 167.9
Vast's 27% relative to Talisman's 40% - Cdn$ 135.6 209.8
Figure 4 above illustrates what the Talisman transaction implies for a “block” value and
takes the ratio of Vast’s 27% working interest to our calculation of Talisman’s implied
acquisition price for its 40% of Block 44. This approach results in a valuation range of
$0.68 to $1.04 per share (undiluted). We understand, and would caution that the
prospectivity of the two blocks may not be comparable, nor might be the chance of
success. At the time of Talisman’s working interest acquisition, the Sarqala-1 well had
been drilling for approximately six weeks. In addition to the straight up comparable
valuation, we have also indicated what a pro-forma diluted value for Vast might be,
assuming that an additional $100 million would need to be raised to successfully exploit
a success. The values range from $0.25 to $0.74 fully diluted.
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13 February 2009
Figure 5: Vast Exploration - Valuation potential under Generic PSC scenarios and - $40/b and $60/b flat oil price scenario
Canaccord's - Generic PSC Valuation (US$ million ) Lower Reserve Case Higher Reserve Case
$40/b flat $60/b flat $40/b flat $60/b flat
At 10% A-tax 693 1,136 2,757 3,617
At 12% A-tax 612 1,026 2,515 3,280
At 15% A-tax 509 884 2,208 2,854
At 18% A-tax 422 765 1,954 2,504
At 20% A-tax 372 696 1,808 2,304
Unrisked Diluted Value at 18% A-tax Lower Reserve Case Higher Reserve Case
Price of additional shares issued ( $/share) mmshrs $40/b flat $60/b flat $40/b flat $60/b flat
$0.15 833.3 $0.14 $0.25 $0.64 $0.82
$0.20 625.0 $0.17 $0.31 $0.80 $1.02
$0.30 416.7 $0.23 $0.42 $1.07 $1.37
$0.50 250.0 $0.32 $0.57 $1.46 $1.87
Unrisked Diluted Value at 20% A-tax Lower Reserve Case Higher Reserve Case
Price of additional shares issued ( $/share) mmshrs $40/b flat $60/b flat $40/b flat $60/b flat
$0.15 833.3 $0.12 $0.23 $0.59 $0.75
$0.20 625.0 $0.15 $0.28 $0.74 $0.94
$0.30 416.7 $0.20 $0.38 $0.99 $1.26
$0.50 250.0 $0.28 $0.52 $1.35 $1.72
Figure 5 illustrates the results of our lower and higher case reserve scenarios from our
generic PSC valuation model under flat oil prices of $40/b and $60/b. We would note that
under the assumptions in Figure 5, the unrisked reserve value to Vast Exploration,
excluding its working capital, ranges from $0.63 to $1.91/share under our lower reserve
case to a range between $3.04 to $6.08/share under a higher reserve scenario. To
account for the fact that additional financing would be required, we have provided what
the diluted impact would be on this unrisked valuation under a range of assumed share
issue prices and discount rates of 15%, 18%, and 20%. While significant upside exists, it
rests more with the higher reserve case than the lower reserve case. In addition, the
potential dilutive effect is equally significant. Our analysis is not to suggest a more likely
reserves outcome than the other, and is unrisked. It is also not meant to indicate the
range of expected values. The expected values would also include various degrees of
success as well as 100% failure. In the event of a failure to fund its current obligations,
we would caution that Vast’s participating interest in the Qara Dagh block may be
subject to penalty provisions as is common in other agreements.
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13 February 2009
CAPITAL REQUIREMENTS
Capital expenditures for the first nine months of Vast’s fiscal 2009 year totalled $19.0
million. The company incurs negative cash flow as revenue from its marginal production
in Alberta is not sufficient to support its current foray into Kurdistan. Vast funds its
capital program primarily through equity raised. Most recently, Vast issued a $35 million
bought-deal financing connected to its PSC in the Qara Dagh block in June 2008. The
company issued 58.3 million units, with each unit comprising of one common share and
one-half of a share purchase warrant, exercisable at $0.90 per share.
At the end of October 2008, the company had a cash balance of $11.2 million. In
November 2008, Vast projected an 18-month capital program of US$85 million for the
block, which will include: signature, capacity building and community support bonuses;
training, technological and environmental fund contributions; its planned seismic
program; and drilling of one exploration well. Vast’s share of capital cost (interest plus
government carry) works out to approximately $26.6 million. Based on the
aforementioned information and assuming the KRG assigns the remaining 20% interest
in the block, we estimate Vast will require $15 million of additional capital to complete
its committed Kurdistan program.
Clearly, the ability of Vast Exploration to sustain its asset position in Kurdistan is
predicated on its ability to secure additional funding on a reasonable and timely basis.
Investment risks
Risks to our investment thesis include, but are not limited to operating risks inherent in oil
and gas exploration and production activities. Oil and natural gas price realizations and
production may be lower or higher than our forecast. Without limitation, other risks
include:
The long-term commercial success of the company is its ability to find, acquire and develop
resources and reserves. There is no assurance the company will be able to locate
satisfactory properties and resources. We also note that with any company's petroleum
reserves, any such calculations remain dependent on long-term oil pricing, geological
assumptions made, and the company's ability to produce said reserves.
There is no resource estimate associated with the Kurdistan properties available at this
time, given the exploratory nature of these assets. Therefore, we note that the values used
carry a higher risk level than an independent third-party engineering evaluation. There are
also risks associated with replacement of reserves required to sustain the long-term growth
of the company.
Development risk
The company's value lies predominantly in the development and production of oil and gas
projects that carry completion risk. Delays in the development schedule or increases in
capital requirements, for example, may negatively impact our suggested valuation.
Country risk
Some or all of the company's exploration, producing and potential producing properties
are located in Kurdistan, Iraq. The company's operations and financial results, and hence
our valuation of the resource and company, could be adversely, or positively, affected by
events beyond its control taken by the current or future governments in that country.
These events could include, but are not exclusive to: changes in government policies,
adverse legislation in Iraq and/or the Kurdistan Region, social instability, risks of war,
terrorism, expropriation, nationalization and renegotiation or nullification of existing
concessions and contracts.
Economic risk
Our suggested valuation is impacted by our long-term price assumptions for oil. Volatility
in crude oil and natural gas prices could materially affect the company's financial
performance and, therefore, the accuracy of our estimates. Our discount rate assumptions
are intended to reflect recent increases in the equity risk premium for the market;
however, different discount rate assumptions could materially change our net present
value calculation.
Funding Risk
Vast's primary assets are the cash on its balance sheet and their rights to their exploration
block, and thus face the additional risk that upon success and during appraisal and
ultimate development, additional funding will be required. In the current environment,
such funding may or may not be available or may only be available at a price that is
substantially dilutive to existing shareholders.
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13 February 2009
Site Visit: An analyst has not visited the company's assets or operations.
Canaccord Ratings BUY: The stock is expected to generate risk-adjusted returns of over 10% during the next 12 months.
System: HOLD: The stock is expected to generate risk-adjusted returns of 0-10% during the next 12 months.
SELL: The stock is expected to generate negative risk-adjusted returns during the next 12 months.
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