20 December 2010 / Company Appraisal IUrals Energy Speculative Buy 12.6p Theoretical ex rights price, EGM 30 th Dec 2010 AIM: UEN Sector: Oil & Gas Producers Share price performance 20 UEN.L URALS EN. ORD USD0.0063 (DI) 18 16 14 12 10 8 6 4 Analyst H1-2010 H2-2010 Source: Fidessa Julian Tolley (t) +44 (0) 207 382 8422 (e) julian.tolley@hbmarkets.com Key Data Broker: Website: Allenby Capital uralsenergy.com 12m High/Low: 19.25p 5.25p No. of Shares: 190.99m +52.42m Mkt. Cap: 24.83m + 5.76m Key Dates: Finals June 2011 Year end: December NMS: 25,000 Screen Size: 25,000 Bid/Offer: 11.5 11.75 (2.1%) No. Mkt Makers: 11. Urals Energy is a Russian oil and gas play with 2 exploration and production licences (Arcticneft to the North-West of Russia and Petrosakh on Sakhalin Island to the East of Russia) with production from refineries and infrastructure in place at both locations. Ural has recently raised 5.8m gross to enable the acceleration of exploration activities on its existing licences and the work-over and refurbishment of existing wells to enhance production. A debt restructuring and asset sales have transformed the financial situation and the group has net cash and positive cash flows from existing operations. The production reduces the risks while the group still offers exploration driven upside. With an increasing proportion of refined product that commands higher prices, and recovering production volumes as wells are revitalised, we see significant upside which will be extended by additional production from side-track wells into the existing known resources. We see a value towards 52p that successful exploration should enhance. Ural Energy s Assets: Urals has two E&P plays, a 100% ownership of Arcticneft in the Barents Sea (North West of Russia) and a 97.16% holding in Petrosakh in the Sakhalin island in the Sea of Okhotsk (East of Russia). The group operates the only oil refinery on the Sakhalin island. The Petrosakh, Sakhalin Island opportunity: Petrosakh is a Russian closed joint stock company formed in July 1991. Urals bought its interest in November 2004 for $46.9m net of assumed debt with the remaining 2.84% held by the administrators of Sakhalin Island. The opportunity includes producing assets with an E&P license that is valid till 31/12/2012 with the option to extend. Petrosakh - oil production already, to be enhanced by further drilling: The group is already producing oil at the Petrosakh from 20 wells, Sakhalin Island at a rate of some 1648 bopd. Mid November 2010 saw the group update on a side track well, 35b, which is already flowing at 152 bopd (included in the production figure above) which it may be able to accelerate with different pumping arrangements. The group will commence the drilling of the next side track well in January 2011. Petrosakh Resource Quantity of oil (MMbbl) Proved 12.0 Probable 4.0 2P Total 16.0 Possible 4.6 3P Total 20.6 Petrosakh high oil quality: The crude oil produced at Sakhalin island is light oil (36.5-37.5 o API), with low paraffin (1.08%) and sulphur (0.24%), which enables a premium of between $2- $3/bbl over the Dubai benchmark to be achieved. Petrosakh oil refinery: The group owns and operates the only oil refinery on Sakhalin island with a current production of some 4,200 bopd. The refinery produces diesel, gasoline, kerosene and fuel oil. Petrosakh established infrastructure: Petrosakh has 2 rigs with 80 and 100 tonnes capacity on the island. It has a rail terminal and oil processing facility with a capacity around 8,300 bopd. The group has current export crude storage facilities of 300,000 bbl and an oil product storage capacity of 64,000 bbl with 2 further 64,000 bbl units to be installed if required. The international sea terminal gives access for tankers up to 80,000 tons deadweight which enables the group to export up to 100% of production. 1
Petrosakh - production outlook: The group will drill a further 4 side-track wells on Sakhalin, undertake 5 additional perforations in pay-ones and convert 8 wells from gas-lift to artificial lift. The work programme on existing wells will combine with 11 new development wells to be drilled by 2013 which should see production lift from around 2,000 BOPD to an average of some 2,900 BOBD average for the 2011 year. Improving Petrosakh margin outlook: Petrosakh has reduced production costs from some $420,000 per month to slightly over $300,000 while overheads have proven stable over the last year at just above $100,000 per month. The group saw reining of crude oil reach 50% of output in 2010, with plenty of scope to push it further. The group has achieved certification of highoctane gasoline which began sales in June 2010. With further investment the group will be able to export the higher margin refined products as well as just crude. The Arcticneft opportunity: Arcticneft is a closed joint stock company formed in 1998 to develop the Peschanoozerskoe field. The E&P licence runs till 31/12/2067 and Urals acquired 100% in July 2005 for $23m net of acquired debt. Arcticneft is already producing with plenty of scope for enhancement of both production and reserves estimates. Arcticneft high quality oil: The Arcticneft oil is high quality, light oil (46.7 o API) with low sulphur content (0.075%) which achieves a typical premium of $1.2/bbl to the local Brent crude price. Arcticneft production: Arcticneft is currently producing 712bbl/day from a total of 24 active wells (total of 38) with artificial lift in use on most wells. Arcticneft has significant exploration upside: Arcticneft has significant upside on its resources;- Arcticneft Resource Quantity of oil (MMbbl) Proved 22.7 Probable 20.9 2P Total 43.6 Possible 20.5 3P Total 64.1 Arcticneft E&P capabilities: The group has 2 well service units with 40 and 80 tonnes capacity, a well pressure maintenance system that utilises high pressure deep water aquifers and a Russian drilling rig with capacity up to 260 tonnes and 5,000m depth. Arcticneft refining capacity: Like Petrosakh, Arcticneft has an oil refinery, though at just 440bopd it produces diesel, fuel oil and straight run gasoline mostly for its own needs and local sales. Arcticneft established infrastructure: In addition to the E&P capabilities described above, Arcticneft has an oil treatment facility with 2,025 bopd capacity, a crude oil export capability of 345,000 bbl with refined storage capacity of 50,000 bbl and a sea loading point that allows loading of tankers up to 80,000 tons. Arcticneft Development Strategy: The group expects to recommence drilling in 2011 with a target of 4 new development wells and 9 side tracks by 2013. The group stopped work on existing wells in 2006 so will recommence work-overs, reactivations and recommence pressure maintenance activities including 6 side tracks. There is also the potential to add to the E&P opportunity by bidding in future licensing auctions. 2
Group Financials: At the half year the group reported a return to operating profits that will complement the debt restructuring. The sale of producing assets in Eastern Siberia led to the reported decline in attributable production, revenues and costs. In addition the group took a $122m hit against the carrying values which we strip out in the reported numbers below. $000s 6 months to 30 June 2010 6 months to 30 June 2009 Year to 31 December 2009 Sales volumes (bbls) 210,385 552,865 876,000 Gross revenues 11,690 15,140 68,989 Net revenues (-taxes & duties) 11,078 15,086 50,881 Gross profits 2,561 5,587 8,669 Gross profit margins (based on net) 23.1% 37.0% 17.0% Impairment charges 0 (122,127) (122,127) Selling & admin costs (4,467) (10,386) (21,342) Other op costs 3,640 0 (2,749) Underlying op profits/(losses) 1,554 (4,799) (15,421) Reported op profits/(losses) 1,554 (126,926) (137,548) (Loss) from disposal of assets 0 (1,090) (31,647) Net Interest 969 (56,563) (87,793) Forex loss (1,554) (3,881) (3,256) JV investment value movement 0 (237,585) (234,106) Movement in financial derivatives 0 (40,480) 161,300 Profit/(Loss) before tax 969 (466,525) (333,050) Income tax benefit 589 26,538 29,035 Post tax profit/(loss) 1,558 (439,987) (304,015) Arcticneft gives a weighting to second-half results: Arcticneft only ships during the July to December months and this year saw no shipments in the first half, though there were some 47,200 tons of crude oil in stock. The group has now made two shipments in H2, 26,800 tons in August 2010 and 25,999 at a $82.744/bbl in October 2010. Debt restructuring: Key debt, to Petraco, was renegotiated to a long term basis to 2013 which the group is meeting from oil sales. As part of the deal Petraco converted some debt into 8.69m new shares and has the option to acquire a further 12.58m shares for $5m - (approximately 25p per share). Although the group ended the June 2010 period with net cash of $2.4m, that masked the Petraco debt which stood at some $2.32m with some $7m due in less than 1 year. Petraco recently agreed a modest delay in a debt repayment when the October crude shipping from Arcticneft was delayed, suggesting on-going support for the group from a key lender. Future repayments on the loan are due as follows:- $8m by Dec 2011, $11.7m by Dec 2012 with the remainder to be repaid by December 2013. Ural s Energy Valuation: Below we show the table of total attributable reserves of the 3 main classifications allowing for the Petrosakh holding of 97.16%. Resource Group Total (MMbbl) Value $/bbl Un-risked value $m POS % Risked value $m Proved 34.4 10 344 90 309.6 Probable 24.8 5 124 20 24.8 2P Total 59.2 59.6 468 334.4 Possible 25.0 1 25.0 5 1.3 3P Total 84.2 84.7 493 335.7 Net Present value assuming 10 year life and 12% WACC 202 NPV/Share (at $1.6: 1) 52p + HB Markets estimates 3
Ural s Energy upside: The valuation makes no allowance for higher achieved prices from the increased sales of refined products which will sell to local markets or the potential for higher oil prices in the future, the potential for lower operating costs per barrel or work-overs and production increases from existing assets. The 5.8m placing enables the group to accelerate the exploration activity and the refurbishment of existing wells which should see significant increases from 2,000+ bopd to a target of 5,150 bopd by the end of the 2013. Strengths Weaknesses Existing production Arcticneft dependent on shipments in just half the year Exploration upside on known oil Exploration has only recently stopped fields, well 35b already flowing production declines from the older wells Increasing sales of refined products Needs to generate in excess of $35m increasing margins over the next 3 years to pay off the Petraco debt. Previous Recommendation: None Ural Energy s operational asset locations Source: Urals s Energy 4
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