Heritage-Genel Deal, Possible Addax Acquisition, Raise Potential for New Frontier Valuation

HeritaGE Takes Shape

The reverse takeover of U.K.- and Canada-listed Heritage Oil by Turkey's Genel Enerji inked yesterday provides the first instance of proper upstream asset acquisition in Iraqi Kurdistan and might herald a renewed flow of investment into the autonomous Iraqi region, following a recent deal between the Kurdistan Regional Government (KRG) and Iraq's central government allowing the region to commence oil exports (see Iraq: 28 May 2009: Who Gets the Money as Iraqi Kurdistan Starts Crude Exports?). With the inflow of oil investment into Iraqi Kurdistan—considering the political risk involved—hitherto having been almost exclusively made up of wildcatters and small non-risk-averse independents, a political breakthrough on the issue of regional oil and gas autonomy and export rights is likely to lead to a number of larger investors looking to enter the region through acquisitions and farm-ins, as the original explorers feel the need to raise development funding and lower their risk exposure.

Heritage, which is likely to have made a very significant discovery on its Miran licence and is currently conducting tests, has estimated its in-place Iraqi Kurdistan reserves at somewhere between 2.3 billion and 4.2 billion barrels, with a recovery rate likely to be within the 50–70% range. Genel Enerji is not a Iraqi Kurdistan newcomer itself, however, having entered the region as one of the original four IOCs taking up acreage—before the central Iraqi government and the KRG fell into dispute over the control of the region's resources. With the reverse take-over, Genel Enerji will complement its 44% working interest stake in a joint venture (JV) with Addax Petroleum on the Taq Taq field, and a 25% stake in the DNO-operated Tawke field (as well as stakes in some other exploration permits where exploration work has yet to start or is in its early phases), with Heritage's Miran licence discovery, where it had a 25% working interest before the reverse takeover. This makes Genel Enerji one of only three companies with significant cash flow from Iraqi Kurdistan since exports started last week, as production at Taq Taq is being ramped up to 40,000 b/d—with a likely plateau production target of about 180,000 b/d within 12–18 months—and the Tawke field is producing close to 50,000 b/d, which is likely to double within a year.

The reverse takeover is structured in such a way that Heritage Oil will acquire Genel Enerji's full share capital through a new share issuance, making Genel Enerji's shareholders 50% owners of the new HeritaGE Oil. Genel—which is owned by Turkey's Cukurova Group, in turn controlled by Turkish tycoon Mehmet Emin Karamehmet—has access to significant funding abilities but will also in effect gain access to Heritage's listing. The combined companies' size is also likely to lead to a relatively swift inclusion of the company in the United Kingdom's FTSE 100 index of leading shares, further opening up potential funding and project finance-raising opportunities. Outstanding issues to be resolved between the companies, however, include the question of Genel's US$1.1-billion liability to the KRG for long-term infrastructure projects, of which US$605 million is currently payable and US$495 million is to be paid from future profits.

Uganda

Heritage's other main asset is the acreage it holds in East Africa: specifically exploration areas (EAs) 1 and 3A in Uganda, which have had six large discoveries out of the six wells drilled there. In January this year Heritage announced a world-class oil discovery in EA1, with the Buffalo-Giraffe complex having initial estimated reserves of over 400 million barrels. Tony Buckingham, CEO of Heritage, commented at the time that the discovery could prove to be substantially more extensive than outlined, unlocking the multi-billion-barrel potential of Block 1. Heritage has announced that it plans to appraise the discovery and intends to drill at least three more wells in EA1 before the end of the year.

Crucially, this deal puts Heritage on firmer financial footing, as further exploration followed by development work would require considerable funding. There has been speculation over the past year that Heritage would look to divest itself of its Uganda assets, but it appears the company wants to remain in East Africa, which could also become a major new play. Heritage also holds the exploration rights to prospect for oil in eastern Democratic Republic of Congo, although it will be many years before serious evaluation work can commence due to the security situation in that part of the country.

Addax Rumors

Meanwhile, rumors have abounded in the marketplace about Genel's Taq Taq field partner, Addax Petroleum. The Swiss-Canadian outfit is significantly larger than Heritage and is widely believed to have attracted interest from East Asian energy companies. China's CNPC and Sinopec have been mentioned, although their stated interest in bidding for upstream licences in Iraq's imminent first licensing round make this somewhat uncertain, given that KRG investors still are being blacklisted and banned from investment in Iraq proper by the Iraqi Oil Ministry. Reports in the U.K. daily Financial Times, however, earlier this week singled out the Korea National Oil Corp. (KNOC) of South Korea, which has already incurred the wrath of Iraq's Oil Minister Hussein al-Shahristani by being one of the few non-minnows investing in acreage in Iraqi Kurdistan.

Companies from China and South Korea already have significant interests throughout West Africa and could be looking to acquire Addax Petroleum's assets in the region to secure future fuel supplies. Addax has made a reputation for itself in the past few years as a strong niche player in the Gulf of Guinea, with attractive assets in Nigeria, Gabon, and Cameroon. Despite the West African region being dominated by the supermajors, the company has proved itself there, and has a number of exciting prospects set for development. The potential prized asset, however, is the acreage in the shared Joint Development Zone (JDZ) offshore Nigeria and Sao Tome and Principe. Addax Petroleum holds a 14.33% interest in Block 2, where it has reached an agreement to work with the block operator, Sinopec. It also has a 15 % stake in Block 3, while it is the operator of Block 4 and holds a 38.3% participation interest. It also acquired ExxonMobil's 40% interest in Block 1 in September 2007. Exploration has been slow, with only one well drilled in the JDZ. This was in 2006 by Chevron; the well did not meet expectations, although it did discover hydrocarbons.

Outlook and Implications

Clearly the HeritaGE deal is centred on Iraqi Kurdistan, but it remains unclear what the company plans to do with its other main asset. The drilling results in Uganda have been very successful, but it will take until the middle of the next decade to realise value and monetise its reserves, as a 1,200-km pipeline would have to be constructed in order to transport the oil to a port on the Indian Ocean. One of the key questions will be whether the new HeritaGE Oil now wants to remain in Uganda and develop this project, or whether it will look to sell on the attractive, if medium-term, asset.

The acquisition of Addax Petroleum would suit any Asian NOC looking to build a broader deepwater Gulf of Guinea portfolio. The Nigerian and Sao Tome JDZ assets could be a major source of new reserves, but exploration is at a very early stage there. In fact, due to its offshore location and the vast amounts of funding it would take to develop such assets, a state-backed firm may well be the most apposite player to acquire Addax Petroleum's African oil assets. Addax's lucrative position in Iraqi Kurdistan, however, suggests that the buyer would be likely to be someone uninterested in investment in Iraq proper, thereby excluding the Chinese companies, which have stated their interest in participating in the first Iraqi upstream licensing round later this month. Were any of them to acquire Addax, they would not have time to divest the KRG assets before being excluding from the bidding by the Iraqi Oil Ministry. For KNOC on the other hand—which is already blacklisted in Iraq proper after having invested in the region and has been a relative latecomer in securing access to African upstream acreage—the investment could be seen as a well-fitting one indeed.