Zenith Energy Ltd (LON:ZEN) (Zenith) is an oil and gas production company incorporated in Canada and dual-listed in London and Toronto. Zenith’s strategy of investing in low costs producing assets with relatively material upside potential, culminated in the recent award of a PSA in Azerbaijan for the redevelopment of mature onshore assets with potentially material remaining oil resources. Meanwhile, Zenith Energy Ltd (LON:ZEN) has continued to pursue a measured development strategy in Italy, centred around monetisation of gas resources. We estimate a potential upside of up to 41p (C$0.66) per share, based on third-party reserves assessment and recognising the risks and challenges facing Zenith Energy Ltd (LON:ZEN) in Azerbaijan. We believe that Zenith’s strategy to own its rigs is a critical risk-mitigating factor for the project, whilst management’s ownership of c. 20% of the equity provides perfect alignment of interests with shareholders.
On 16/3/16, Zenith entered into a Rehabilitation, Exploration, Development and Production Sharing Agreement (REDPSA) with the State Oil Company of Azerbaijan Republic (SOCAR) and SOCAR Oil Affiliate (SOA). Following Cabinet of Ministers’ approval (25/4/16) and Parliament ratification into law (14/6/16), the official handover of the assets to Aran Oil, a newly incorporated operating joint venture between Zenith (80%) and SOA (20%), was completed on 11/8/16. The REDPSA has now the dignity of an Ordinary law in the Civil Code of the Republic of Azerbaijan, and consequently cannot be cancelled or rescinded unless for reasons of extreme gravity.
The REDPSA area (Muradkhanli Contract Area) has a duration of 25 years, with a possible additional 5-year extension to be approved by SOCAR, and covers some 642km2 in the lower Kura Basin some 300km West of Baku, the capital city. The Contract Area covers the largest onshore oil fields discovered in Azerbaijan, Muradkhanli, Jafarli and Zardab, which have been producing since the 1970s (Figure 1).
The low bound of the EV/2P multiple range (0.25) equates to a value for Zenith of about 5.7p, whilst Zenith’s current share price equates to an implied EV/2P multiple of 0.40.
We arrive at a valuation of 45p, based on the median value of the range which equates to a value of 91p and subsequently discounting it by 50% to account for the financing as well as execution risks inherent in Zenith, which might not be the case for some of the companies within the peer group.
Our value estimate of 41p (C$0.66) is based on the average of SOTP and multiple based valuations.
The risks attached to this valuation are the uncertainty regarding the reserves estimates, the ability of the operational and management team to deliver these reserves through increasing production, and finally the ability of management to raise the capital necessary to execute the work programme in a context of an uncertain and potentially weaker oil price environment.
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