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Ishan Majumdar
Ishan Majumdar
Articles (68)  | Author's Website |

Indonesia Energy: A Cheap Oil and Gas Stock With Strong Unit Economics

In the current bear market, the company has lost a large chunk of its value, but its fundamentals are strong

March 20, 2020 | About:

With the coronavirus-related fears causing markets to crash across the globe, almost all sectors have been affected. Oil and gas are no exception to this. The Brent Crude price has fallen below $3,0 which can largely be attributed to an ongoing price war between de facto OPEC leader Saudi Arabia and the non-OPEC leader Russia.

On March 6, Russia refused to sign OPEC's proposal of deeper production cuts to ensure crude oil price stability while claiming the $30 level as a comfortable level for them. This price crash, coupled with the coronavirus situation, has affected several oil-dependent economies such as Saudi Arabia, Iraq and Algeria. Even the U.S. oil majors, such as Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP), have each lost more than 50% of their value.

In such a scenario, investors are waiting for a reversal and a recovery, which seems imminent as the coronavirus infection rate across the globe is slowly flattening. In such an environment, it is important to keep an eye on promising stocks and start accumulating them at low prices to maximize  gains when the reversal takes place.

In my view, one such attractive target is an interesting new micro-cap pick within the oil and gas space, Indonesia Energy Corporation (INDO).

About Indonesia Energy

Indonesia Energy is an oil and gas exploration and production company focused on the Indonesian market. The company was recently in the news for its initial public offering of about 1.36 million shares and its listing on the NYSE American LLC Exchange at the end of December 2019, which was right before the novel coronavirus (Covid-19) was first identified. Unsurprisingly, the stock has taken a beating along with the rest of the market in the past couple of months owing to weakened investor sentiment, but the business fundamentals remain strong.

Indonesia Energy boasts three main assets – Kruh, Citarum and Rangkas. While Kruh is a stable, oil-producing, cash flow-positive asset with about 29 drilled wells, the company is at the development stage with respect to the Citarum property, which has a proven hydrocarbon presence and is located hardly 16 miles from Jakarta. The management is close to commercializing Citarum and is also exploring the Rangkas province, which has a proven petroleum system and numerous oil and gas seeps. It appears to be a matter of time before these assets start generating strong cash flows for the company. The fact that it operates in a high-demand Indonesian market that has not been hit too badly by Covid-19 is a big positive in favor of the company.

A strong macro environment

Being based in Indonesia and catering to the local oil market demand works significantly in favor of the company. Not only is Indonesia among the less affected nations by the coronavirus, but the country’s oil consumption is also 1.78 million barrels per day, and its year-on-year natural gas demand is growing at the rate of 6.3% whereas its total energy demand is growing at 5.3% per annum. The following chart throws some light on the rapidly increasing oil consumption in Indonesia:

The oil consumption is largely driven by a huge population of about 262 million people, the fourth largest in the world. Historically, Indonesia has had a fantastic exploration drilling success ratio of over 60%, and these factors are the reason why the country has many global giants with operations on the islands. Some of the big names include Chevron and ExxonMobil (XOM).

There is solid government support as well. Indonesia has the concept of a Production Sharing Contract (“PSC”) mechanism based on the sharing of a “Gross Production Split.” This gives oil and gas companies flexibility in their operational activities and allows them to focus on cost efficiency and reducing delays. The government is expected to continue its involvement in approving key regulations of upstream business developments (i.e. from the PSC award up to production).

Kruh – Indonesia Energy’s biggest cash cow

Coming back to Indonesia Energy and its core assets, let us first have a look at the company’s biggest asset that is already producing oil – Kruh. Kruh is a block located in the southern region of the Sumatra islands, where the company is already able to produce oil after having drilled 29 wells and generated close to $3.5 million of revenue and $2.1 million of net cash flow in the very first year of operations.

Indonesia Energy has a 100% participating interest in Kruh, and its contract is expected to last for an additional 10 years until 2030. There is an immense amount of untapped potential in Kruh, and the management claims that it can generate close to five million barrels of crude oil from the region. With about four active wells as of today, the company is in the process of drilling nine additional wells in 2020. Their goal is to drill an additional nine wells over 2021-2022, which would result in an average drilling cost of $1.5 million per well. The unit economics is strongly in Indonesia Energy’s favor as they expect to drill more than 300 barrels per day and incur a variable production cost of $21.34 per barrel. Given the fact that the current oil prices per barrel is about $30 despite the recent crash, it implies strong profitability for Indonesia Energy from the Kruh region alone.

Other high potential assets

Citarum is the second core asset of Indonesia Energy, but it is still at the development phase and hasn’t started production yet. Spread across an area of nearly one million acres near Java, Citarum is virtually a risk-free asset for the management. The company has a significant edge with respect to the development process at Citarum, as it was previously managed by Pan Orient Energy Corp, which had invested as much as $40 million on development in this block and had already drilled four wells and discovered natural gas. The successful discovery of these hydrocarbons is the reason why the management considers this asset risk-free. The location of the asset and the oil and gas fields around can be better described in the graphic below:

The third high potential asset is the Rangkas area, another block of almost one million acres, which is adjacent to Citarum. The best part about Rangkas is that it is a proven hydrocarbon generating province as a result of the numerous oil/gas seeps within the block. Also, there are multiple sub-basins from geophysical data showing the potential for higher chances of multiple hydrocarbon accumulations in this region. It is a matter of time before the company can start the development process within this region as well.

Why is Indonesia Energy resilient?

The management team of Indonesia Energy recently announced that despite the recent drop in oil prices and the global outbreak of the novel coronavirus, the company remains on track to move forward with its 2020 plans to drill and complete six new production wells on its Kruh block. This comes as big positive news, especially given that many oil and gas companies in the United States and across the globe have announced the suspension of drilling operations on their uneconomic assets.

On the other hand, Indonesia Energy is making the best use of its IPO proceeds from December 2019 to continue drilling at the same rate in the Kruh block in the second quarter of 2020, concurrent with the previously announced renewal of the company’s operator contract with the Indonesian government. This block has the potential to generate an average production cost of only $21.34 per barrel, which could go lower as per the company’s experts pushing a strong gross margin. This makes the company highly resilient to the current market situation.

Key takeaways

Indonesia Energy has lost a large chunk of its valuation in this crisis and is available at pennies on the dollar today. However, it is worth mentioning that I believe the company is strong enough to weather the storm. In the current environment, it is hard for investors to be confident about any stock while seeing the broad indices like the Dow Jones and the S&P 500 losing in double digits every week.

However, such times present an opportunity to start adding promising stocks to one’s watch list. In my view, Indonesia Energy deserves a place on the list of all growth-oriented, micro-cap investors who are comfortable with the risks associated with pink sheet investments. The management needs to continue delivering strong communication to the markets regarding the progress of the well-drilling in Kruh and Citarum in order for the stock to start its recovery..

Disclosure: No positions

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About the author:

Ishan Majumdar
I am a qualified Chartered Accountant with a Masters in Management (Grande Ecole) from HEC Paris. I run a proprietary boutique financial advisory firm called Baptista Research (www.baptistaresearch.com) specializing in M&A, corporate advisory, equity research and valuation of listed companies.

I have nearly a decade of experience spread across investment banks, financial advisory firms, investment funds and other corporates in many different geographies, such as France, Spain, India and others. I was a part of the LBO Financing team at BNP Paribas where I worked on deals with a combined enterprise value of over $1 billion. I have also worked in mergers and acquisitions with Credit Agricole CIB and corporate strategy with Groupe Danone SA. Over the years, I have developed a strong specialization in corporate valuations, strategy and financial analysis.

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