Wednesday, February 23, 2011

Petrobras -- Economics of Deep Sub-Salt Operations Hinges on Cash Costs per Barrel

Petrobras´ market value is nearing $250Bn which is fairly high but if (the key) is ´the cash costs of the deep sea oil per barrel. PBR is spending at least $174Bn to develop this (one of the largest capital projects in history, ever).

I did a quick calcuation of the payback period of the deep sea oil costs. The estimate is that initially the deep sea will produce an additional 2 million barrels of oil -- quick calculation, assuming a profit per barrel of $40 after direct operating costs = $29.2Bn of profit per year, or a 5.96 year payoff period -- this is at the high end of aceptable levels of payoff, in which oil and gas firms want payoffs to be below 5 years.

If the profit after operating costs is $60, the payback period drops to 3.94 years. Need to find better data on direct operating costs. If it is only costing PBR $20 to hire workers, equipment, power, water, foodservice etc then this isn´t bad at all (since the deposit is likely very large and will last for decades)(the price of oil should be in the $70-90 range for a while).

One more note: I did find data that at least at Tupi the gas/oil ratio is 15-20% -- majority oil (perhaps the pressure maintains the longer hydrocarbon chains). In geological theory, the deeper the deposit, the hotter and the more the longer hydrocarbon chains will have been broken to form natural gas, but PBR seems quite confident the deposit is mainly oil (of course natural gas is cheaper currently and less profitable and also is much more difficult to transport from offshore locations).

Polyus -- High Reserves but Some Operating Problems

I did some more research on Polyus and they had some mixed operating performance in 2010 -- their biggest mine, currently Olimpiada showed a decrease in production of almost 30%, from 839,000 ounces in 2008 to 584,000 ounces in 2009 -- apparently the problem is that two other mines are close by, and Polyus is allowing ore from the other two mines to be processed at the processing center at Olimpiada, which caused problems with the exaction of ore. The solution appears to build a separate processing center (which can crush the ore, and exact the gold by a bath of high-grade acids and chemical solutions) but it doesn´t appear that the firm has this in the works.

Another concern was that the production was up 10% y/y to 1.39M ou (approx) but the profit didn´t increase, mainly due to higher costs -- I´m not sure I did note that the mines are spread around the country in mainly three locations, which are extremely far away from each other (well over 1000 miles), so the co isn´t getting any syngeries from the operations.

Polyus is having serious problems with its acquisition of KazahkGold, and is going to divest this -- about 2 years after acquiring it -- the owners of Polyus and the ruling family (Nazerbyev) of Kazakhstan really got into an argument. On the negative side, KazahkGold was the one asset so far that is significantly increasing production

Current forecast is for 1.5M ou, which one analyst takes to mean that the problems at Olimpiada will continue. The capital expenditures appear to be (according to UBS) well under maintance levels -- strangley, the CEO (who is also the owner to the New York Nets) wants to sell the firm, not develop it.

The basic idea is to find Gold miners which are the most undervalued on reserves. Below is a useful chart by UBS that shows potential undervaluation by reserves, since Gold is not really concentrated in one geographical area, there are many firms and it does appear that Polyus is undervalued, although perhaps not by a whole lot (in the chart below, Anglo Gold, Harmony and Gold Fields appear to be the cheapest on an EV/Reserves and Resources). I´ll look into these -- (although I´m not sure how these miners stack up against individual gold mines, I did like the fact that Polyus had one very large mine in the works -- will research).

Sunday, February 20, 2011

Polyus' Gold Reserves: Under-Appreciated

Polyus Gold may have significantly larger reserves of gold than is credited to the stock by the market currently. Polyus Gold (ADR: OPYGY) is the gold mining spin off from Nolisk Nickel. Polyus has the world's second largest gold mine by reserves, Natalka, at 40.8M ou of gold in place -- this compares to all of Barrick's Gold's reserves of 138M ou.(Barrick is the world's largest gold miner).

Gold miners report proved (90%) and probable (50%) reserves all together, unlike oil which typically report only proven (90%). Barrick reports it has 138M ous of reserves of gold, when you look at the 40-F, it has 30.3M ou of proven gold, 109.4M ou of probable

In comparison, Polyus reports reserves in the Russian classification system, which is A,B,C1 and C2. According to Nikolai Vlasov, chief geologist, Peter Hambro Mining plc, A,B,C1 are roughly equivalent to proved and probable.

Polyus reports in its 2009 Annual Report 77M ou of A,B,and C1 gold reserves. Polyus also reports international standard reserves, mesaured of 14M ou and 66.3M ou of indicated. (total 80.4M)

Note that measured means that the reserves exist with high certainty (90%) but are not yet proven, in so far that they have not been proven to be economically mined through a feasibility study and

According to Polyrus' investor's relations, Natalka's mine life to 2073 (very large mine), average cash costs per ounce of $51.3 (should be very profitable)(this is the mine info). The mine will double Polyus' current output of 1.38M ou per year of gold towards 2020, in 2014 it will increase by 48%.

In comparison Barrick (market cap: $50.9Bn) produces 7.4M ou. Newmont (market cap $28.8M) produced 5.3M ou in 2009, reserves of 92 M ou.

Polyrus I'm not sure the market cap, one source is saying $10Bn, another around $5Bn -- it is really attractive at $5Bn. I will double check this.

You can find a comparison of the world's richest gold mines here: There are only 6 mines with reserves of 30M ou or above,and only 8 with total reserves of 20 M ou or above. Barrick does not own any of these top 8 mines, but has interests in many smaller mines -- it appears Barrick has consolidated many individual mines, to form the world's largest gold miner.

Natalka will come on-stream in 2013 - actually late 2013. The shares haven't moved up too much -- except for after the financial crisis.

Overall I can tentatively say that Polyus is comparable in size to Barrick, in so far that it is a major miner of gold (the Russian reserve show that Barrick has 80% more gold than Polyus) -- but the market cap of Barrick is far higher, $50Bn verses $10Bn. Of course this reflects geopolitical risk (mining in Russia) -- next steps would be to compare average costs per ounce -- it seems most gold miners would have higher than Polyus' cash costs since the mines will be located in many different locations (a single, large deposit will lower cash costs per ounce since the set up costs of the electricity, water, housing, roads, equipment etc can be depreciated over a longer mine life). Further next steps are to analyze political risk.

Frontier Gold: Is the Andewa Deposit Legit?

Frontier Resources (FNT.AX) has move from sub-..10 to mid .30's in a week -- the main reason is the announcement of exploratory drilling information at the Andewa prospect on the island of New Britain in Papua New Guinea.

Frontier has 7 deposits in Papua New Guinea - the main source of value is Andewa in the Island of New Britain- the firm is implying that there is gold deposits between 14 to 66 g/ton in this region which stretches for about 7 km, at a good seam -- in comparison Barrick Gold, the world's largest gold producer averages about 2 g/ton, so this would be 7-33x more concentrated.

Actually Frontier also has 2 projects in Tasmania, but again the best potential is the Andewa project in PNG. (actually the Bulago deposit is also promising, see below)

I sort of don't believe the numbers. I was searching through the world's richest gold mines and all have gold per ton numbers below 3 g/ton see:
This would be by far the most rich gold find in the database --well so far I've searched Barrick's deposits (in their annual report, and the Polyrus Gold (Russia) deposit which is #2 on the list and this averages 1.5 g./ton.

The newest release has some geological data but not nearly enough to establish reserve numbers - so far this is all in the beginning stages.

The firm is really small, having to raise capital even for exploratory drilling. (they had to raise $A1.1M to survey the region -- Frontier will certainly have to raise capital to develop the project. Actually the deposit looks like it is close to the coast, so could be served by water transport, see a map of the projects in the 2010 Annual Report, p. 3:

Previously in 3/10 Frontier announced another 67 g/ton deposit, this time on the main island of PNG, in the Bulago deposit, but this didn't generate much excitement -- I don't know why all of a sudden the latest report has really made the stock go off, but the previous ones did not. (more word of mouth, or a better geological survey, actually I don't know).

Anyway I'll be researching more and will try to find out if the find in legit.

Wednesday, February 9, 2011

If the economy doesn't grow, will it collapse?

An interesting question has been posed, mainly by pundits concerned with peak energy but also by economist and fund managers -- whether the economy will shrink dramatically if the economy does not offer the promise of growth. This subject or question can be rephrased in several ways, such as "if the economy doesn't grow, will it collapse?" or, as Bill Gross of PIMCO theorized in his August 2010 Investment Outlook "...Not only growth but capitalism itself depends on a growing population," as, Bill Gross states, that a growing population implies steady growth in consumer demand.

However, most articles on this topic state capitalism will collapse without higher demand in the future, without going into detail as to why. Why, in more depth, will shrinking demand -- and also importantly lower expectations of demand -- lead to dramatically lower GDP numbers? This is to say, why can't capitalism exist in a steady state (no growth)?

John Maynard Keynes would answer this question based on the relation of investment to consumption demand as components of GDP, as explained in Chapters 5 and 6 of his General Theory of Employment, Interest and Money. The largest component of GDP is consumer demand. In the US consumer demand ranges from a high 60% of total GDP to low 70%s of GDP. Investment ranges around 15% of GDP (the other parts of GDP according to GDP = C+ I + G +(E-I) are net exports and governmental spending, which total in the US approximately 15% of GDP).

The investment component of GDP is related to the consumption measure, in so far that businesses will not invest in new capital and equipment unless they expect a steadily increasing market (demand) for their products and services.

So, if the businesses expect future demand to be lower, they will dramatically cut back on investment - why would a business invest in more capacity if it doesn't expect to have higher sales? This means that the 15% of GDP represented by investment will drop significantly faster than the 70% of GDP represented by consumption. John Maynard Keynes referred to the attitude of businesses to invest famously as "animal spirits" -- this phrase was recently picked up by George Acklof and Robert Shiller in their book with the same title, published in 2009. (Keynes exact discussion of animal spirits argued for a non-rational contemplation of future investment, verses other schools of economics that argued that investment was rational, but for this purposes of this post, we will not go into detail on this, the discussion however is important for implications on the future equilibrium of aggregate demand and aggregate supply in terms of GDP)(and actually is a bit beyond the understanding of the author :).

A Malthusian version, where peak energy or peak food results in high prices and therefore lower consumption, would also impact future investment, and also carry a re-enforcing cycle between consumer demand and investment (however the details of the exact transmission mechanism from higher prices to investment could be different than expectations of lower demand from for example higher saving rates, which is not analyzed here, in so far peak energy would be a production issue, not at first a demand issue).

The relation between investment and consumer demand can be explained as a self-reinforcing cycle. We can see many examples of re-enforcing cycles in nature, such as theoretically higher temperatures, which melt snow caps, which then do not reflect as much solar radiation, which then leads to higher temperatures, which further melts snow caps etc (this is theoretically proposed by scientists such as the late Steven Schneider of Stanford University). In a GDP measure, lower consumption could reinforce a lower investment, which in turn could reinforce lower consumption, leading to a downward cycle which means significantly lower GDP at the final equilibrium.

The idea here is relevant in so far that sustained declines to consumer demand, from a declining population (in Bill Gross's concerns, outlined above) to lower levels of consumer credit, to deleveraging of consumer debt, to average declines in expenditures from declining capital gains from property, can all lead to significantly lower GDP than at first calculated based on reduction in demand, through the relationship of demand with investment.

The analysis appears to be supportive of emerging economies such as China and Brazil (at first glance) in which businesses are more confident of future demand, in terms of a positive, self-reinforcing cycle between consumer demand and investment by business. (both Petrobras and Vale of Brazil have announced record breaking investment budgets for 2011 and beyond, for example at over $US70Bn and $US20Bn, respectively).

However, the analysis does not initially (in the author's opinion) support slower growth economies that are deleveraging, such as many EU countries, and the US. Businesses in the US and certain countries in the EU may not be as confident of future demand increases, due to deleveraging of consumers in these countries, and other factors.

As a final note, this relation of demand and investment explains some rational of John Maynard Keynes insistence on governmental, stimulus spending, which would find its way, through Keynes' multiplier (which is incidentally currently being debated in the economics profession, in terms of its size and impact on the overall economy), which, in turn, would support demand and then support investment, as businesses would be more likely to invest in an expanding economy.