HRT Participacoes Has An Asymmetric Risk/Reward Profile

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By Stan Holland :

HRT Participacoes (HRTPY.PK) has a high risk/high reward profile and is not a stock for everyone. Below I will argue that the risk of losing all of your money is outweighed by the opportunity to make multiples on your money, but again, this is not an investment for everyone. However, if you are a fan of Nassim Nicholas Taleb's barbell strategy, then I believe that this is a stock worth owning.

In its 11/26/2012 material report HRT announced a farm-out with Galp Energia (GLPEF.PK) for a 14% participating interest in PEL 23, PEL 24 and PEL 28 offshore exploration blocks in Namibia. HRT is scheduled to start its Namibian drilling campaign in February 2013, using Transocean's ( RIG ) Marianas semi-submersible rig over a 280-day lease period. As it stands now, HRT will drill three wells; Wingat, Moosehead and Murombe (the Murombe well will also test the Baobab prospect). HRT is also negotiating another farm-out so HRT's other top prospect, Meerkat (Sitatunga also gets tested when the Meerkat well is drilled) is likely to be added to the drilling campaign, assuming a favorable negotiation. The company has indicated that it would like to farm-out approximately ⅓ of its total Namibian interest.

The chance of success and Pmean for each near-term prospect is as follows:

Prospect chance of success Pmean
Wingat 27% 1 billion barrels of oil equivalent
Murombe 23% 4 billion barrels of oil equivalent
Baobab 27% 1 billion barrels of oil equivalent


3 billion barrels of oil equivalent
Meerkat 20% 1 billion barrels of oil equivalent
Sitatunga 20% 1 billion barrels of oil equivalent

Case 1 - No further farm-out agreement is reached

Chance that all 4 prospects fail = .73 x .77 x .73 x .75 = 31%
Chance that at least one well is a success = 69%

In the event of success, the odds of an oil discovery must be greater than the odds of a gas discovery (these prospects wouldn't be called oil prospects if this wasn't true), but I do not know how much greater so I am going to assume that it is equally likely to find oil or gas. Therefore, there is at least a 34% chance that either Wingat, Murombe, Baobab or Moosehead will be a successful oil discovery. (I don't believe that the market will place much value on a gas discovery.) There is roughly a 90% chance that a successful discovery will be at least 50% of the Pmean Prospective Resource. Assigning a value of $7 per barrel of oil equivalent in the ground, there is roughly a 30% minimum chance of one of these four prospects being worth at least $3.5 billion gross, or $10 per share net to HRT (Galp gets 14%).

Case 2 - Another farm-out agreement is reached

Chance that all 6 prospects fail = .73 x .77 x .73 x .75 x .8 x .8 = 20%
Chance that at least one well is a success = 80%
Chance that at least one well is an oil success is at least 40%

Using the same assumptions as Case 1, there is roughly a 36% minimum chance that at least one of these six prospects will be worth at least $3.5 billion gross, or $8 per share net to HRT (assumed Galp + others get 33%).

Even if the value of the company is an all or nothing bet on the outcome of the Namibian drilling, the Kelly Formula says that at the current share price ($1.23) HRT is a favorable bet using the odds and the payoff that I have presented in either Case 1 or Case 2. However, between the cash on the balance sheet (which exceeds the market cap) and the value of the Solimoes basin campaign (which I confidently predict is somewhere between zero and a whole lot), I believe that the downside is at least partially protected.

Disclosure: I am long [[HRTPY.PK]]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. I do not work in the petroleum industry, and there is a risk that there is an error in my logic. Please perform your own due diligence.

See also Ultra-Deepwater Investors Should Prefer Younger Fleets on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Stocks

Referenced Stocks: RIG



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