Harvest Natural Resources (ticker: HNR) is an oil and gas exploration company headquartered in Houston, Texas with exploration projects in Indonesia, Gabon, Oman and producing assets in Venezuela. On June 21, 2012 the company announced it had sold its 32% interest in its Venezuelan affiliate, Petrodelta, to the Indonesian state-owned oil company, PT Pertamina for $725 million in an all-cash transaction.

Subject to the definitive Stock Purchase Agreement (SPA), Pertamina will buy Harvest’s shares representing its 32% equity ownership in Petrodelta with an effective date of January 1, 2012, subject to obtaining the required approvals. Net proceeds are estimated to be $525 million, net of taxes and related transaction costs. Both Boards of Directors for Harvest and Pertamina have approved the sale. If the deal does not close on or before March 21, 2013, either party can walk away from the deal or negotiate an extension.

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Valuation Metrics

In its most recent investor presentation made in April 2012, Harvest indicated that Petrodelta’s gross oil production had reached approximately 37,000 BOPD, up 18% over the full-year average for 2011. The company further reported proved, probable and possible reserves net to Harvest of 43.3 MMBOE, 103.8 MMBOE and 210.5 MMBOE, respectively. Based on the company’s investor presentation, the after-tax PV-10 value (after Venezuelan tax, but not U.S.) of Petrodelta’s proved (1P) and probable (2P) reserves net to Harvest at December 31, 2011 was $543 million and $1.1 billion, respectively, using an oil price of $98.40 per barrel.  Click here for the company’s April 2012 presentation.

Petrodelta’s primary assets consist of six oil fields with an estimated 9.1 billion barrels of oil originally in place. Harvest indicated that it was forecasting full-year 2012 production to average 40,300 BOPD, based on a $300 million capital plan to build new infrastructure and drill 33 new oil wells.

Using year-end 2011 proved reserves, the transaction is valued at $16.74 per BOE. That number compares to an average enterprise value to proved reserves value of $19.62 per BOE for the 89 companies in EnerCom’s U.S. E&P database. On a value per flowing BOE, the transaction values Harvest’s 32% share of Petrodelta’s gross production at $61,233, as compared to an average of $108,588 for the 89 companies in EnerCom’s U.S. E&P database. The 15 companies in EnerCom’s international E&P database are valued at $20.88 on the basis of enterprise value to 2P reserves and $109,038 per flowing BOE. Considering the perception of heightened risk associated with Venezuelan assets, the deal does not appear to have been priced at a large discount on the basis of reserves.

The sale represents a key milestone in the company’s process of evaluating strategic alternatives, which it initiated in September 2010 to increase shareholder value through the possible sale of assets or sale or merger of the company. After-taxes and fees, we estimate the deal is worth $14.05 per share. At March 31, 2012, Harvest had $34 million of cash on its balance sheet and $15.5 million of debt.

Pertamina’s Global Search

Indonesia left OPEC in 2008 after becoming a net importer of oil after unsuccessful efforts to replace production with new reserves resulted in persistent production declines. According to the June 2012 edition of the BP Statistical Review of World Energy, Indonesian oil production in 2011 fell to 942 MBOPD, down 5.6% from the prior year and 6.1% lower than 2008. BP reported in the same study that Indonesia consumed 1,430 MBOPD in 2011, up 13.2% from 2008. With consumption rising and domestic production falling, Indonesia is looking abroad to buy assets that have both proved reserves and enough development potential to grow in order to meet the needs of its growing population estimated at approximately 248 million (source: CIA World Factbook), the fourth largest in the world.

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The need to secure and grow oil reserves and production is driving Pertamina’s global search. On May 27, 2012, the JakartaGlobe reported that Pertamina was evaluating an upstream opportunity in Kazakhstan. Karen Setyawan, CEO of Pertamina, said “We would like to have an additional 100,000 BOPD from that business in Kazakhstan.” Pertamina hired HSBC, Barclays Capital and Citigroup as financial advisers this year as part of its plan to sell up to $2 billion in global bonds in 2012. Karen said last month that proceeds from the debt sale would be used to finance the company’s business plans. Pertamina has set aside about Rp 52 trillion ($5.6 billion) for capital expenditures this year, after setting aside Rp 40 trillion ($4.31 billion) last year.

Venezuela’s Domestic Need

It is no secret that the Venezuelan economy is in a precarious state. After two years of recession, that nation’s central bank estimated that the country’s GDP grew by approximately 4.0% in 2011, primary due to a surge in government spending. Venezuelan Finance Minister Jorge Giordani said last October that the government would continue boosting the economy and announced that public spending would increase 46% in 2012.

Higher government spending has made a difference. Bloomberg reported that Venezuela’s GDP expanded by 5.6% in Q1’12, the fastest pace in almost four years. Record oil revenue enabled President Hugo Chavez to finance a boom in housing construction ahead of the October 7, 2012 presidential election. Chavez, who is widely known to be battling cancer, is seeking to extend his 13 years in power with another six-year term.

The run-up in public spending, however, masks Venezuela’s dependence on oil. Domestic policies have siphoned capital out of the nation’s oil and gas industry, money that could have otherwise been invested back into building reserves and production. Consequently, Venezuelan oil production declined in 2011 to 2,720 MBOPD, down 2.0% from the prior year and down 9.4% from its peak in 2005 (source: BP Statistical Review of World Energy, June 2012), before the industry was nationalized.

Unless Venezuela gets its petroleum industry back into growth mode, the government won’t be able to sustain spending at its current rate, which could plunge the nation back into recession. Accelerating production has proved challenging, however, as many OilService companies have left the country. As we understand it, because of difficulty getting paid and the penchant of the government to nationalize their assets.

Higher government spending, however, has a price and it is in the form higher interest rates. On April 4, 2012, Fitch Ratings announced that it might downgrade Venezuela’s credit rating, as the result of over-dependence on oil and the increase in public spending. Fitch updated its outlook for the Venezuelan state-owned oil company Petroleos de Venezuela SA (PDVSA) and the government-run utility company Electricidad de Caracas to negative. PDVSA has approximately $19.5 billion of dollar bonds outstanding and the state utility has about $663 million of bonds due in 2014 and 2018. As reported by Bloomberg, the additional yield that investors demand to hold Venezuelan debt instead of U.S. Treasuries widened 11 basis points to 943, according to JPMorgan Chase & Co.’s EMBI Global index.

Combined, lower oil prices and more expensive money will make it hard for Venezuela to simply borrow its way to prosperity, which is a method debt-adverse investors are unlikely to support.

Aligned Interests

Given both countries’ situations, the interests of Pertamina and Venezuela appear to be closely aligned, as they both need access to oil reserves and to grow production. In addition, Pertamina would seem to be a good operating partner for PDVSA, since there is relatively little, or no, political friction or heated rhetoric between Indonesia and Venezuela. Pertamina has access to capital and the ability to allocate large sums to projects, liquidity that Venezuela needs. We’re not saying that there isn’t any political risk to closing the deal, but it would seem relatively low, given the incentives that both sides have to make the partnership work.

For Harvest, the deal provides an opportunity to exit from Venezuela, a country U.S. investors never seemed to be able to warm-up to for various reasons. We anticipate Harvest’s Board of Directors will evaluate several potential uses of the sale proceeds, including but not limited to, returning cash to shareholders (e.g., special dividends, share buybacks, etc.) or even funding an expanded capital budget for maturing its exploration portfolio. Clearly, Harvest will have the means to pay off its remaining debt of $15.5 million.  HNR’s 2012 total capital expenditure budget for its projects in Indonesia, Oman and Gabon is $24.5 million. The Petrodelta sale will have no impact on capital spending, as that company’s capital plans were funded entirely from internally-generated cash flow.

Given the material nature of the transaction, in that it involves a substantial portion of the company’s assets, the sale is subject to the approval of Harvest shareholders at the threshold of 50% plus one share.

Putting Risk into Perspective

There are risks to any deal, and this one is no exception. Approvals will be required by Harvest shareholders, the buyer and Petrodelta’s majority shareholder, PDVSA. It is difficult to handicap the approval process, given that seemingly everything involving Venezuela gets hyper-politicized in the U.S. press, and the fact that it is election season in Venezuela. That country’s presidential election scheduled for October 7, 2012.

However, we are mindful that the interests of both Pertamina and PDVSA are aligned and we believe they have strong incentives to close the deal. Given Harvest’s drilling success in the Petrodelta oil fields, we would anticipate strong increases in oil production with the systematic application of capital and resources that Pertamina can provide.

In summary, the deal provides Pertamina access to a world-class asset at a fair price and gives Petrodelta (and Petrodelta’s 60% majority shareholder PDVSA) a well-capitalized and motivated partner. And, Harvest shareholders stand to realize a substantial increase in value, given our estimate that the after-tax value of the sale is $14.05 per share. Shares of HNR closed at $4.88 on June 21, 2012.

Given the upside and strategic importance of the transaction to the buyer, seller and PDVSA, it would seem that all parties have a mutual interest in closing the deal.  The shares were trading at $9.12 per share in after-market trading, as of this writing.


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