Model Portfolio rmcduff:RMG2

BPZ Resources, Inc. (amex: BZP) ($21.64) is a developer of offshore oil and natural assets in Peruvian waters. The company has a current enterprise value of $1.76 billion.

BPZ is headed by some highly seasoned oil executives in Peru, with close connections to the IFC and the Peruvian establishment. Accordingly the company was able to secure some promising and relatively shallow concessions offshore Peru's major oil producing areas for nominal costs. At the time of my original purchase, BZP had an enterprise value of about $350 million. They were preparing to re-enter a relatively under explored field, dating back to the 1970's, which had been abandoned. The field was highly prospective for natural gas. However, until recently, Peru had no domestic market capable of consuming large quantities of natural gas. There was also a lack of infrastructure capable of transporting gas to end users.

The executive of BPZ had felt that modern drilling techniques would improve productivity of several oil wells in this gas field which had demonstrated initial promise, but had quickly become uneconomic.

I have some familiarity with the geology of oil formations in the area, and considered that the strategy was sound. The economics of doing business in Peru have also changed considerably. As Peru is now an oil importing nation, EcoPetro (The Peruvian oil company) persuaded the government to implement a very generous royalty regime. Oil companies pay no more than 20% of gross production on discoveries and development.

BPZ raised sufficient capital to re-enter several well bores. With modern techniques, initial well productivity (mostly natural gas) has seemed shockingly high. Rates of 26 million cubic feet per day were recorded in several wells and oil test rates in excess of 2000 bpd were recorded at several wells.

The market has responded, by driving the price of BPZ up sharply. Management has issued equity on several occasions to pay for development. Most recently, the firm has obtained sponsorship from Canaccord Adams for a $37 million underwriting.

At current prices, I feel that new investors are taking relatively high risk. The geology of the area is complex. Due to complex faulting fields in Peru are relatively small. Elephant sized fields (according the US Geological Survey) are practically impossible to find in this area of the Pacific.

In order to justify the present share price, PBZ needs to find at least one other field the size of their present operations. This is possible, but by no means assured.

On the plus side, the firm has good sponsorship. Market speculation can carry the shares for a while yet, beyond the fundamental valuation, which I consider to be about $12 per share.

I will be selling at least of this position on strength, and will be reinvesting in Spindletop Oil and Gas (SPND), based in Texas.