Executive Summary
The Kurdistan region of Iraq is a geological extension of the world’s richest petroleum fairway, which extends from Saudi Arabia to Syria. Due to geo-political conflicts, the resources in Kurdistan have been essentially untapped. Upon the overthrow of Saddam Hussein’s regime in Iraq, however, Kurdistan began to open itself to foreign investment (the tapping of the Kurdistan keg). Those lucky enough to sign the first contracts received their pick of the most attractive exploration blocks and the most generous terms. One such company was Calgary-based Western Oil Sands (WTO CN). Upon its sale to Marathon Oil (MRO) in 2007, WTO’s Kurdistan assets were spun out into what is now the public “pure play” on oil in Kurdistan, WesternZagros Resources Ltd (WZR CN or WZGRF).

stock chart
Investment Thesis
Our attraction to WZR, the elephant hunter, can be summed up as follows:
- Extreme undervaluation. We believe that the fair value of this stock (details to follow) is conservatively about C$3.60, or roughly 3X its current price. There are many cheap lottery tickets in the E&P universe, but what makes this one unique is its high likelihood of success.
- High scarcity value. As mentioned above, Kurdistan holds one of the world’s most coveted oil fields, which up until recently was locked away, protected from foreign ownership. WZR was one of the first movers, and because it took incalculable risk as a foreign investor at such an early stage, its potential reward is near limitless.
- “Elephant” potential. An “elephant” oil field is one whose recoverable reserves are at least 100 million barrels. According to the well respected oil and gas consultancy Sproule and Associates, as of March 31, 2009, WZR’s exploration block has P90 prospective resources of 1.6 billion barrels. P90, for those unfamiliar with the industry jargon, refers to reserves that have a 90% certainty of actually being produced. WZR’s find, if “proved” would count among the 100 largest producing oil fields in the world.
- Kurdistan is actually safe. Kurdistan is by no means a recommended destination for Spring Break or a family vacation, but it is certainly an enviable “security oasis” within the war-battered Iraq, and it is ranked “secure” by the US military. Over 20 E&P companies have been operating in the region over the past several years with no major interruptions, which makes this a safe haven among prospective untapped oil reservoirs.
- Terrific takeout potential. WZR, although well capitalized for a “junior” oil exploration company, with $130 million in cash and no debt, is extremely unlikely to remain independent long term. Its exploration partner, Talisman Energy (TLM CN), with $8 billion of revenue and a $16 billion market cap, is better suited to take on this elephant, and may wish to increase its stake by acquiring WZR itself. Other large oil companies who either have been waiting on the sidelines due to lack of a clear regulatory framework or who already have small stakes, are undoubtedly eying WZR’s prized oil fields hungrily.
Valuation
We used two methods to value this pre-production company: discounted cash flow and comparable peers analysis. To build an additional margin of safety, a probability weighted price was calculated based on different scenarios of timing and magnitude of success.
Discounted Cash Flow Valuation
WZR finalized the terms of its Production Sharing Contract (PSC) with the Kurdistan Regional Government (KRG) in 1Q09, which helped shorten the list of major assumptions to success rate, oil price, discount rate and capex schedule (see Table 1). Please note that a relatively high discount rate is used in the model simply because in a high default rate market environment, it is reasonable and prudent to apply a higher than normal rate and discount essentially the investment grade asset with a high yield rate.
Table 1 Model Assumptions
| Key Variables |
Assumptions
|
Comment |
| P90 reserves |
1.6 bn bbl
|
Audited data from the company |
| Success rate |
60%
|
Average success rate in Iraq is about 70-75% |
| First production year |
2010
|
Its second exploration well won’t have any results until Oct 2009. 2010 thus seems reasonable for production start. 2nd scenario assumes first production year is 2011 |
| Oil price |
60
|
Conservative relative to the current curve, see chart below |
| Bonus pmt ($million) |
25
|
PSC term |
| Inflation |
2.0%
|
Inflation, what inflation? |
| KRG+ Talisman take |
60%
|
PSC term |
| Royalty |
10%
|
PSC term |
| Max share of profit |
35%
|
PSC term |
| Min share of profit |
16%
|
PSC term |
| Corporate tax rate |
0%
|
It is already included in KRG’s take and federal government in Baghdad has no legal power to impose additional tax. |
| Discount rate |
15.5%
|
As a reference, peak yield of Iraqi treasuries was almost 16% (see chart below). If Kurdistan had treasuries, the yield would be lower due to its lower credit risk profile. |
Table 2 Capex Assumptions
| Total recovered oil (mboe) |
1,039
|
| F&D per barrel |
3.13
|
| F&D per barrel adjusted for ownership |
1.25
|
| 2009 |
39million
|
| 2010 (if first production is 2011) |
40million
|
| Year 1 % |
25%
|
| Year 2 % |
25%
|
| Year 3 % |
20%
|
| Year 4 % |
15%
|
| Year 5 % |
10%
|
| Year 6 % |
5%
|
| Maintenance capex ($million) |
50
|
Chart 1 ICE Brent Oil Price Curve

Chart 2 Iraqi 5.8% 2038 Government Bond Yield
It is also assumed that the first discovery is made in early 4Q09 and first production starts in 2Q10. However, we assume the production will not ramp up to 200k bpd until 2014, which builds in enough cushion for potential infrastructure uncertainties (pipeline primarily). An output plateau is assumed to be around 280k bpd in 2016. The decline rate is set at 13% based on empirical precedent.
Based on the above mentioned assumptions, WZR is valued at CAD 3.57/share, representing almost 200% upside from the close of 1.20/share on May 25, 2009. In other words, if the upside of holding the stock is 3.57/share and the downside is zero, the current price of 1.20/share implies a 66% probability of the downside scenario happening. Below are the sensitivity tables.
Table 3 NPV/Share Sensitivity Analysis (assuming first production in 2010)

If the first production year is postponed to 2011, the valuation will be CAD 2.92/share, representing 140% upside from the May 25 close of 1.20/share. Please note that WZR has a clean and healthy balance sheet and should have no liquidity problem if there is a delay in the first production year. As of 1Q09, WZR has $106.5 million of working capital, more than covering the company’s projected $39 million in capex in 2009 and our assumption of $40 million in 2010. WZR has no debt outstanding.
Table 4 NPV/Share Sensitivity Analysis (assuming first production in 2011)

Comps Valuation based on EV/3P Reserves
WZR has two groups of comparable peers: 1) foreign E&P companies that have made discoveries in Kurdistan; 2) foreign E&P companies that are not operating in Kurdistan but are deemed speculative by the market, due to the early stage nature of their productive fields, and/or the riskiness of their assets due to geopolitical concerns
There are currently 20 plus international companies in the Kurdistan region and 7 of them are meaningful comparables to WZR in terms of production status and market cap (see Table 5). Please note that none of them is a pure play company in Kurdistan, and information about their Kurdistan-specific asset valuation is also sporadic. Addax and DNO, however, do provide good reference points in Table 6.
Table 5 Kurdistan Comps
Table 6 Pure Kurdistan Asset Comps

- Addax has a 45% working interest in a currently producing oil field: Taq Taq and another 26.67% interest in the Sangaw North PSC. Addax provided year-end NPV estimates for all of its assets without a geographic breakdown – the average NPV/ 3P boe is CAD 13.7 in 2008, but it is difficult to tell whether the Taq Taq specific NPV is close to this level.
- DNO entered into a PSC with the KRG as early as 2004. It has a 55% working interest in the producing Tawke field. In 2Q07, DNO received and subsequently rejected an unsolicited offer ($700 million) for its Kurdistan assets from an unidentified international oil company. Based on DNO’s reserve data as of 2Q07, the offer represented CAD 8.3/3P boe.
Table 7 Speculative E&P Comps

Based on EV/reserve multiples from both peers groups, 4-12x seems to be a reasonable range. To further discount the uncertainties, 5x is used for the valuation of WZR, yielding a price of CAD 3.68/share. This represents a 206% premium over the 1.20/share close on May 25, 2009.
Table 8 Comps Valuation
Probability Weighted Price
For our final valuation methodology, we assign probabilities to several potential scenarios to calculate a weighted target price. Due to the fact that WZR’s exploration block contains oil on the surface of the ground (in pools, or “seeps”) we assign a 90% probability of finding oil. It is also assumed that there is a 40% probability that production starts in 2010 and 60% in 2011, just to be conservative. The probability-weighted price therefore is CAD 2.86/share (based on DCF analysis), a 138% upside from the close price on May 25; or CAD 3.04/share (based on comps analysis), a 154% upside.
Table 9 Probability-weighted NPV/Share price analysis

One final point of reference: WZR stock has been trailing both its peers with E&P operations in Kurdistan and those outside of Kurdistan, but considered “speculative” by the investment community (see Chart 3). This chart should also remind the reader that in the short run all speculative oil companies will be correlated to each other (as well as to the price of oil itself). However, what will differentiate each speculative E&P stock from the others is ultimately going to depend on the success of their respective discoveries.
Chart 3 Relative Equity Performance
Notes:
- Prices on 5/20/08= 100
- Kurdex = index for E&P companies with operations in Kurdistan, including Addax, DNO, DANA Gas, Heritage Oil, Gulf Keystone, Sterling Energy, HKN, MOL, OMV and Talisman
- SEPex=Speculative E&P companies index, including BRY, BBG, COG, XEC, CXO, DPTR, DNR, KWK, RRC, SM and WLL
Catalysts
Near term catalysts include
- positive results from Kurdamir-1 exploration well
- positive policy development for exporting oil from Kurdistan
- Kurdistan elections on July 25, 2009
- Iraqi federal election in November 2009
Long term catalysts include
- the passage of the Iraqi Federal Petroleum Law
- any other meaningful geopolitical improvement, e.g. peaceful solution for PKK conflicts with Turkey
Major Shareholders

Note: Paulson & Co built their original position as an offshoot from the merger arbitrage of Western Oil Sands / Marathon Oil completed on 10/22/07. The recent addition to their position shows conviction in the long term value of WZR.
Management Team
WZR’s management and the Board have extensive experience in both domestic and international E&P companies. Its chairman, CEO, and other E&P related executives all have work experience of over 30 years.
Management Team Profile
Fred Dyment – Executive Chairman
Mr. Fred Dyment has over 30 years of experience in the oil and gas industry. As Executive Chairman, Mr. Dyment provides direction and leadership to management and chairs the Board. Prior to WZR, he was CEO at Ranger Oil Limited and Maxx Petroleum Company.
Simon Hatfield – CEO
Mr. Simon Hatfield has over 30 years of international and domestic experience in technical, managerial and executive positions with Imperial Oil, Exxon Production Research Company, Petro-Canada, Chauvco Resources, Talisman Energy and Western Oil Sands. He initiated the Kurdistan opportunity for WesternZagros and led the technical and business process which successfully concluded the signing and ratification of the Company’s Production Sharing Contract.
Robert Theriault – Senior Vice President Engineering & Operations
Mr. Robert Theriault has over 30 years of international and domestic experience in upstream and midstream oil and gas operations for several companies, including Cairn India Limited, Husky Oil, CSR Petroleum and Suncor.
Greg Stevenson – Vice President, Finance
Mr. Greg Stevenson is a Chartered Accountant with over 11 years’ work experience. Prior to joining WesternZagros, he was Controller at Western Oil Sands.
Dr. George Pinckney – Vice President, Exploration
Dr. Pinckney has spent the majority of his 32 year career with Mobil Oil and ExxonMobil in locations throughout Canada, the United States and Southeast Asia. He holds a PhD degree in Geology.
David Reeve – General Manager, Petroleum Engineering
Mr. Reeve has over 30 years experience in consulting and staff positions in the engineering and operation of projects in China, Iran, Australia, Indonesia and domestic. Prior to joining WesternZagros, Mr. Reeve held the position of General Manager with Ivanhoe Energy in China.
Board of Directors
David Boone President & CEO of Barrick Energy Inc, former executive for EnCana Corporation, PanCanadian Energy and Escavar Energy.
Fred Dyment, former CEO of Ranger Oil and Maxx Petroleum Company.
John Frangos, co-founder and former COO of Western Oil Sands.
Simon Hatfield, former executive with WesternZagros, Imperial Oil, Exxon Production Research Company, Petro-Canada, Chauvco Resources and Talisman Energy.
Jim Houck, President and CEO of The Churchill Corporation, former President and CEO of Western Oil Sands.
Randall Oliphant, Chairman of Western Goldfields Inc. and President and CEO of Silver Bear Resources Inc., former President and CEO of Barrick Gold Corporation.
William Wallace, former President and Chief Operating Officer of Barrett Resources/Plains Petroleum Company; former Regional Vice President and Vice President Exploration with Texaco; and former Group Vice President of CSX Oil and Gas Company.
DISCLAIMER: THE AUTHOR IS LONG WESTERNZAGROS STOCK.