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Mari Petroleum (MARI): Dismantling of Gas Price Formula Unlocking Value

• Investment Thesis: We initiate coverage on Mari Petroleum (MARI), Pakistan’s fourth largest Exploration & Production (E&P) company and third largest gas producer, with a ‘Buy’ recommendation and DCF based target price of Rs2,134/share. Our thesis is based on MARI’s 1) dismantling of GPA (Gas Price Agreement) and its replacement with an international crude oil price-linked market oriented formula, based on Petroleum Policy (PP) 2001, 2) incremental production (over a set benchmark) to be priced under high yielding PP2012, 3) significant revision in 2P (Proved & Probable) gas reserves and 4) new discoveries (Tipu-1, Shaheen-1 and Shahbaz-1 finds), falling under PP2012 and farm-in opportunities. These will serve to boost MARI’s revenues and earnings at 3-Year (FY17-20) CAGR of 30% and 44%. On EV/BOE basis, MARI trades at attractive US$42/BOE vs. Topline E&P Universe avg. of US$71/BOE.
• From regulated returns to market based price regime: In 2014, the Govt. dismantled MARI’s pricing mechanism for wellhead gas prices (that limited the company's growth) which was replaced with a crude price linked formula, in-line with the industry practice. Under the new pricing mechanism (effective from FY15), Mari gas field prices (Mari field is ~95% of the company's total gas production and ~93% of total revenue) are now linked to Arab Light Crude price (providing higher price than previous cost plus formula that was effective till FY14) with gradual unwinding of wellhead gas price discount, on semiannual basis. This entitles company for higher prices every 6 months till Jan 2019.
• Incremental production to fetch higher pricing: The Govt. also approved higher price for Mari gas field for incremental production; exceeding by 10% from benchmark 525mmcfd. This higher price (unlike the crude oil price regime approved in place of cost plus formula for Mari gas field) is based on PP2012 without any discount (providing ~3.6x higher wellhead gas price vs. current price). In FY18, we expect MARI to achieve incremental production of 136mmcfd from Mari gas field, boosting revenues by a considerable 31% and adding 61% to MARI’s bottom-line.
• Reserves revised up 61%: Another catalyst for MARI is significant revision in its gas reserves, as reported by the company in its latest annual filing. According to the data, gas reserves of MARI fields were revised up by 61% to 5,308 Billion Cubic Feet (BCF) vs. reserves level in Jun 2016. Resultantly, MARI fields’ 2P reserves life were substantially increased from 14 years to 22 years, implying that the company can sustain its current gas production level for the next 22 years.
• Investment in power plant: As per our channel checks, the company is eying an investment in a gas fired power plant (with expected capacity of 400-500MW), which would result in fixed returns for the company. The project as of last information was under feasibility status and the company is most likely awaiting regulatory approvals. Any development on this project will be positive as it will help diversify the company’s bottom line going forward, we believe.
• Risk: We flag 1) inability to meet set benchmark of incremental production (levels exceeding by 10% from benchmark 525mmcfd gas) to avail higher pricing, 2) slowdown in demand from Fertilizer sector (~80% of fertilizer production depends on gas supplied by MARI) and 3) lower than anticipated international oil prices and 4) delay in settlement of the company’s dues by its customers, due to circular debt issue (power sector) thereby affecting the company’s liquidity as key risks for MARI.