HNR: Is the recent price drop justified by deterioration in fundamentals?

I have previously posted about my rationale for a large position (in fact my largest holding) in Harvest Natural Resources (NYSE:HNR).

Lately, the stock has not done too well - in fact it is down about 25% in the last few weeks. So I have been doing some digging to see if anything changed regarding the fundamentals.

The main trigger for the decline seems to be an analyst downgrade (2 levels below previous). Rather strangely, the main reason he gave for the downgrade was the lack of stock price appreciation in response to a positive event (more on this later). I expect a better reason from a professional analyst: if there is no fundamental deterioration and the price is lower than before then I would expect the stock to be upgraded rather than downgraded.

The positive event the analyst referred to is the recent sale of a neighboring oil field asset by Anadarko (NYSE:APC), which established a comparable market value to HNR's relatively illiquid assets. Now the APC sale established a value of proven & probable ("2P") reserves of about $6 to $8 per barrel of oil equivalent. Using comparable metrics, the enterprise value of HNR implies that their oil & gas assets are being valued at $3 per barrel of oil equivalent, implying that the stock is selling at least 50% below what just the Venezuelan assets are worth. Note that the "Chavez" discount would be shared by both APC and HNR assets since they are neighboring fields. And there are more assets outside Venezuela that are not being valued in the stock price at all.

Today the company announced its Q1 results which indicate that the recovery towards normal oil production is still intact, albeit a bit slower than I would have liked. Production is up to 13.3Kbpd which is up slightly from last quarter. While I am a bit disappointed at the slow pace of progress, most of the disruption due to the two year hiatus seems to be finally over, and normal operation seems to have resumed. During the conference call, the CEO suggested that the peak production that is possible (based on pre-disruption 2004 performance) may be in "mid 40Ks" range, as more and more production drilling takes place. And since the fixed costs are high, every extra barrel of oil produced adds disproportionately into profits.

Here's the rest of the story on HNR.

Has Berkshire Lost Its Hathaway?

How is Buffett doing in his plan to take over the municipal bond insurance market? The Berkshire Hathaway shareholders meeting featured a discussion of progress to date, as well as the potential risk to the financial system posed by the large amount of outstanding credit default swaps. For a person who once characterized derivatives as financial instruments of mass destruction, Buffett is very comfortable with them, remarking that Berkshire has written two types of them and expects to make very good money doing so. These instruments aren't that scary, apparently, when he is using them.

On bond insurance, Berkshire wrote 400 million premium during the first quarter, more than any other player, and possibly more than all others combined. Buffett was very pleased with Ajit Jain's performance: he was able to command a premium of 2.25% in order to backstop insurance that was originally written at 1%. That to me illustrates Buffett's approach - he always has extra capital and employs it to write risks at generous premiums when market conditions permit. This opportunitic approach serves him well but may limit Berkshire's long term prospects in the muni-bond business, as other players return to the market and rates return to normal.

There has been a lot of concern lately that the counterparty risk on the 60 trillion of CDS outstanding as of the end of last year may lead to a collapse of the financial system. Asked to comment on the topic, Buffett's response seemed to lean toward the idea that it's a zero sum game: there will be winners and losers, but to the financial system as a whole the outcome doesn't make any difference. He doesn't think the amount of CDS in and of itself will cause a problem, although it would exacerbate chaos in the event of financial stress from other sources, such as the Bear Stearns crisis.

Read the rest of my thoughts on Berkshire Hathaway and where it's headed.

Time for the Fed to Stop

"In matters of style swim with the current, in matters of principle-stand like a rock"
-Thomas Jefferson

Someone famous once said "Invest in inflation. It's the only thing that is going up" and you know what- I could not agree more. In this world of fiat money one thing is guaranteed - your money will be worth less tomorrow than today. As you might have guessed from my previous posts I am not a great believer in politicians' abilities to guide/understand the economy in general, and definitely get extremely irritated when some of the most vocal and most popular of them try to give advice to the Fed. This advice usually says something like this:" I can't believe you have not reduced rates yet... What the hell is taking you so long-my constituents are suffering and you are doing nothing about it... etc." I think there should be a prize of some sort that is awarded annually to a politician that actually asks to increase rates for once- the only problem is - this prize could go unclaimed for years...

I've posted my opinion on the subject of Fed's rate cuts many times in the past and instead of reinventing the wheel will just repost some of my previous thoughts as I think they have not yet lost their relevance...

Get the rest of Vad's thoughts on the Fed's action in his most recent post here.