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Cash in on Pakistan's energy crisis
With Pakistan's power stations unable to afford the oil and gas to power their generators, the country is turning to coal. Tom Bulford examines Pakistan's energy crisis, and picks one small-cap miner well-placed to take advantage.
The lights have been going out across Pakistan. From Islamabad to rural villages, residents regularly have to go without power for up to 15 hours a day.
The economy is being crippled and there is a very simple reason for it: for some months now, the country's power stations have been unable to afford to import the oil and gas that is needed to power the generators. And with the country's own production of oil and gas going into decline, this problem is only going to get worse.
But there is a ready solution - coal. The Government is determined to reduce the country's reliance on imports by promoting the coal industry. And one penny share company that wants to help it on its way is Oracle Coalfields(OFEX:ORCP).
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Last week I met Shahrukh Khan, chief executive and 24% shareholder of thisPlus Markets-quoted venture, and he explained how Oracle's coal mining project could alleviate Pakistan's looming power deficit and turn this penny share into mining titan in the process.
First and foremost I should say that Oracle's licence is on the Thar coalfield, which is in the south-eastern province of Sindh, well away from the troubles in the north of the country. It is 380km from Karachi, with its population of an astonishing eighteen million, is well served by roads and unaffected by the recent floods.
Development of the Thar coalfield is seen as essential if Pakistan is to generate the power that it needs. Today it generates some 20,000MW of power, with some 30% of this from hydro, 66% from oil and gas and the small balance split between nuclear and coal.
Demand for power is growing at some 7%-8% per year and the generators can barely keep pace. Next year, demand for power is forecast to exceed supply by a slim 628MW. But by 2020 Pakistan's government has forecast that this deficit will swell to over 14,000MW unless new capacity is added. With domestic production of oil and gas in decline and the government determined that the country should not rely upon imported fuel, it wants to boost coal-fired generation using domestic supply.
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How Oracle is seizing a three-million-tonne opportunity
So Oracle has taken a licence on block VI of the Thar coalfield, which is thought to host over 175 billion tonnes of coal. This is not of the highest quality and so although the China Northeast Coalfield Geological Survey Bureau has assessed the field, China is not intent upon acquiring its output for its own iron and steel industry. But this lignite coal is good enough for power stations and the energy intensive cement industry, and so Oracle is working to exploit its mine in conjunction with two such customers.
Principal of these is the Karachi Electricity Supply Company (KAR:KESC), which wants to build a power station beside the mine. Given the propensity for things to happen slowly in parts of Asia, it is reassuring to know that the KESC is owned by the Dubai-based Abraaj Capital, the largest private equity firm in the Middle East and one that should be able to push things along. This will be crucial because the majority of the mine's projected annual output of three million tonnes is earmarked for KESC's power station so any delays here would seriously inconvenience Oracle.
So to allow for the possibility that it will be producing coal before the power station is able to take it, Oracle has signed a second agreement with Lucky Cement, the largest cement producer in Pakistan and a major exporter to the Middle East. With energy accounting for over 70% of the production cost of cement and the world market price of coal being driven higher by Chinese demand, Lucky is also keen to find alternative sources of supply.
How to turn a 0.43p tonne of coal in an £18 haul
The greatest risks to Oracle's plans lie with the need to attract some $300m to finance the construction of the mine in the face of Pakistan's volatile political situation, while there is also a risk that its customers will not be ready to take the coal when production starts.
But if it all comes together then Oracle could be a winner. It has a JORC-compliant coal resource of 1.4bn tonnes which can be mined through what the industry calls a 'muck operation' - in other words an open pit operation that begins with the removal of the overburden. Edison Investment Research has pointed out that Oracle's current stock market value of £6m values each tonne of coal in the resource at just 0.43p. To this must be added the $300m capital investment needed to produce 3m tonnes per year which, assuming a 20-year mine life, equates to $5 per tonne of mined coal. "Once developed," Edison points out, "investors will have access to a profit margin of $15-$30 per tonne". That equates to the potential of around £18 per tonne of coal.
In summary both as a project and as a penny share investment Oracle makes a lot of sense. The next step will be a 'bankable feasibility study' which, according to Shahrukh Khan, is being prepared to the most exacting international standards. Armed with this, Oracle is looking to step up from Plus markets to Aim early next year. As Pakistan races against time, I will be keeping a close eye on Oracle's role in solving the country's desperate energy crisis.
This article was first published on 14 October in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.
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Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International, he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund.
