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    Can Sherritt Capitalise on Cuba’s Capitalisation?

    Can Sherritt Capitalise on Cuba’s Capitalisation?
    Posted on November 8, 2015 by Christopher Ecclestone

    Frankly the management of Sherritt, since way back, have not been seen
    as amongst the sharpest knives in the drawer. While they have rightly
    been obsessed with their persona non grata status in the US due to their
    supposedly falling foul of the wretched Helms-Burton Act, they have
    largely taken the ball off the means by which they could remake the
    company to maximise value for the long-suffering shareholders.

    Here I shall examine the rather dire handling of the matter of the
    scarcely-known energy assets the company holds in Cuba, which are NOT
    subject to Helms-Burton problems but are being largely ignored as the
    country barrels towards a Vietnam-style “opening to the West”. The
    obvious solution is to demerge these assets and let them evolve as
    potentially one of the purest play entry points for emerging market
    investors into this nascent frontier market.

    Electricity generation

    One of the interesting positions that Sherritt has built up using its
    non-remittable funds in Cuba has been its push into electricity. This
    division has an internal logic in that Sherritt also has an interest in
    natgas production in Cuba. The company is also pushing into power
    generation in Madagascar in association with its Ambartovy project.

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    Sherritt holds an indirect one-third interest in Energas, a joint
    venture established to generate electricity for sale to the Cuban
    national electrical grid. The remaining two-thirds interest in Energas
    is held equally by two Cuban agencies, Union Electrica and Cubapetroleo.
    Energas runs a power generation system with 506 MW of gross production
    capacity with generation derived from gas supplied from Cuba’s north
    coast by Cubapetroleos.

    Energas produces around 12% of Cuba’s total power output. The location
    of the plants and their individual capacities are shown on the map below.

    Sherritt financed, constructed and commissioned each of the integrated
    gas treatment and power generation facilities located near the Varadero,
    Boca de Jaruco, and Puerto Escondido oil fields.

    The Varadero facility is located approximately 140 km east of Havana.
    The facility consists of two integrated raw gas processing plants, three
    gas turbines and associated electric generators, a heat exchange system
    for generating high-pressure steam, and a steam turbine and associated
    electric generator. In addition, the Varadero site includes an
    electrical substation and transformers, to facilitate connection of the
    facility to the Cuban national grid, and an integrated maintenance and
    administration facility. Aggregate net power capacity of this facility
    is approximately 329 MW.

    The Boca de Jaruco facility (pictured below) is located 50 kilometres
    east of Havana. The site initially consisted of a sour gas processing
    plant, one gas turbine and an associated electric generator with a net
    power capacity of 33 MW. The site also includes an electrical
    substation, a transformer to facilitate connection of the facility to
    the Cuban national grid and an administration facility. The facility
    commenced operation in August of 1999.

    The 85 MW Phase 6 expansion of the Boca de Jaruco facilities completed
    in 2006 included the installation of two additional gas turbines and
    associated electric generators at the Boca de Jaruco plant site with a
    net power capacity of 65 MW and a third gas turbine and associated
    electric generator with a net power capacity of 20 MW located at a new
    plant site in the Puerto Escondido oil field. This phase of the
    expansion also included the installation of sour gas processing
    facilities at the Puerto Escondido plant. The Phase 7 expansion of the
    Boca de Jaruco facilities completed in 2007 included the installation of
    two additional gas turbines and associated electric generators with a
    net power capacity of 65 MW.

    Then the company embarked on a project to expand capacity to 150MW via a
    combined cycle plant which came online in February 2014.

    Depending on the availability of gas reserves, Sherritt could add a
    second 70MW phase.

    Obviously as economic activity rises in Cuba then electricity
    consumption will rise. The chart above shows production by Sherritt’s
    Energas soaring. Indeed since last year these have risen even further.
    In the September quarter sales were 30% higher in dollar value than the
    same quarter of the previous year. They were up 23% in the nine months
    over the same period in 2014. Realised prices were up 20% also showing
    that demand is leading to firmer prices.

    Results in electricity

    One gets the feeling that Sherritt is “hiding its light under a bushel”
    in its energy divisions. Why it should do this is anyone’s guess. It
    reports high losses despite the EBITDA soaring. The electricity business
    made adjusted EBITDA of $24.5mn in the nine months to September 2015
    (compared to $19.4mn in the first three quarters of FY14). Total
    revenues were $39mn (compared to $37.31mn). Cash provided by operations
    was $55mn.

    Oil & Gas assets

    Sherritt has interests in oil & gas fields in Cuba (as well as Spain and
    Pakistan, though those make up less than 4% of sales in the division).
    Its Cuban oil joint venture is juicier than its nickel. Average gross
    working-interest production in the first nine months of 2015 for the
    Cuban JV was 18,666 bopd (down from approximately 20,164 bopd in 2012).
    This makes the JV the largest domestic oil producer in Cuba,
    representing half of total production. Production had been even higher
    until early 2009 when the company was compelled to surrender its
    position in one producing block.

    The company has production-sharing contracts for four offshore
    exploration blocks and vertically integrated operations, with seven
    production sharing contracts in the deepwater zone in the Gulf of Mexico
    northwest of Havana. These blocks cover approximately two million acres
    with proven and probable reserves of 50.5 million barrels. The oil in
    Cuba is located about 1,500 metres below sea level and it drills
    directional wells up to 5,600 metres long to pump oil to the surface.

    With $132.1mn in revenues in the first nine months of FY15 and $219.7mn
    in the same period of FY14, the EBITDA so far in 2015 was $72.2mn
    (compared to $165.6mn in the same period of FY14) the Cuban oilfield
    business remains highly lucrative for Sherritt. It’s worth noting that
    the unit operating costs were $9.04 in Cuba compared to $43.8mn on the
    Spanish fields. This shows that Sherritt dropped the ball on selling the
    Spanish assets when the market was hot. Will it miss the ball on
    realizing the Cuban assets while the demand for exposure to that economy
    is so heightened.

    Conclusion

    In coming back to review Sherritt’s energy assets in Cuba, we went back
    to the research piece we wrote on this theme in 2009. We then went to
    the latest MD&A on Sedar for Sherritt. The shocking thing is that the
    asset base of these divisions has been virtually unchanged since that
    time. The division neither got larger nor smaller, only the numbers
    fluctuated with tariffs, demands and prices for oil & gas. The “orphan”
    O&G assets in Spain and Pakistan still made up less than 4% of the
    total. Any other company in the space would have ditched such small
    participations to focus management effort and reduce costs of travelling
    such great distances. Clearly Sherritt doesn’t mind being spread too thin.

    The Cuban power plants, being de novo, are relatively secure from
    rapacious émigrés (not that not having title would ever stop them
    wanting them). A scenario worth pondering is Sherritt either floating
    them off should a Havana Stock Exchange come into existence. They would
    be prime fodder for such a new market. Another possibility would be
    Spanish majors in the construction/utility space snapping them up in the
    nearer future to get positioned for an eventual wider opening of the
    economy.

    With the rapid opening of the Cuban market to Western investors there is
    obviously a hunger for exposure to this emerging (or frontier) market.
    Investors in the EM space usually pay sizable premiums for exposure.
    Clearly they are not going to buy Sherritt shares with its overwhelming
    preponderance to Nickel and Cobalt to get leverage into an opening Cuba.
    What such investors (Templeton being a good example) want is “pure”
    exposures. In this case the most value could be realized by “liberating”
    the Cuban energy assets into a spun-out vehicle and listing it on a US
    exchange. It would less like creeping around the Helms-Burton Act than
    bulldozing that antiquated and anomalous legal oddity.

    In one stroke Cuba would become instantly available to US equity
    investors. Meanwhile the long-suffering Sherritt shareholders would get
    a bonus prize that they could realise, or keep depending on their own
    investment objectives. Buried deep within the bowels of Sherritt this
    division does no-one any good.

    What will make the Sherritt management see the light? Hmm.. interesting
    question. Anywhere else a shareholder revolt might trigger it. On past
    experience though, and in light of the bunker mentality that rules in
    the company, its more likely they would just put on their Pickelhaubers
    and hunker down for the fight rather than think forward as to what might
    be in everyone’s best interest.

    Source: Can Sherritt Capitalise on Cuba’s Capitalisation? |
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