Energy -- Oil and Gas, Exploration and Production
The Kurdistan Region of
Iraq – ‘Rewards2 for Risks4’
• With estimated undiscovered resources in the order of 75 billion barrels, Iraq is
home to large scale undeveloped reserve potential. The Kurdistan region in
particular has met with early success with recent discoveries each exceeding 200
million barrels.
• Substantial value has already been created through successful exploration as
indicated by Addax Petroleum’s recent reserve valuation of US$1.0 billion for its
45% share of the 242 million barrel Taq Taq oil field.
• The competitive and operating environment is dynamic, with the Kurdistan
Regional Government (KRG) having awarded contracts (PSCs) to over 20
independent oil companies ranging in size from $10 million to over $50 billion.
• Among the existing companies covered by Canaccord, we highlight the exposure to
Kurdistan for Heritage Oil (HOIL : LSE, HOC : TSX | SPECULATIVE BUY, C$6.00
target price), Niko Resources (NKO : TSX | BUY, C$95.00 target price) and Talisman
Energy (TLM : TSX, NYSE | BUY, C$16.00 target price).
• In addition, we are also initiating coverage on two sole purpose Kurdistan
exploration companies, Vast Exploration (VST : TSX-V | SPECULATIVE BUY,
C$0.25 target price) and WesternZagros (WZR : TSX-V | SPECULATIVE BUY,
C$1.60 target price). By their nature, these two companies are higher in
comparative risk and at a minimum require additional funding upon success. Our
SPECULATIVE rating reflects the risk that in the worst case scenario, without
success or funding, the companies may well spend their current cash and
ultimately have no assets. So while we may believe the rewards in the Kurdistan
region of Iraq appear substantial, so are the risks. Hence the title caption for this
report reads “Rewards2 for Risks4”.

EXECUTIVE SUMMARY
The Kurdistan Region of Iraq provides unique opportunities for exploration companies
seeking exposure to large-scale reserves. Kurdistan may represent as much as 50% of
the estimated 75 billion barrels of undiscovered Iraq potential. Excluding the more
capital intensive oil sands business in Canada, there are few areas that match
Kurdistan’s potential. Early success has been achieved by Addax Petroleum estimates
through its 242 million barrel Taq Taq field, while DNO International ASA’s (DNO)
Tawke field is estimated at 230 million barrels. Both fields have commenced early
production and are awaiting approval to access export markets.
The oil economics of Kurdistan are driven by its Production Sharing Contracts (PSCs),
which allocate revenues between the state and the contractors. Importantly, contractors
recover invested capital out of early field cash flows, before the government maximizes
its take, thus making even smaller discoveries economic. We estimate the present value
for a smaller ~200 million barrel discovery to range between US$372 - $693 million at
$40/b flat oil to US$1,808 - $2,757 million at $60/b flat oil. Substantial value has been
created from early exploration success. In August 2007, DNO was approached by an
unnamed international major to buy its Kurdistan assets for a price of US$700 million.
More recently, on February 4, 2009, Addax Petroleum reported its 45% share of the 10%
after-tax reserve value on forecast prices for the Taq Taq field was US$1,031 million.
The exploration and production business in Kurdistan is currently dominated by what
could be considered smaller E&P companies; however, market capitalizations range from
$10 million to $52 billion. We believe the “Big Oil” majors did not pursue these
exploration agreements as they wanted to be positioned for risk service contracts
expected from the Central government for the larger southern fields in Iraq. However,
operating in Kurdistan is not without risk. Much has been made about the disagreement
between the Kurdistan Regional Government (KRG) and the Central government of Iraq.
We believe that outstanding inter-governmental issues will be resolved as the overriding
interest of Iraq in maximizing its oil wealth outweighs other interests. We have identified
what we see as the main investment risks elsewhere in the report.
Among the existing companies covered by Canaccord, we highlight the exposure to
Kurdistan for Heritage Oil (HOIL : LSE, HOC : TSX | SPECULATIVE BUY, C$6.00 target
price), Niko Resources (NKO : TSX | BUY, C$95.00 target price) and Talisman Energy
(TLM : TSX, NYSE | BUY, C$16.00 target price).
In addition, we are also initiating coverage on two sole purpose Kurdistan exploration
companies, Vast Exploration (VST : TSX-V | SPECULATIVE BUY, C$0.25 target price)
and WesternZagros (WZR : TSX-V | SPECULATIVE BUY, C$1.60 target price). By their
nature, these two companies are higher in comparative risk and, at a minimum, require
additional funding upon success. Moreover, while WesternZagros has funds for its first
two commitment phases, Vast Exploration does not and will likely seek future financing.
We have valued these companies under several benchmarks, but have focused more on
cash plus invested capital. Invested capital is important, given that it is a fully
recoverable amount upon success. While not to take away from the exploration upside,
this approach attempts to be conservative regarding future funding risks. Our
SPECULATIVE rating reflects the risk that without success or funding, the shares may
ultimately be worth nothing at all.