23 April 2014

OIL & GAS

Initiation of Coverage Marketing Communication (Connected Research) Oil#

BBG Ticker: MOIL LN Price: 16.25p Mkt Cap: £86.4m BUY

Year to Revenue EBITDA PBT EPS EV/Sales EV/EBITDA P/E December (US$m) (US$m) (US$m) (US$¢) (x) (x) (x) 2012A 0 (13.6) (13.6) (5.5) n/m n/m n/m 2013E 0 (10.3) (10.4) (2.0) n/m n/m n/m 2014E 0 (11.0) (11.1) (1.0) n/m n/m n/m 2015E 108.6 87.4 87.6 6.0 1.0 1.3 4.3 NOTE: US$/£ forward exchange rate = US$1.60. SOURCE: Company, VSA Capital estimates. Approaching Delivery

Giant Tsimiroro Field Close to Commerciality Company Description is an E&P company with Madagascar Oil (MOIL) is the largest acreage holder onshore Madagascar, undeveloped assets onshore Madagascar. with interests in five blocks covering approximately 30,000km2. The One Year Price Performance Tsimiroro field is by far the most important asset owned by the company. It (m sh) Volume (LHS) (p) 40 20 was discovered in 1909, but remained undeveloped, largely due to political Price (RHS) 35 instability in the country, low oil prices and lack of infrastructure. This 30 15 onshore low sulphur heavy oil field, located at a very shallow depth of 25 between 100 and 200 metres below ground, is estimated to contain a 20 10 massive 1.7bnboe of 2C contingent resources. To confirm the commercial 15 potential of this resource, MOIL started its Steam Flood Pilot project in April 10 5 5 2013. A year after the project was launched, oil production was in excess of 0 0 60kboe for the period and results have been conclusive with regard to the 04/13 07/13 10/13 01/14 04/14 reservoir response to the thermal recovery technique. We expect MOIL’s Price % chg 1mn 3mn 12mn Board to declare commerciality and launch the development phase on this -5.1% 15.0% 20.4% vast oil field before the year end. 12mn high/low: 18.0p/8.68p SOURCE: FactSet, as of 22 April 2014 close. Next Year Will be a Turning Point Market: LSE AIM Price target: 70p After several years of political turmoil, Madagascar has now regained Shares in issue: 531.5m credibility with international institutions through its newly-elected President Free float: 24% and his government. This should help rebuild confidence among investors Net cash (Dec 2013E): US$26.7m and bring long-awaited stability to the country, creating a solid basis on Enterprise value: US$111.5m which companies can rely to develop their projects. MOIL will soon be able Next news: Commerciality/H2 2014 to start its first phase of development. This three to four-year phase targets Major shareholders Benchmark 39.0% first oil in 2015, with a quick ramp-up to reach a 10kboe/d plateau by 2017. SEP African Ventures 20.1% The capital expenditure required to build the entire project infrastructure Outrider Management 21.9% will be significant, but 2015 will see the first real production, making MOIL profitable for the first time. We think investors should be encouraged by the Marc Anis-Hanna, Oil & Gas Analyst operational progress as the field development moves forward. +44 (0)20 3617 5182 | [email protected] Edward Vaughan, Recommendation and Target Price Geologist/Assistant Analyst We initiate coverage on Madagascar Oil with a BUY rating and a 70p target Edward Hugo, Head of Research price, in line with our risked NAV using 11% WACC and US$100/boe flat +44 (0)20 3617 5187 | [email protected] long-term oil price.

#VSA Capital acts as Corporate Adviser to Madagascar Oil. This research brochure is a MARKETING COMMUNICATION. It is not investment research and has not been prepared in accordance with legal requirements designed to promote investment research independence and is also not subject to any prohibition on dealing ahead of dissemination of investment research.

Investment Summary Strong Potential for Growth

Madagascar Oil (MOIL) offers investors access to a largely underestimated onshore oil project that has attractive long-term economics. Over the next 20 years, rapid production growth will be delivered through the development of MOIL’s main asset, the giant Tsimiroro heavy oil field.

This already-established resource, located at a very shallow depth of between 100 and 200 metres below ground, was discovered 100 years ago and is estimated to hold significant 2C contingent resources of 1.7bnboe. After several delays, largely due to political instability and low oil prices, the company recently commenced its proof-of-concept Steam Flood Pilot which will continue to operate throughout 2014. During this appraisal phase, more clarity has been provided regarding the reservoir quality and the ultimate recovery rates. In our view, this will lead the company to declare commerciality on the Tsimiroro field before the year end.

Risked NAV breakdown (US$m) Production Profile (kboe/d)

Exploration Financing NAV, 2% NAV, 12% 100 Phase 1 - Risked 80 NAV, 5%

60

40

20 Contingent NAV, 81% 0 2015E 2019E 2023E 2027E 2031E 2035E 2039E 2043E

SOURCE: VSA Capital estimates. SOURCE: VSA Capital estimates.

Following the declaration of commerciality, MOIL will then proceed with a full field development plan, in order to launch Tsimiroro Phase 1 development, primarily targeting production of 10-20mboe of this heavy low-wax crude oil. First oil is expected in 2015 and should quickly ramp up to plateau at 10kboe/d. In the same year, initial cash flow will enable the company to support the funding of part of the capital spending required to build infrastructure for the subsequent phases, which will start in 2018-19, and build towards plateau production of 100kboe/d from the field over a number of years. In our view, this will make MOIL an extremely interesting growth story. Some Challenges Remain

Questions remain regarding MOIL’s ability to reinforce its management team, having not had a CEO since July 2013. Although the company is effectively run, and major milestones have been validated, future steps will require a new CEO to be hired, either externally or sourced in-house.

The second challenge concerns high initial capital costs. Madagascar is an undeveloped country and lacks infrastructure. Operating in this environment could easily become difficult for oil companies, especially with the region’s tropical weather. MOIL will have to invest in road upgrades, a new pipeline and onsite constructions. (See Appendix 1: Madagascar Overview.)

Nevertheless, we think there is deep value in the project which is not currently factored into MOIL’s share price. The company is now ready to take a major step towards rapid production growth and to increase shareholder value. The initial cash inflows will also allow it to start exploring its three other blocks, potentially scaling up its asset base in the case of successful campaigns.

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Valuation

Value creation in the E&P industry follows a number of different stages: exploration, appraisal, development and eventually production. MOIL has completed the exploration stage with the Tsimiroro discovery, which has a massive resource estimate of 1.7bnboe. The Steam Flood Pilot (SFP) appraisal phase, launched by the company a year ago has proved the recovery potential of the source and the Board should now confirm commerciality of the project and submit a full field development plan (FDP) by the end of 2014.

The company will then enter into the more capital intense development phase. MOIL will have to support capital spending for the upgrade of existing roads from the field operation to the capital, Antananarivo, in order to allow transportation of its oil via trucks. The company will also need to upgrade parts of its facility in order to increase the overall production capacity. We estimate the capex required for Phase 1 to be between US$200m and US$400m.

We think the quickest route for MOIL to be rerated is to Required Funding (US$m) complete its initial Phase 1 development and de-risk the rest of its asset while ramping up production through 180 the following phases, and eventually delivering a strong 160 stream of cash flows. On our estimates, production 140 during Phase 1 should reach 10kboe/d, allowing cash US$150m required 120 funding for the from operations to exceed US$100m/year from 2016E. next 2 years. 100 However, because MOIL will be loss-making until 2015E 80 and is not currently generating cash, it will require 60 funding over a number of years to fulfil its future 40 development capital spending. For our NAV calculation, we use an estimate funding requirement of ~US$150m. 20 0 As MOIL is still a small company, and therefore, -20 accessing the debt market is not straightforward, the 2009 2010 2011 2012 2013e 2014e 2015e company is currently debt free. We believe it has two Total Sources of Funds Total Uses of Funds main options to fund itself: either by reducing its stake in the project or through an equity raise. SOURCE: VSA Capital estimates. Farm-Out

MOIL is currently undertaking a farm-out campaign on its exploration assets in licences 3105/3106/3107. As the number of wells drilled to date is very low and there is not yet sufficient data, we have decided to allocate a very low chance of success to the exploration and development of these assets, reducing their NAV. In our view, farm-out of the exploration blocks would not be enough to raise adequate funding, and we believe that MOIL may have to reduce its stake in its main Tsimiroro asset. Equity Raise

The second option would be to proceed with an equity raise, in which case MOIL would potentially dilute its shareholders and substantially decrease its risked NAV per share. However, this would also allow it to bring in a strategic partner, such as an oil services company or an oil trading firm.

We believe MOIL would require around US$150m, which has diluted our risked NAV valuation by approximately 50%.

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Breakdown of Madagascar Oil Risked NAV (p/share)

Prospects Unrisked Equity Net CoS Net EMV EMV Net Net Potential unrisked risked unrisked risked upside mboe % mboe % mboe US$/boe US$m per share per share per share Tsimiroro Phase 1 19 100% 19 70% 13 5 68 5 4 2 Tsimiroro 488 100% 488 30% 147 7 1,019 185 56 130 Contingent NAV 508 508 160 1,087 190 59 131

Financing NAV 146 8 8 Exploration NAV 219 219 5% 11 3 33 36 2 34 Risked NAV 726 726 171 1,266 234 69 165 SOURCE: VSA Capital estimates.

Regarding our valuation, we think the market has already factored in the high probability of MOIL achieving the initial Phase 1 field development (the key story for the next four years), with the share price now trading between our Phase 1 and contingent NAV valuations.

NAV Waterfall Chart

80

70 Risked NAV 2 60

50

40 56 67 30

20 Share Price

10 8 4 12 0 Core NAV Phase 1 - NAV Tsimiroro Contingent Exploration NAV NAV

NOTE: This scenario assumes that MOIL will raise its US$150m funding requirement through equity (@15.5p/share). SOURCE: VSA Capital estimates.

The long-term value for MOIL is derived from our DCF-based NAV, assuming a conservative recovery rate of 30%, as this would be the first time that steam-flood technology was used for the development of a project in Madagascar. We need to mention that for this type of technology, oil recovery can reach up to 60%.

Moreover, following the SFP results, we estimate that 45% of the crude produced was consumed by the steam generators. As this rate tends to decrease gradually over time, as the reservoir is heated, we use a lower but still cautious ratio of 30% of production being reinjected into the steam generators, and therefore not available for sale.

Our approach is very conservative in order to properly capture the risk assumed by the field characteristics, as the resources are unconventional low sulphur heavy oil, located in a not-yet producing area. Therefore, for our key assumptions, we use a long-term flat oil price of US$100/boe and an US$1.60/£1.00 exchange rate, discounted to 1 January 2015 with a WACC of 11%.

We think that at the current time, the value of MOIL is mainly derived from its Phase 1 development and risked contingent resources. The main risk to factor in relates to when and how the company will find the funding to develop this vast project. In addition, other risks include further delays on the development of Tsimiroro Phase 1, production ramp up and political risk. We initiate coverage on MOIL with a BUY rating and a target price of 70p, in line with our risked NAV.

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Business Overview

MOIL was founded in 2004 and acquired 100% rights to operate in five blocks in Madagascar, including the Tsimiroro and fields. The company completed its first equity raise of US$20m in 2006, allowing it to start its exploration activities. Since its foundation, MOIL has raised more than US$150m in equity, which has enabled it to increase its resource estimates from around 300mboe to 1.7bnboe.

In 2008, MOIL farmed out 60% of its Bemolanga exploration licence to French oil major Total for a US$100m consideration in cash and a US$100m gross work programme. In November 2010, MOIL listed on the AIM market, raising US$80m to begin construction of its Steam Flood Pilot (SFP) project.

In 2011, MOIL succeeded in resolving a dispute with the Malagasy government, which eventually accepted the validity of the Tsimiroro PSC and granted an extension on the Bemolanga PSC.

After several management shake-ups, the Board is actively looking to appoint a new Chairman and Chief Executive to run the company and eventually deliver MOIL’s projects. In the meantime, Gordon Stein (CFO) and Stewart Ahmed (COO) are effectively managing the company, and have made significant progress in bringing the company several steps forward. (See Appendix 3 for more details on the current management team.) Development Overview

MOIL currently has two development projects, which represent the core of the business. Tsimiroro

Tsimiroro is MOIL’s flagship asset and the only one which is currently producing. This giant, heavy oil field is located onshore western Madagascar. It was first discovered at the beginning of the twentieth century in Block 3104, along with Bemolanga in Block 3102. The first resource estimate for Tsimiroro, in 2008, was only 300mboe, but following the last independent audit, the contingent resource estimate (P50) was upgraded to 1.7bnboe. This represents a major upward adjustment, giving a STOOIP (stock tank oil originally in place) six times higher than previously expected.

Tsimiroro & Bemolanga Fields Compared to Other Prospects (Schematic Cross-Section Across the Mozambique Channel)

SOURCE: ENVOI.

As the resources are mainly heavy oil (15° API), the company must initially use a technology referred to as cyclic steam stimulation (CSS) to recover the oil. The CSS method works by injecting steam directly into the reservoir, which heats it to very high temperatures. This lowers the viscosity of the oil within the reservoir to the point at which it is able to flow. The oil can then be drawn to the surface along with the condensed water. Only one well is req uired for the process but recovery factors tend to be low.

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CSS involves three different stages: injection, soaking and CSS Stages production. During the first stage, steam will be injected into the reservoir for a defined period. During the following few days, no operations are carried out while steam heats the viscous oil (soak). Then the final third stage lasts for approximately one to two months, during which time the well will be producing and oil pumped to the surface.

(See Appendix 2 for more details on the CSS process.)

The development of Tsimiroro will require several phases beginning with the SFP phase. Steam Flood Pilot

The SFP is the initial phase of development. For Tsimiroro, this initial period tested the reservoir and established the achievable rate of production in order to SOURCE: Canadian Association of Producers. assess the commerciality of the field. The SFP began in April 2013 and has so far shown very conclusive results.

Production rates increased slowly, but substantially, from 222boe/d in December 2013 to 425boe/d in February 2014, +91% in only two months. This allowed MOIL to get closer to its near-term target of 500boe/d. Ten-month cumulative production was more than 63kboe as of March, with half of this being stored on site and the other half consumed for steam generation purposes.

At the beginning of the year, MOIL successfully commissioned three steam generators, allowing the continuous steam injection and cyclic requirements of the SFP wells to be met during 2014. All three generators run effectively on 100% Tsimiroro crude. Steam injection rates have improved with the commissioning of a third generator, with the average uptime rising from 83% last year to 89% in February 2014. A fourth generator will be commissioned as a back-up in the coming weeks, to maintain and increase the production rate.

These encouraging results have been achieved with only 22 operating wells, from 25 originally planned. Three were halted as they were experiencing shallow casing leaks. A remedial rig operation to reinstate these wells is planned by the company. There are also additional water source and disposal wells. The initial wells are now into their sixth cycle of ‘huff and puff’ and the results so far look promising.

The company has been able to successfully resolve the following field issues encountered during the SFP:

Issue Effect Resolution Steam injection rates lower than forecast Rates of 50-250bwe/d versus 300bwe/d Increased injection pressures Two steam to surface events Steam needs to be kept within reservoir Repair or re-drill faulty wells Effect of bottom water, loss of heat to the Water leg being heated rather than the oil Being monitored, plug back of Lower water leg Amboloando may resolve situation SOURCE: Madagascar Oil.

Some of the crude produced will be used to generate the required steam for injection, but primarily it will b e blended with up to 15% of gasoil and then sold as feedstock for Malagasy power generation plants, and to supply other local industry demand. To validate the commerciality of the project, MOIL is also planning to start a six-month continuous market sales test for its crude oil: the first ever market test of crude produced within the country.

Assuming these positive results continue, we expect MOIL’s Board to validate the SFP, declare commerciality and launch the development phase on its vast oil field before the year end. Following the SFP phase, the field will be developed through increasing area blocks, until the field is depleted.

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Phased Field Development

Phase 1

Phase 1 of development will be very similar to, or even a continuation of, the SFP, as it will use the same CSS technology during the early years. The main difference will be quantity. MOIL is planning plateau production of 10kboe/d by 2017 and aims to extract 10-20mboe, with one well to be drilled every four days on average from 2015.

MOIL plans to have two rigs on field that can perform the initial development phase, drilling not less than 700 wells over a four-year period, which will require approximately 28 steam generators. This phase is expected to last four years until the 2019 launch of Phase 2 and targets 10-20mboe of oil production.

In term of capital expenditure, MOIL is working through several options to upgrade roads from the field operation to the capital, Antananarivo, in order to allow transportation of its oil via trucks, even during the wet season. The company is also planning to upgrade its facility in order to increase the overall production capacity. We estimate the capex required for Phase 1 to be between US$200m and US$400m, the majority of this being drilling related cost.

The key aspect for MOIL will be the feedstock used to generate steam. Currently, the company burns 30% of its oil production, which could be sold at a US$100/boe with a 15% discount. It is considering long term alternatives such as importing gas to inject into its generators, or more innovative technologies such as solar panels, which were previously tested by Chevron on its Coalinga field in 2011 through a solar-to-steam project. In this project, 7,600 mirrors track the sun and reflect its rays to a receiver positioned on a solar tower. Using heat from the concentrated sunlight, the solar tower system produces steam that is distributed throughout the oil field and then injected underground for enhanced oil recovery.

In our view, the more probable solution would be to use coal. Madagascar holds large quantities of coal within several deposits, mainly located in south-western parts of the island, which are estimated to contain as much as 100Mt of good-quality coal. Several development projects are under way by the mining industry which, once developed, would be able to supply MOIL.

Phase 2

By 2019, MOIL plans to have completed the construction of a 120km oil pipeline which will link the Tsimiroro Block to the west coast, where the oil will be loaded onto ships ready for export. To enable this to occur, the company will also have to invest in offshore facilities, as the water on the Malagasy west coast is shallow and therefore oil tankers cannot dock at ports on that coast.

Unlike Phase 1, the company will rely solely on cyclical huff and puff well recovery but will move to continuous steam- flood injection, ensuring that production is stable. The huff and puff wells will be converted to continuous service, either steam injection or production, and observation wells will be drilled to collect data in order to improve reservoir management. During this four-year phase, production is expected to be stable, reaching a plateau in the range of 25-50kboe/d. Target cumulative production is 300-500mboe.

Subsequent phases target total production ramping up towards a significant 100kboe/d. Bemolanga

The Bemolanga Block covers an area of approximately 5,463km2 and is operated by Total E&P, which holds a 60% working interest. The block contains an extensive tar sand deposit that could be surface mined. The potential mining project was the subject of a detailed evaluation by Total, including a two-year 160-well coring programme in 2009/10. The results indicated that the oil (bitumen) content of the sand varied from 3.5% to 11% by weight, with an average oil content of 5.5% for the effective mineable area. This is approximately half of the oil yield encountered with typical Canadian .

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Laboratory studies were conducted into the extraction of the bitumen from the rock and an economic model was built. Despite the size of the deposit in the area studied, estimated at 1.2bn barrels of mineable bitumen, the study confirmed that at a base oil price range of US$60-100/boe Brent blend, the cost of mining the ore; crushing the rock; extracting the bitumen; and upgrading, blending and shipping the heavy oil product; would not support a commercial mining project.

MOIL and Total therefore elected to switch their attention to potential conventional oil and gas plays on the block . They carried out an 8,000km2 AGG survey in 2011 which identified two promising prospective features. The results of this work indicate that further seismic acquisition is required in order to confirm the presence of drillable prospects. A 400km2 programme of 2D seismic has been planned, with Total assuming the majority of the costs, in accordance with the terms of the farm-in agreement. An amendment to the Bemolanga Production Sharing Contract is awaiting government approval. Exploration

Aside from Bemolanga, MOIL has a further three exploration projects: Manambolo, Morondava and Manandaza. The three exploration blocks cover a total area of 17,400km2 in the Morondava Basin and lie immediately to the south of the Tsimiroro Block. Earlier operators discovered both gas and light oil in the exploration blocks, but the number of wells drilled to date on modern data is very low and Madagascar is still a frontier area. However, all the elements of a working petroleum system are present, and it is entirely possible that commercial volumes of light oil and gas are waiting to be discovered in the exploration blocks.

Following a seismic programme carried out by MOIL in 2009, a number of encouraging structural leads were identified on the exploration blocks. This work was followed in 2010 with an 800km2 hydrocarbon micro-seepage survey over the identified leads but the results were inconclusive.

In 2012 MOIL carried out a 24,000 line km AGG survey over the exploration blocks and these results are now being integrated with the 2009 and earlier seismic surveys, well data, surface geology and regional studies, in order to produce a comprehensive prospect register.

It is likely that some additional seismic data may be required prior to drilling and plans will be made to acquire further data. Once the evaluation has been completed, MOIL expects to invite interested parties to make farm-in proposals for an exploration drilling programme targeting light hydrocarbons, starting in 2015/16.

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Appendix 1: Madagascar Politics

Madagascar is a former French Colony. The population went through difficult times during the French occupation and even suffered a bloody suppression after an uprising in 1947. The island gained its independence in 1960, and subsequently entered into a period of political instability, with various ruling governments, and a military coup in the 1970s.

In 2009, Andry Rajoelina’s seizure of power via a coup left the country isolated by the international community and deprived of foreign aid, which represented 40% of Madagascar’s budget before the intervention of rebel troops. Clashes between the local populations severely affected the already weak economy, as the island relied heavily on tourism, and risk aversion among investors left the oil and mining industries without funding.

In 2010, a new constitution was adopted by referendum, establishing the Fourth Republic. Three years later, presidential elections saw former Finance Minister Hery Rajaonarimampianina elected as President, with 54% of the vote, with his inauguration taking place in late January 2014. He was swept to power by promising better management of the island’s natural resources, cracking down on corruption and stating that renewing ties with donors can kick-start the economy. Despite criticisms made by the opposition regarding fraud during the elections, his election is perceived as a strong positive signal.

The new president increases confidence in the ability to end five years of deep political crisis in the country, and rebuild confidence among major donors. This, in turn will bring stability to the country and improve economic growth outlook. In April this year, Roger Kolo, a radiologist who returned to Madagascar last year after spending more than 30 years abroad, was appointed as the Prime Minister. President Rajaonarimampianina highlighted that the majority required by the Constitution for the appointment of a new PM was easily exceeded. Mr Kolo has already announced a new government of 31 ministers, which will aim to reinstate good governance and political stability.

Since the beginning of the year, the President has re-engaged in discussions with international institutions such as the IMF and the EU, and has recently held meetings with the US government, French President François Hollande and UN Secretary-General Ban Ki-moon. The World Bank has approved US$341m in lending for the next three years and the EU ambassador to Madagascar has said that Europe will donate €455m for the period 2014-20. The total sum could reach a significant amount of US$1bn to support the Malagasy economy. As a consequence, the World Bank forecasts that the Malagasy economy will expand 3.7% this year and 4% in 2015. Madagascar’s Finance Minister is even more optimistic, forecasting that GDP growth could hit 12% by 2020.

This rapidly improving environment is creating a solid basis on which companies can rely to develop their projects and the timing is key as MOIL will soon launch its vast Tsimiroro field development. Geology

Madagascar formed as a result of the break-up of the ancient supercontinent of Gondwana Land, and is made up of two main geological entities. The core of the island consists of the Precambrian crystalline basement (>500 million years old), which outcrops over two-thirds of the surface. The rest of the island is dominated by five sedimentary basins that lie above the basement, mainly developed on the west of the island.

The majority of hydrocarbon exploration is concentrated in the three main sedimentary basins: Ambilobe, Majunga and Morondava. The giant Tsimiroro and Bemolanga oil fields are both located onshore in the Morondava basin and are believed to be sourced by the lagoonal to lacustrine source rocks of the Lower Triassic, prevalent within East Africa. Good source rocks consisting of type II and III organic matter have also been proved across the Jurassic and Early Cretaceous. However, these relate to a younger petroleum system that may only be of sufficient maturity offshore Madagascar.

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The sediments deposited across Madagascar consist of two main systems: the Karoo Formation (Permian-Early Jurassic), consisting of thick continental sediments; and the Post-Karoo Formation, which was mainly deposited in a marine environment. The formation of the basins and subsequent sedimentation was in response to several episodes of rifting that saw Madagascar drift off the coast of Somalia, and also the continued drifting of India to the north -east. Importantly, the Amboloando Sandstone is a member of the Karoo Formation, which acts as the reservoir for both the Tsimiroro and Bemolanga projects.

The trapping mechanisms for the petroleum systems in Madagascar are also related to the main tectonic events which have affected the sedimentation. The traps related to the rifting of Madagascar from Somalia include tilted fault blocks, flower structures and draping anticlines on to the basement. Resources

MOIL’s assets are located close to major recent discoveries made in East Africa. Since 2010, exploration and appraisal drilling programmes have confirmed the presence of significant resources offshore Tanzania, estimated to be in excess of 15Tcf of gas; with estimates of recoverable gas reserves in Mozambique approaching 30Tcf. East Africa is clearly becoming a major oil and gas region. We believe Madagascar could become an important part of the story.

East Africa Resources

SOURCE: US Geological Survey.

The country’s existing heavy oil resources are well known. However they are undeveloped as yet, due to low oil prices and lack of infrastructure, which have so far made the basin uncommercial.

The discovery of the giant Tsimiroro and Bemolanga oil fields, at the beginning of the twentieth century, first stimulated petroleum exploration activities on the island. Its petroleum exploration history can be divided into three main periods:

1. Prior to 1960, exploration was conducted mainly by SPM, a subsidiary of the former French national oil company ELF Aquitaine.

2. From 1960-75, other international companies such as Chevron and Conoco entered the country through the acquisition of interests in several blocks.

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3. Following the creation of OMNIS, the Malagasy national oil company, in 1976, several partnerships were established with important major international oil companies such as Shell and Exxon Mobil.

MOIL is by far the largest acreage holder on the island, with licences in five basins covering an area of c30,000km2. Following the change in the political climate with the election of the new President, we also expect Oil Majors to re-engage with the country. Infrastructure and Weather

Because of the lack of infrastructure, transportation of products via road is difficult during the three to four-month rainy season. Oil companies based on the west of the island are likely to have significant difficulties transporting products to the east side, where the capital Antananarivo and refineries are located. MOIL is therefore planning to upgrade the roads and build other infrastructure, such as a pipeline and an export terminal, to improve its ability to transport hydrocarbons.

However, the island still remains heavily exposed to tropical cyclones bringing torrential rains and destructive floods, such as the storms in 2000 and 2004, which left thousands of people homeless and presents a considerable risk for companies operating on the island.

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Appendix 2: Steam Injection Technology

Steam injection is the most widely implemented enhanced oil recovery (EOR) technique and is commonly used on shallow, immobile oil fields, ie those containing heavy oil. The method works by injecting steam directly into the reservoir, which heats it to ~300-400°F. This lowers the viscosity of the oil to the point at which it is able to flow. It can then be drawn to the surface along with the condensed water. The water is then separated from the oil at a central processing facility before it is recycled through the steam generators. While the method is expensive, typical recovery factors for this process can be as high as 60%. We have used a very cautious recovery rate of 30% in our valuation of MOIL.

Steam injection projects are measured by steam to oil ratio (SOR) to assess efficiency. This represents the barrels of water used to create the injected steam per barrel of oil extracted. MOIL has an SOR of 12, which is approaching commerciality: typically an SOR of 8-10 is considered commercial. The efficiency of heating the reservoir is a key parameter that affects the SOR. Therefore the ideal properties suited to the technique are thick oil zones; high porosity, high oil saturations; and geologically homogeneous reservoirs with few inter-beds. Efficiency can be further increased by maintaining the reservoir at the required temperature.

There are two main types of steam injection: cyclic steam stimulation and steam-flood. Cyclic Steam Stimulation

CSS involves three different stages: injection, soaking and production. The process differs from steam-flood in that only one well is required for the process, but recovery rates are substantially lower. During the first phase, steam injected into the reservoir lowers the viscosity of the oil to the point at which it can flow. The well is then suspended for several days, allowing the steam to soak into the oil, after which the same well is put into production. A ten-day injection stage at Tsimiroro will allow for one to two months of production, with artificial lift required after one to three days of flowing.

It is possible to use both steam-flood and CSS techniques to complement one another. In this case, a well will be produced using CSS for several cycles before being put on a steam-flood regime with other wells.

In both processes, the amount of time it takes for the steam to reach the producing wells after injection is called the Neumian time. For successful projects, this is typically eight to eighteen months, depending on the well spacing and reservoir quality. Once the steam has reached the producing wells, the rate of injection is regulated to make sure that heat loss in the reservoir is minimised. Steam-Flood

This involves a steam injector well with either one or Steam-Flood Technology several producing wells. The injector pumps steam into the reservoir which warms the oil and drives it in the direction of the producing well.

Typically, the steam-flood process uses around 25% of the produced oil to make steam in the initial stage, but this falls to around 15% over time. After 10-15 years of steam injection, the reservoir builds up latent heat, allowing the field to produce for some time after. Additionally, recovery factors can be improved by processes, such as CO₂ injection or by using gravity, which forces oil in the direction of producing wells. SOURCE: PXP.

However, a series of shaly intervals, faults and igneous intrusions in the Tsimiroro field mean that a gravity assisted project is not feasible for MOIL’s main project.

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Appendix 3: Management Team

After several management shake-ups, the Board is actively looking to appoint a new Chairman and Chief Executive to run the company and eventually deliver MOIL’s projects. In the meantime, Gordon Stein (CFO) and Stewart Ahmed (COO) are effectively managing the company and have made significant progress in moving the company forward. Stewart Ahmed, Chief Operating Officer & General Manager

Stewart joined MOIL in 2013 and has more than 28 years of experience in the oil & gas industry. He holds a BSc in Mining and Petroleum Engineering and worked at Chevron on various North Sea and Gulf of Mexico development projects, including heavy oil experience on the Alba Field. He also worked as resident General Manager for Dove Energy in Yemen, where he managed the exploration and development of the Sharyoof field (25kboe/d). He is based in Madagascar. He is also General Manager of the company’s operating subsidiary, Madagascar Oil SA. Gordon Stein, Chief Financial Officer & Director

Gordon joined MOIL in 2013 and has more than 24 years of experience in the oil and gas industry, in a range of roles across both business operations and finance with Monument, LASMO, British Gas, and Fairfield Energy. He has also been CFO at various organisations, including Regal Petroleum and Cadogan Petroleum. With Vanguard Energy he was instrumental in raising a US$750m debt and equity finance package for UK offshore assets. He is a qualified accountant. Stuart Wesson, Group Controller

Stuart joined MOIL in 2012. He has more than 35 years of experience as Finance Director across a range of oil & gas petrochemical and infrastructure projects for Total, Chevron, Texaco, Shell, AP Moeller, BP Chemicals, CNR/Ranger Oil and PPLI/Bimantara. More recently, he was Finance Manager for KBR’s Bonny Island LNG Project in Nigeria. He is a qualified accountant and is based in Madagascar. Dr Emma Ralijohn, Deputy General Manager

Emma joined MOIL in 2007 and is primarily responsible for working with the government and authorities for contract and environment requirements. She has been a faculty member for a leading Business School in Madagascar since 1991 and has worked as Finance Advisor to the President of Madagascar. She has also served as a Director in the Banking and Financial Supervision Board of the Madagascar Central Bank since 2005 and is a founding member of the American Chamber of Commerce in Madagascar. Dr Ralijohn has a PhD in Finance and a Doctorate Sciences de Gestion in Strategic Management.

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Appendix 4: Peer Group Table

Company Local Share Price Mkt Cap PE (x) P/B (x) ROE (%) Currency (local) (US$m) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E GBP 1.45 2,685 5.6 12.1 11.9 2.1 1.3 1.1 31% 11% 9% Africa Oil CAD 7.52 2,119 n/a n/a n/a 4.8 2.4 2.3 (8%) (3%) (4%) Altima Resources CAD 0.11 32 n/a n/a n/a 0.5 n/a n/a (8%) n/a n/a GBP 1.65 1,602 n/a n/a n/a 0.7 0.5 0.6 (17%) (5%) (4%) Fortune Oil GBP 0.13 434 1.2 n/a n/a 0.7 n/a n/a 61% n/a n/a Genel Energy GBP 9.25 4,354 25.4 15.7 10.1 1.1 1.0 0.9 5% 6% 9% Gulf Keystone Petroleum GBP 0.93 1,385 n/a 46.9 11.6 4.4 2.5 2.0 (6%) 5% 17% Lundin Petroleum SEK 134.4 6,291 77.0 47.5 30.7 5.1 4.7 4.0 7% 10% 13% Madagascar Oil GBP 0.16 142 n/a n/a 4.2 0.6 0.8 0.6 (5%) (4%) 16% Ophir Energy GBP 2.25 2,238 n/a n/a n/a 1.5 1.0 1.0 (19%) (6%) (3%) GBP 3.07 2,719 11.1 9.6 8.5 1.2 1.2 1.0 12% 12% 12% Primeline Energy Holdings CAD 0.67 68 n/a n/a n/a 0.7 n/a n/a (1%) n/a n/a GBP 0.94 449 n/a n/a n/a 1.7 1.4 1.5 (20%) (6%) (4%) Taipan Resources CAD 0.40 37 n/a n/a n/a 1.2 n/a n/a (20%) n/a n/a Sector 24,555 26.1 20.0 12.6 2.8 2.2 1.9 4% 5% 7%

Company Gearing (%) EV/EBITDA (x) FCF Yield (%) Return on Invested Capital (%) 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E Afren 47% 43% 36% 3.8 3.9 3.2 15% 9% 10% 19% 22% 18% Africa Oil (56%) (18%) 14% n/a n/a n/a (1%) (16%) (17%) (8%) (4%) (5%) Altima Resources 22% n/a n/a n/a n/a n/a (41%) n/a n/a (7%) n/a n/a Cairn Energy (39%) (26%) (10%) n/a n/a n/a (4%) (33%) (33%) (17%) (5%) (4%) Fortune Oil 4% n/a n/a n/a n/a n/a 12% n/a n/a 50% n/a n/a Genel Energy (17%) (12%) (10%) 15.5 7.7 4.6 6% (4%) (0%) 5% 6% 9% Gulf Keystone Petroleum n/a 66% 74% n/a 20.1 10.9 (3%) (16%) (14%) n/a n/a n/a Lundin Petroleum 95% 176% 180% 10.8 9.5 6.8 (11%) (18%) (6%) 4% n/a n/a Madagascar Oil (12%) (40%) (10%) n/a n/a 1.2 (17%) (11%) (33%) (5%) (5%) 21% Ophir Energy n/a (48%) (29%) n/a n/a n/a (21%) (26%) (28%) n/a (4%) (5%) Premier Oil 67% 82% 77% 4.7 4.6 3.8 (13%) (12%) (8%) 7% 6% 7% Primeline Energy Holdings 9% n/a n/a n/a n/a n/a (0%) n/a n/a (1%) n/a n/a Rockhopper Exploration (90%) (80%) (77%) n/a n/a n/a (2%) (10%) (9%) (20%) n/a n/a Taipan Resources (29%) n/a n/a n/a n/a n/a (8%) n/a n/a (20%) n/a n/a Sector 25% 51% 57% 6.5 5.9 4.0 (4%) (13%) (9%) 3% 3% 3% SOURCE FOR THESE TABLES: FactSet data.

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Appendix 5: Financials

Pricing and Production

Year End December 2009A 2010A 2011A 2012A 2013E 2014E 2015E Brent oil price average (US$/bbl) 61.5 79.5 86.7 115.5 110.2 100.0 100.0 WTI price 61.3 79.6 83.5 96.1 92.0 95.0 95.0

Volumes Working interest production rate (kboe/d) ------5.0 Total annual oil production (mboe) ------1.8 SOURCE: Company data, VSA Capital estimates.

Profit & Loss

Year End December (US$m) 2009A 2010A 2011A 2012A 2013E 2014E 2015E Revenues 0 0 0 0 0 0 109 EBITDA (3.4) (10.7) (13.1) (13.6) (10.3) (11.0) 87.4 Depreciation (0.4) (0.3) (0.2) (0.1) (0.1) (0.1) (0.1) Consolidated operating income (3.8) (11.0) (13.3) (13.7) (10.4) (11.1) 87.3 PBT (3.8) (11.5) (13.2) (13.6) (10.4) (11.1) 87.6 Tax charge (0.0) (0.1) (0.0) (0.0) 0.0 - (19.3) Tax rate 1% 1% 0% 0% 0% 0% 22% PAT (3.9) (11.6) (13.2) (13.6) (10.4) (11.1) 68.4 Minority interests ------Net income -group share (3.9) (11.6) (13.2) (13.6) (10.4) (11.1) 68.4

Per share data Average number of shares outstanding (basic) 124.1 139.5 196.5 247.0 531.4 1,136.2 1,136.2 Average share price (p/share) - 81.2 50.6 24.2 16.3 16.3 16.3 Average share price (US$/share) - 1.25 0.79 0.39 0.26 0.26 0.26 EPS (£) (0.02) (0.05) (0.04) (0.03) (0.01) (0.01) 0.04 EPS (US$) (0.03) (0.08) (0.07) (0.06) (0.02) (0.01) 0.06 EPS growth (US$) 167% -16% -18% -64% -50% n/a SOURCE: Company data, VSA Capital estimates.

Balance Sheet

Year End December (US$m) 2009A 2010A 2011A 2012A 2013E 2014E 2015E Non-current assets 94.9 104.8 123.9 196.7 235.2 255.3 425.5 Current assets 3.4 68.9 43.3 18.9 28.6 147.3 56.6 Of which: Cash 2.9 67.5 40.5 14.8 26.7 146.1 50.1 Total assets 98.2 173.7 167.2 215.6 263.8 402.6 482.2

Equity - group share 96.8 170.6 160.4 173.7 231.8 365.1 477.5 Total debt 0.0 0.0 0.0 15.0 0.0 0.0 0.0 Other long-term liabilities 0.6 0.2 0.3 4.5 4.5 4.5 4.5 Other current liabilities 0.8 2.9 6.4 22.3 27.5 33.0 0.1 Total liabilities 1.4 3.1 6.8 41.9 32.1 37.6 4.6

Equity & minorities 96.8 170.6 160.4 173.7 231.8 365.1 477.5 Total equity& liabilities 98.2 173.7 167.2 215.6 263.8 402.6 482.2 SOURCE: Company data, VSA Capital estimates.

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Cash Flow Statement

Year End December (US$m) 2009A 2010A 2011A 2012A 2013E 2014E 2015E PBT (3.8) (11.5) (13.2) (13.6) (10.4) (11.1) 87.6 DD&A 0.4 0.3 0.2 0.1 0.1 0.1 0.1 Unsuccessful exploration expense 5.1 1.3 3.1 1.9 0.8 0.8 0.8 Interest paid (0.0) 0.5 0.0 0.0 0.0 0.1 0.4 Tax paid (0.1) (0.0) (0.0) (0.0) 0.0 0.0 (19.3) Other non-cash items (7.5) 0.9 0.5 2.8 (0.3) (0.1) (0.4) Cash flow from operations (5.9) (8.5) (9.5) (8.8) (9.8) (10.1) 69.3 Disposals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Shares issued 5.8 83.7 0.0 25.0 57.9 150.0 0.0 Total sources of funds (0.1) 75.1 (9.5) 16.2 48.2 139.9 69.3

Capital expenditures 0.2 (0.1) (1.9) (7.8) (13.0) (20.0) (170.1) Acquisitions 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Dividends 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (4.3) (12.4) (15.2) (50.8) (22.7) 0.0 0.0 Total uses of funds (4.1) (12.5) (17.0) (58.6) (35.7) (20.0) (170.1)

Working capital changes (1.3) 0.4 0.1 0.2 (0.5) (0.6) 4.4 Cash flow surplus/(deficit) (5.5) 63.1 (26.4) (42.2) 11.9 119.3 (96.4)

Change in FX 0.2 0.5 0.2 0.1 (0.2) 0.0 0.0 New loans/(repayments) 0.0 (0.1) 0.0 15.0 (0.0) 0.0 0.0 Other 1.8 1.2 (0.9) 1.4 0.3 0.1 0.4 (Increase)/decrease in net debt (3.5) 64.6 (27.1) (25.7) 11.9 119.4 (96.0) SOURCE: Company data, VSA Capital estimates.

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Disclaimer

Investment Analyst Certification In our roles as Research Analysts for VSA Capital Limited, we hereby certify that the views about the companies and their securities discussed in this report are accurately expressed and that we have not received and will not receive direct or indirect compensation in exchang e for expressing specific recommendations or views in this report. Non-Independent Research This is a marketing communication. It is non-independent research as it has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Important Disclosures This research report has been prepared by VSA Capital Limited, which is party to an agreement to be paid a fee as corporate f inance advisors and arrangers with, or has provided investment banking services to, Madagascar Oil, or has been party to such an agreement within the last twelve months, and is solely for, and directed at, persons who are Professional Clients as defined under Annex II of the Markets in Financial Instruments Directive, Directive 2004/39/EC, or as defined in the FCA Handbook. Persons who do not fall within the above category should return this research report to VSA Capital Limited, New Liverpool House, 15-17 Eldon Street, EC2M 7LD, immediately. This research report is not intended to be distributed or passed on, directly or indirectly, to any other class of persons. 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In any case, ratings (or research) should not be used or relied upon as investment advice. An investor’s decision to buy or sell a stock or investment fund should depend on individual circumstances and other considerations. VSA Capital Limited’s recommendations are defined as follows: BUY: The stock is expected to increase by in excess of 10% in absolute terms over the next twelve months. HOLD: The price of the stock is expected to move in a range between -10% and +10% in absolute terms over the next twelve months. SELL: The stock is expected to decrease by in excess of 10% in absolute terms over the next twelve months. In addition, on occasion, if the stock has the potential to increase by in excess of 10%, but on qualitative grounds rather than quantitative, a Speculative BUY may be used.

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Distribution of VSA Capital Limited’s Equities Recommendations VSA Capital Limited must disclose in each research report the percentage of all securities rated by the member to which the m ember would assign a “BUY”, “HOLD, or “SELL” rating, and also the proportion of relevant investments in each category issued by the issuers to which the firm supplied investment banking services during the previous twelve months. The said ratings are updated on a quarterly basis.

Equities breakdown: 31 March 2014 Spec. BUY BUY HOLD SELL Overall equities coverage 15.8% 65.8% 13.2% 5.3% Companies to which VSA has supplied investment banking services 18.8% 81.3% 0.0% 0.0%

Recommendation and Target Price History

Madagascar Oil (p): Recommendation/TP history 70 Valuation basis 60 The long-term value for MOIL is derived from our DCF-based NAV, Price assuming a conservative recovery rate of 30%; with 30% of crude oil 50 TP production being reinjected into the steam generators and therefore not available for sale. Our key assumptions are a long- Rec Chg 40 term flat oil price of US$100/boe and an US$1.60/£1.00 exchange BUY, TP 70p rate, discounted to 1 January 2015 with a WACC of 11%. 30 23/04/14 Risks to that valuation 20 The main risks to our target are further delays on the development 10 of Tsimiroro Phase 1, production ramp up and political risk. This recommendation was first published on 23 April 2014. 0 04/13 06/13 08/13 10/13 12/13 02/14 04/14

SOURCE: FactSet data, VSA Capital estimates.

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