AIM’s hottest stock this month is oil and gas minnow Petro Matad (LSE: MATD), which has seen its shares spike by more than 200% this week alone.

Petro Matad’s gains have been driven by the decision of the company’s partner in Mongolia to withdraw from a joint-venture between the two firms. The withdrawal will lead to the company receiving compensation that will be, according to management, “highly material” to Petro Matad. What’s more, not only will the company receive compensation from its partner’s decision to exit the JV, but Petro Matad’s stake in the joint venture production blocks will soar to 100% from the current 22%.

Larger partner 

Petro Matad’s now ex-joint-venture partner is an “affiliate” of oil giant Royal Dutch Shell PLC. According to Petro Matad’s management, the decision by the partner to pull out was based on Shell’s optimisation of its own portfolio, and isn’t related to the technical prospects for the blocks.

The oil assets in question are production sharing contracts covering blocks IV and V in western and central Mongolia. Under the terms of the farmout agreement signed between Shell’s affiliate and Petro Matad in April 2015, Shell had the option to exit the agreement at certain points in the development process, as long as compensation was paid.

As of yet, it’s impossible to tell how much compensation Petro Matad will receive from its larger partner’s change of mind. However, while the settlement is likely to be “material” it could well be insignificant given that Petro Matad now has to foot the bill for the development of blocks IV and V. 

During the first half of this year, the company is conducting seismic programmes in blocks IV and V and has plans to drill two test wells on its acreage back to back in 2017. Existing seismic data has already shown that there are multiple potential drilling targets for the company to aim for.

Time to buy?

So, should investors buy into Petro Matad’s recent rally as the company prepares to receive a game-changing lump sum from its former JV partner?

Well, as with all early-stage oil and gas exploration companies, Petro Matad is a high-risk, high-reward play. While any compensation should alleviate any near-term concerns about the state of the company’s balance sheet, there’s still a lot to do before Petro Matad can call itself a fully functioning oil company that can generate enough cash to keep the lights on without asking shareholders for additional funds.

All in all, it comes down to your own personal investment preference. If you’re willing to take the risk with a micro-cap oil explorer, and will do so as part of a well-diversified portfolio, Petro Matad could be an attractive bet. But this is one company that isn’t suitable for widows and orphans.

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Rupert Hargreaves owns shares of Royal Dutch Shell B. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.