LAST week, Briefcase looked at the many opportunities presented by Australian gold miners and project developers.
LAST week, Briefcase looked at the many opportunities presented by Australian gold miners and project developers.
During the early 1990s, patient gold sector investors saw many emerging companies re-rated as they entered production, with the best of the pack rising 10-fold or more. Briefcase sees potential for a repeat performance during 2009, but the big difference this time around is limited access to fresh capital. The most likely source of development funding today is either from sovereign wealth funds, Chinese companies or some of the local heavyweights, such as Newcrest, which has just raised a $750 million war chest to take advantage of new opportunities.
This week we turn our gaze towards the oil and gas sector. There is no greater evidence of an inefficient stock market than the way it currently prices ASX listed oil and gas production companies. Briefcase surveyed 31 leading producers to find that they trade with an arithmetic average enterprise value (EV) per barrel of proven and probable (2P) oil reserves of just $US8.50/barrel of oil equivalent (boe) ($A12.74).
Stretching my imagination to calculate a rating against proven, probable plus possible (3P) resources, produces a valuation of just $US3.50/boe ($A5.24). If I weight the calculation by EV, the results show a weighted EV/2P reserves of $US14.80/boe and EV/3P reserves of $US4.05/boe.
These results indicate that oil companies are now amazingly cheap on almost any metric you can name. A valuation at these low levels could only be justified if the oil price is going to sit at around $US35/bbl for many years. In the US, a recent survey valued stocks on that market at a lowly $US12/boe, which is in the middle of my unweighted and weighted EV/2P numbers. These valuations are well below current average finding and developing costs for oil and gas, which Briefcase estimates are closer to $US20/bbl, and this valuation is based only on oil and gas reserves, effectively valuing exploration acreage at zero.
Recent takeover valuations in the US show a willingness to pay an average price of around $US19.40/boe, which is a 32 per cent premium to the weighted average of my survey and is in line with an ongoing oil price of around $US75/bbl. However, it looks like control of incremental petroleum (IPM) is about to pass for and incredibly low EV/2P valuation of just $A5/boe, which I would say is at best, half price.
Secure producers with large amounts of net cash, such as AWE, PanPacific, Oil Search, and NZOG are best rated, but still cheap in Briefcase's estimation. The really cheap stocks include AED and Cooper Energy, which have negative enterprise values. Incredibly, the market is effectively giving these companies away at a discount to their cash asset backing and ascribes a negative value to their hydrocarbon reserves. Oil producers, Salinas and Carnarvon are in a similar situation, with both companies trading with an EV of around $A1 to $A3 per barrel of oil in reserves.
The real value in many of these companies lies in their contingent resources, which is why Horizon Oil, Oil Search, Mosaic, Roc Oil, and Otto Energy look so cheap.
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Why are we seeing this huge disconnect in market valuation? Briefcase believes that the market is taking a very hard-nosed approach to valuing companies, based largely on their ability to fund growth in an environment where capital markets have virtually gone on strike. Cashed-up companies generally score well, while those with development assets, such as AED, Mosaic, Salinas, Marion and Cue may suffer from uncertainty about management or funding capability. Cooper Energy is a standout aberration. The company has $88 million of cash and about 2.1 million barrels (mmbbls) of oil in the Cooper Basin, but clearly the market does not value the company's exploration upside, since past exploration efforts in Indonesia were expensive failures.
Tap Oil is another anomaly. The company has adequate cash to fund ongoing growth, along with a secure operating cash flow. The company's exploration exposure is clearly attracting a negative value following the drilling of a duster at its first outing in the Philippines.
Briefcase takes the reasoned view that the oil price will rebound in 2010 and by late 2011 it will be well over $US100 per barrel. Peak global oil production may already have occurred and will certainly be seen by 2012. The current oil price weakness is a function of a catastrophic decline in demand, leading to production cutbacks of up to 4 mmbbls per day and rising inventories. This might seem like a large buffer, but oilfield production declines by about 3.5 mmbbls every year unless more drilling is undertaken. Globally, 'new' or additional production must be brought on stream each year, just to maintain production levels at a steady state.
The current weak oil price environment is leading to curtailment of the sort of development work required to maintain output, not to mention exploration drilling, which will impact on production in seven to 10 years' time. By the end of 2009, much of OPEC's production buffer will be needed just to meet a steady demand level as underlying production capacity is eroded by natural field decline.
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With the oil price sitting around $US40 per barrel and the price of oil shares languishing, one hope for short-term interest in the sector is the possibility of significant discovery. Recently we witnessed Shell and Nexus Energy make a nice discovery at the Libra Prospect in AC-P-41, but this remote project, with an estimated 500 billion cubic feet (Bcf) of gas and about 28 mmbbls of condensate was not enough to move the market. Since Nexus has been obliged to reduce its interest in the area to just 15 per cent, the value impact might only be an estimated seven cents per share to Nexus.
All eyes are now focused of Karoon Gas, which is drilling a couple of large targets in WA-314-P & 315-P, initially seaward from Inpex's Ichthys LNG development, with 51 per cent partner ConocoPhillips. Poseidon, a 7 trillion cubic feet target is currently drilling. This well will be followed by Kontiki, which has a similar estimated size. Karoon will fund 20 per cent of drilling costs and retain an initial 49 per cent, but has the option to dilute to 40 per cent for additional farm-in support. Discovery at both prospects would be worth over $20 per share to Karoon, given an expected high level of condensate associated with gas in this location. The stock is presently trading at about its risk-adjusted value, assuming a 15 per cent probability of success.
Post-drilling, Karoon will be left with about $95 million in net cash, leaving it well funded and supported by its partner. No doubt a discovery would trigger the need for some additional equity, but Karoon would be a standout acquisition target at that point, with its other interests in Australia, offshore West Africa, Peru and Brazil seen as bonus exploration to any acquirer.
Major independent companies Hess and Woodside have begun drilling at their 50/50 Martell well, near Jansz/Io in deep water. Again, this is elephant country, but gas in this location tends to be very dirty (high CO2 levels). A multi-trillion cubic feet discovery at Martell would open up options for both Woodside and Hess and could provide further gas for a regional approach to development of the Gorgon gas fields.
Underperforming oil junior MEO Australia is also drilling at the Zeus prospect in WA-361-P, where it is partially carried for a 35 per cent interest and Cue also has a 15 per cent interest in what Briefcase estimates could be a recoverable target of about 12 trillion cubic feet of gas if 70 per cent of pre-drill gas in place expectations can be recovered.
Clearly this would be a life changing experience for MEO, with discovery estimated to be worth at least $5 per share for MEO and over $1.40 per share for Cue, if the gas is accompanies by 180 mmbbls of condensate.
Shares of both companies have moved up in anticipation of this action, with MEO rising from 11 cents to 30 cents before the traders and one stale bull seller knocked it down to 22 cents and Cue rose from 10 cents to 16 cents, before settling to 13 cents. Briefcase sees Zeus as a rank wildcat, but it is a very exciting play.
n Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au
