Oil and gas sector ebbs and flows

27/08/2008 - 22:00


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During the past six months, the shape and size of Australia's listed oil and gas sector has changed and shrunk beyond recognition.

During the past six months, the shape and size of Australia's listed oil and gas sector has changed and shrunk beyond recognition.

Excluding BHP, the sector has a total market capitalisation of just under $90 billion, with Woodside Petroleum accounting for 44 per cent of that value and the largest five companies, including Origin Energy, accounting for 83 per cent by market capitalisation.

Meanwhile, at the bottom of the stack, 50 companies with market capitalisations of $20 million or less account for about 0.7 per cent of the sector by market value.

However, looking through the list for value opportunities, many companies appear to be trading well below the replacement value of their hydrocarbon reserves and some companies are even trading at a discount to the value of their cash and liquid investments, which is hardly a ringing endorsement of management's ability to generate shareholder value.

Odin Energy, for example, holds cash and shares in Victoria Petroleum with a total value of about $11 million, but its market capitalisation is just $8 million, which is a $3 million discount for management.

Given that the sum-of-the-parts valuation for many companies is often much more than the market is currently prepared to pay for the company as a going concern, Briefcase believes many companies must be considering whether the best way to improve shareholder value might be to haul up the white flag and put the whole shop up for sale, just as Arc Energy has done. For instance, Amadeus Energy - with proven and probable hydrocarbon reserves of 10.4 million barrels of oil plus 23 billion cubic feet of gas - might well be worth $1.16 per share if it sold these reserves in a trade sale and paid off all its debt.

A similar calculation could be done for Petsec, to reveal a value of at least 85 cents/share for underlying net assets, before allowing any value for exploration appeal.

Meanwhile, companies involved in development of coal seam methane projects (CSM), which continue to consume vast amounts of shareholders' funds and have little prospect of generating a positive free cash flow for at least five years, are trading at huge premiums to otherwise reasonable valuations. These companies have the virtue of controlling long-life projects, while the prospect of further corporate action, combined with a longer term prospect of higher gas margins after LNG plants are established on the Queensland coast post 2012, also plays on a positive valuation.

Briefcase concludes that the market is willing to pay a premium price for project life. This assumption may also explain the valuations of Woodside, Oil Search and Australian Worldwide Exploration, all of whom are well placed with strong resource bases, even though, in the case of Australian Worldwide Exploration's Otway and Bass Basin gas projects, the profit margins are not fantastic, given a low gas price of $3 per thousand cubic foot (Mcf).

No wonder that Santos is moving downstream into power production. At least by converting the gas into electricity, it will be able to capture more value for its gas.

Coal seam methane companies make up an increasingly important part of Australia's energy market, despite uncertainty surrounding their ongoing profitability and the funding issues facing these companies.

Even conventional gas companies such as Beach, Santos and Origin are now heavily involved in CSM.

Incredibly, there are currently 50 companies in the sector, which have a market capitalisation of $20 million or less. Briefcase believes many of these companies will not survive.

Looking up the list a little further, there appear to be many companies with a market capitalisation of less than $60 million, which may also be on the endangered species list.

Briefcase expects several corporate failures in the sector, as sources for funds dry up for companies with little prospect of ever generating any shareholder wealth.

A long-awaited rationalisation of assets and skills will also be forced on the oil and gas sector as the price of oil and gas declines during the rest of this year and possibly into 2009. Australian companies operating in the US are likely to suffer the most from weaker energy product markets.

A belated spurt in oil and gas production globally, brought on by four years of higher price environment, especially in the US where natural gas production has moved ahead, spurred on by prices above $US8 and up to $US12 per Mcf, is lifting production capacity in the US.

Many companies are trading at serious discounts to the value of their resources and cash. Nexus and New Zealand Oil & Gas are the standouts in the plus-$400 million price range, while down the list both Roc Oil and Carnarvon trade with an enterprise value of around $12 to $14 per barrel of oil in reserves Others, such as Petsec, Amadeus, Mosaic, Salinas, Incremental Petroleum and Otto Energy, trade at around this level or lower.

Today, the average capital cost of finding and developing an oilfield has jumped to around $US40-$50 per barrel and deep water projects in West Africa will need $US70/bbl to break even, so some of these undervalued companies must be starting to look a little interesting to peers with healthy balance sheets and strong cash flow.


Our pain monitor continues the check. Last month, one in every 464 US households received a foreclosure filing, up 55 per cent year on year. The median single family, existing home price in the US plunged 7.6 per cent to $206,500 from $223,500 in the second quarter, and housing starts fell 11 per cent in July. Meanwhile, in Sacramento California, prices plunged 35.6 per cent year-on-year to $$229,500, while Cape Coral Florida recorded a loss of 33.1 per cent, prices in Riverside California dropped 32.7 per cent and Los Angeles prices are down 29.6 per cent. Prices in Las Vegas fell 23.6 per cent and Phoenix was down 22.5 per cent for the quarter. While the number of sub-prime victims continues to rise, this situation is not going to improve.

Briefcase believes that it will be February or March next year before we see any relief. First we will need to see a new US president installed in the White House and we will also need to see a decline in the number of sub-prime loans converting from teaser interest rate deals, before the situation is able to stabilise.

A sign of the times was recorded last week when Barbeques Galore went bankrupt in the US. Low activity in the housing market means fewer bake-outs.

The latest price surge left US inflation running at the fastest pace in 17 years. A rise of 0.8 per cent in last month in CPI and a lift of 9.8 per cent in the PPI in the year to July, foretells a higher lift in the CPI over coming months. Welcome to stagflation!


In Europe, GDP in the 15-nation Euro area fell 0.2 per cent in the June quarter. It was the first time since the creation of the Euro currency in 1995 that quarterly growth declined in the bloc as a whole. Output in Germany fell 0.5 per cent and the French economy, the second largest in the Euro zone, posted a 0.3 per cent decline. So let's not talk about disconnected economies.

Fire sales have also begun, with Babcock and Brown hitting the sale path. Allco Finance Group announced completion of the sale of part of its Singaporean real estate arm to Frasers Centrepoint Ltd for $A90 million, to be used to further reduce Allco's senior debt and provide liquidity. Macquarie Countrywide sold its Seaford Plaza shopping centre in Adelaide for $72 million, a 4.1 per cent discount to book value and Babcock Power flogged off its Tamar power project for a $42 million dollar loss. Well done boys.


- Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au


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