Warro may provide gas opportunity

13/08/2008 - 22:00

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Australia's iron ore industry has just become much more valuable.

Warro may provide gas opportunity

Australia's iron ore industry has just become much more valuable. Alarmingly, Rio Tinto Plc recently received correspondence from the president of Guinea, purporting to rescind its concession over Rio's Simandou iron ore project. Rio Tinto said it remained confident it has complied with all obligations associated with its exploration right, but this 2.2 billion tonne, high-grade iron ore project would now appear to be in limbo as non-market forces come into play.

Briefcase can only speculate over what is going on behind the scenes, but can't wait to see the movie. One might expect there has been pressure on the Guinean government from competing developers and potential customers (I wonder who that could be?). One might also expect that, given past performance by governments in that part of the world, a large sum of money may well have also passed hands.

The bottom line for companies such as Midwest, Murchison, Fortescue, Gindalbie and even tiddlers like Venture Minerals is that, by virtue of location in a relatively safe geopolitical location, their iron ore projects are now looking very much more valuable, as long as they remain in the hands of parties committed to maximising value for shareholders.

Continuing on with the Briefcase pain-monitor theme, there is no doubt that the flow of awful news in our daily media is rising. Western Australia's food manufacturing industry has been dealt another blow with smallgoods manufacturer Don KRC, which manufactures products under the Watsonia and Don brands, announcing it will close its Spearwood facility next year. The closure will result in 220 staff losing their jobs. Additional closures in Victoria and NSW will also result in job losses.

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In one new development, Briefcase is cynically inclined to think that it's an ill wind that blows no-one any good. News that US coffee giant Starbucks is closing three in four of its stores in Australia as cash-strapped consumers give up their daily caffeine hit will simultaneously improve the overall quality of coffee available in Australia and also work to relieve a chronic shortage of skilled baristi in Australia. Interestingly, Briefcase's hometown of Perth, where coffee is almost as serious a business as it is in Melbourne, never suffered under the Starbucks scourge, so baristi remain in high demand.

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Meanwhile, some of the same 'masters of the universe' who tried to take over Qantas early last year must have a similar view of Pacific Rail's owner Asciano Limited, as expressed in last week's Briefcase.

In a post-peak oil world, rail operators will be at a premium and the boys and girls at TPG Capital and Global Infrastructure Partners know this. This time around, however, their dancing mates at one-time masters of the universe, Allco Finance are nowhere to be seen. Allco has experienced a nasty collapse of its business model and its management is in disarray, so unlikely to be able to organise a chook raffle, let alone such a bid. Once more, Briefcase is left to wonder at the potential fate of Qantas, had the private equity mob gained control last year. Given the turbulent skies that have overwhelmed many of its competitors, Briefcase is left with the impression that the highly geared business model proposed by the one-time masters of the universe would have severely weakened Qantas to the point that it may have faltered.

Airlines are very capital-intensive businesses and operating costs are sensitive to fuel costs. It is always amazing to see the uninformed commentators complaining about the profits eked out by Qantas. Those complainants need to look at the company's cash flow and compare that to its huge capital and operating spending budget. What drives Qantas is its return on assets and that is the important gauge, not the number of dollars it earns.

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There is a growing awareness in global markets that funding for corporate growth has become the key area of risk for mining developments. In many cases, it will not matter how good a project's geology looks or how carefully all the metallurgy has been tested or how skilled are the engineering designers and marketing people. The key question for investors will be 'does the company have access to funding to make it happen?'

Briefcase has already said that today's global stock market will treat pure exploration and development companies very harshly, since equity will be available only for the best of the best, but beyond exploration, project development debt will also suffer from this funding drought. Smaller companies that do not already have funds tied up now face death by a thousand cuts, while the more nimble may be forced to accept much more stringent joint venture funding from cashed-up peers, looking for opportunities among the adversity. Luckily for shareholders of local nickel companies, Albidon and Mirabela, funding is in place and operating cash flow will support them. Others, such as Sipa Resources and Havilah, while still in the exploration and development phase respectively, are fortunate to have the support of industry partners and cash in the bank.

Given current market conditions, readers should look carefully before making investments in smaller companies further down the share list, since fresh equity has become much more difficult to obtain and banks are facing a period of balance sheet restoration, before they can resume funding at the level of underlying demand. This current debt drought will leave many, otherwise deserving projects, high and dry to wait out the debt turmoil, which will require very patient capital.

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Since the temporary disruption to gas supply from Varanus Island, the state's gas consumers and its government have been searching for answers and looking at ways to improve security of supply. The Warro field in the Perth Basin was originally drilled in 1977 when a 205-metre net column of Jurassic sands averaging 9 per cent porosity and 68 per cent gas saturation was intersected below a depth of 3,542 metres. The low permeability of these formations restricted gas flows on test. Unlike the Whicher Range field located south of Busselton, which was also discovered at about the same time, the Warro reservoir appears to hold no swelling clays, which might interfere with stimulation.

Local company Transerv's early move to provide funding for development of the project places it in a strong position to benefit from funding, which will be provided by Alcoa of Australia, to drill and stimulate the tight gas reservoir at this field.

Market access and gas pricing should be extremely favourable for a commercial project at the Warro field. As a result of a seed funding arrangement with project owner Latent Petroleum, Transerv holds a 10 per cent interest in the Warro Gas Project. The company is well positioned as the only ASX-listed vehicle with exposure to the project, in a market that is keenly interested in alternative sources of domestic gas supply in WA. The company is free-carried through the first $40 million of spending by farm-in partner Alcoa of Australia, which will effectively test the project's commercial viability. Independent resource expert Gaffney Cline, estimates a range of contingent, recoverable gas resources for the Warro Gas Project of between 1.1 trillion cubic feet (Tcf) and 2.1 Tcf at the 2C and 3C levels of confidence respectively.

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

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