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Most
investors may not have Australian resource companies on their radar screens,
but that doesn't mean that there aren't some great opportunities worth
pursuing Down Under. In this exclusive interview with The
Energy Report, Ivor Ries, utilities and
energy analyst at E.L. & C. Baillieu
Stockbroking Ltd., one of Australia's oldest securities firms, describes the
challenges faced by energy-related companies in his country and how they are
taking advantage of the opportunities available both at home and in the U.S.,
Canada and South America.
The Energy
Report: Your firm has been in the investment business for
over 120 years. Can you give us an overview of the energy markets and the
challenges and opportunities that energy companies in Australia face?
Ivor Ries: Australia has historically been
the quarry and energy source to emerging Asian economies. As a result, our
economy is inextricably linked with the progress of China, Korea, Japan, India
and the other Southeast Asian economies. Initially, we were mostly a supplier
of minerals, but in recent years, the liquefied natural gas (LNG) markets
have become a very large part of our economy. We have two very large LNG
projects in production and a third smaller one in Darwin. Another five LNG
projects are now under construction, which will more than triple Australia's
LNG output over the next five or six years.
The LNG boom has its pros and cons. The investment spending is a huge boost
to our economy, but it also has caused a huge shortage of contractors and
manpower. The price of labor has gone through the roof in any business
related to oil and gas. An unskilled laborer working on an LNG project in
Australia is probably paid somewhere between two and four times as much as he
or she would be elsewhere. Australia has very tight restrictions on labor
coming in. At the moment, the industry is forcing the government to change
that. The government recently announced it is going to reduce the visa requirements
for American and Canadian oil and gas workers, so they can help plug that
gap. That would be a huge relief for the industry. We have a very
heavy-handed set of regulations here, and there has been a lot of media
hysteria surrounding fracking, particularly in the
coal-seam gas areas and a very strong campaign to have fracking
stopped. Anyone running coal-seam gas or unconventional gas here has to run
through a very stringent and time-consuming environmental approvals process,
which probably adds two to three years to getting a project off the ground.
When it comes to the cost of getting things done, everything takes longer and
is more expensive than expected. That's frustrating.
TER: What's the breakdown of Australia's energy production versus its
consumption of oil, gas, coal and other energy sources?
IR: The domestic market in Australia is overwhelmingly coal driven.
Australia is the world's largest seaborne coal exporter, and our domestic
power industry runs about 80–85% off coal and to a smaller extent off
hydroelectric power and gas. Cheap coal gives us very low-cost baseload power across the entire economy. A population of
only 23 million (M) people is just not enough to create a significant market
for gas, and that has resulted in a terrible oversupply. Until we started
shipping LNG, gas prices were incredibly low. We're just now starting to see
the connection between the domestic gas price and export prices. Typically,
for the last five years, the price for gas on the east coast of Australia was
about $3.50 per million British thermal units (MMBtu).
Now we're starting to see some longer contracts being signed at about
$7–8/MMBtu.
TER: Do LNG exports offer a big potential opportunity?
IR: Yes. In Australia, unlike the U.S., the mineral resources belong
to the government. So the people who own the land do not own the minerals
underneath. In the States you have the overriding royalty system where the
landowner typically gets a percentage of the production. Here in Australia,
the state government gets a royalty that is typically about 10%. The net cost
of producing coal-seam and conventional gas is very low. There is a good
network of pipelines on the east coast for moving the gas around where cash
production costs, particularly from the better coal-seam gas fields, are
typically less than $1/MMBtu. That's very cheap.
With an LNG plant, the price is now around $12–13/MMBtu.
Even after the pipeline charges and the LNG plant operating costs, that is
quite a big margin. In the recent years, we've had quite a lot of
consolidation with global names buying up the smaller coal-seam gas players
to increase their reserves and have a bigger stake in LNG.
TER: Are most Australian energy companies geographically diversified
with operations in other countries?
IR: Our bigger companies here tend to be multinationals, like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), Rio Tinto (RIO:NYSE; RIO:ASX) and
Woodside Petroleum Ltd. (WPL:ASX).
The Australian market is so small that to grow beyond a certain size, you
have to become multinational in some way. The next tier down is a huge drop
in terms of size. Our biggest pure domestic gas play is probably Origin Energy Ltd. (ORG:ASX). It has about a $16 billion (B)
market cap.
TER: About how many energy-related public companies are there in
Australia?
IR: There are a lot. Our market is a bit like Calgary in that we have
a lot of really small exploration companies here. There are probably more
than 250 listed energy companies on the Australian Stock Exchange (ASX).
TER: You have a fairly broad range of companies in your coverage list
in terms of stage of development, type of business and the price of the
stock. How do you decide what companies you want to cover?
IR: Many companies are working on a lot of small things. Our chief
criteria is the company has to be involved in pursuing one or more core
projects where the central resource is at least 100 million barrels oil
equivalent (Mboe). Otherwise, there's no point.
Companies chasing smaller projects tend to burn through shareholders' capital
and then ask for more. We figure if you chase a 100MMbbl target and you derisk it, you may not actually produce it, but someone
will come and pay you some real money for it. So that's the first criterion.
The other criterion is the quality of the management. Once we feel
comfortable in that area as well, the company goes onto our coverage list.
But as you can see, there are not many.
TER: What are your favorite companies right now?
IR: The ones that stand out to me at the moment are companies like Karoon Gas Australia Ltd. (KAR:ASX), which is a midsize
explorer/developer with an LNG project in Australia and a huge exploration
project ahead in Brazil. Molopo Energy Ltd. (MPO:ASX) and Red Fork Enegry
Ltd. (RFE:ASX) are essentially American companies that happen to
be listed on the ASX. Molopo has acreage in the Bakken
in Saskatchewan, Canada and a project in the Wolfcamp
play in the Permian Basin in Texas. It has about 25,000 net acres in Texas.
We're very excited about that. Red Fork has about 75,000 net acres in the
Mississippi limestone play in Oklahoma. It has been getting some good results
from its early wells there. We think these stocks are all very
undervalued relative to the size and quality of the land positions they have.
The next 12–18 months for all three will be exciting because they have
a lot of wells going in and production will be ramping up. If they get a
reasonable run of drilling success, their share prices will be significantly
higher than they are now.
Molopo's Wolfcamp drilling areas are surrounded by
a lot of very big players getting some really good results. These include EOG Resources Inc. (EOG:NYSE), El Paso Pipeline Partners L.P.
(EPB:NYSE), Approach Resources Inc.
(AREX:NASDAQ), ConocoPhillips (COP:NYSE), Pioneer Southwest Energy Partners
L.P. (PSE:NYSE) and Devon Energy Corp. (DVN:NYSE). On
some of their better wells, those guys are getting over 1.8 Mbpd from long laterals. Molopo has drilled three short
lateral wells so far, and all have flowed oil. It is about to crank up
production and put in somewhere between 8 and 10 wells there by year-end.
Long, lateral wells will target much higher flow rates than achieved to date.
As the company derisks the project, the market will
really appreciate that asset.
TER: What about Red Fork?
IR: Red Fork is up in the Mississippi limestone area in Oklahoma.
That's a real hotspot, and the last time I looked, there were 240 drill rigs
running in the area. Red Fork is run by some very experienced oil guys out of
Tulsa. It's had a couple wells on pump so far and has been getting some nice
oil flows, and is about to crank that up. Red Fork has a very big land
position. It will be getting a big following from the States as its
production cranks up, going to somewhere between 10–12 wells this year.
Toward the end of the year, I wouldn't be surprised if its production was
getting close to 2 Mbpd.
TER: Does that hold up or does it taper off relatively quickly?
IR: Because it has so much acreage, it will just keep drilling. I
think it will eventually have more than 300 well locations that it can drill
there. It will certainly be able to grow its production by just steadily
increasing the footprint there. Its neighbors are getting 30-day initial
production rates around 350–550 bpd on pretty low-risk wells. If it can
string together a whole bunch of those, we think it will then be seen as a
serious company. At the moment, Australians see Red Fork as purely
speculative and they haven't really bought the story yet.
I should talk about Karoon Gas Australia Ltd. for
American investors. Over the years, it has looked long and hard at whether it
should actually be listed in America simply because the Australian market is
probably struggling to value it. It has three projects, including a huge gas
condensate field discovery in a joint venture with ConocoPhillips in the Browse
basin off the northern coast of West Australia. That's the Poseidon fields,
which have estimates ranging anywhere between 3 trillion cubic feet (Tcf) and 15 Tcf gas, with a P50
estimate of around 7 Tcf gas, and a reasonably high
condensate cut in that. It's drilling another five wells there with Conoco
this year to get it to the point where it can have bankable reserves and then
start going out and looking for customers. It's not really an exploration
project anymore, but more of an appraisal development-type thing. It will
require very big capital and a contract offtake for
at least 4 million tons (Mt) LNG before that project will stand up. We're
talking an $18–20B capex to get that project
up and going. Karoon is the junior partner in that.
It originally scoped it, found it and then took it to the market, and Conoco
farmed into it. Since then, it's just working it up to the point where it can
start signing up customers. That's its number-one project.
The other two projects are in Brazil and Peru. In Brazil, it won five blocks
in a government tender two years ago. It has spent a huge amount of money and
time on 3D seismic and developed a large number of 200–300 MMbbl targets there, which it will start drilling in the
second half of this year. This is a very high-impact exploration program.
Before it does that, Karoon is almost certainly
going to farm it out to a larger player because it lacks the people and
manpower to carry out a project of that size alone. Degolyer
& McNaughton have done some work on this and estimate around about 900 MMbbl potential in those five Karoon
blocks. So we're expecting a strong interest in it.
TER: So that amounts to about $90B in the ground, correct?
IR: Yes. These are huge targets in not terribly deep, but not shallow
water, either. These are $80–100M wells, and Karoon
will be looking for someone to make a commitment to at least three wells and
fund its back costs. Anyone coming through probably has to have a check in
their pocket for $500M. That farm-out process is now almost complete with the
partner announcement expected around mid-May, and drilling starting in the
second half of the year. It already has a drill ship contracted so whoever
buys into it is getting a fully worked-up project and it's going to get
instant excitement as soon as it buys.
In Peru, Karoon has some onshore and offshore
leases with potential for up to 700 Mboe. Again,
it's looking for farm-in partners for that. The approval will probably come
out toward the end of the year. This is a company that is chasing really big,
high-impact projects. The stock is generally not held by Australian
institutions. Most of the non-aligned shareholders are American pension and
hedge funds and high net worth individuals.
TER: So it is definitely working in elephant country.
IR: That's right. With these sorts of companies, the only way you can
value them is by applying a probability or a risk factor to the chance of
success. Poseidon is definitely a project. We just don't know how big or how
valuable it is. You have to apply some probability to the rest of the stuff.
We end up with a valuation range of between $7.04 and $17.35/share. It is
about $6 at the moment. Our midpoint value is $12.20. These are risked
valuations with pretty heavy risk factors so if one of these things in
Brazil, in particular, turns into a discovery, then obviously that valuation
would increase very dramatically. It's a high-risk, high-reward kind of
stock, not for the faint-hearted.
TER: Are there any other companies you'd like to talk about or
mention?
IR: In big-cap land, Origin Energy has been a great performer over the
years. Its share price is really suffering at the moment because the market
is so concerned about cost blowouts on LNG projects. It's building a $20B LNG
project with Conoco up in Queensland. Because other project costs are blowing
out, the market is very wary, and its stock has really been sold off over the
last 12 months. We think it's really an excellent company, with about
$2.5B/year cash flow from its domestic operations. It's a really great
business that's been one of the best performers in the Australian market for
as long as it's been listed. If anyone wanted to play the big and liquid way,
certainly Origin would be the standout.
TER: How would you summarize the big picture on energy investment
opportunities in Australia?
IR: We think there is certainly a lot of value in Australia. Our
market is somewhat thin and illiquid, so we don't have the depth of analysis.
We have a lot of companies often holding U.S. assets, which actually trade at
a huge discount to what they would do in their home market. If you're
selective, you can find some real bargains here.
TER: Thanks again for joining us today
IR: Thank you.
Ivor Ries is a senior
analyst and director of industrial research at E.L. & C. Baillieu Ltd., a long established stockbroking firm with
offices in Melbourne, Sydney, Perth, Bendigo and
Newcastle. Ries joined the world of stockbroking in
2001 after a 22-year career in media, included reporting and commentary roles
with The Age, Business Review Weekly and The
Australian Financial Review. Ries joined
E.L. & C. Baillieu in July 2001. The firm
specializes in research and corporate advice for medium-sized industrial and
resource companies and counts many of the country's major institutional
investors as clients. Ries' areas of specialization
are utilities, oil and gas and online media and e-commerce. A native of
Queensland, Australia, Ries
lives in Melbourne with his wife and daughters. He is a Brisbane Lions
supporter.
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DISCLOSURE:
1) Zig Lambo of The
Energy Report conducted this interview. He personally and/or his family
own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Energy Report: Molopo Energy Ltd. Streetwise Reports does not accept
stock in exchange for services.
3) Ivor Ries: I personally and/or my family own
shares of the following companies mentioned in this interview: Karoon Gas Australia Ltd. and Molopo Energy Ltd. My
employer, E.L. & C. Baillieu, has acted as
broker to and earned commissions and underwriting fees from Karoon Gas Australia Ltd., Molopo Energy Ltd. and Red
Fork Energy Ltd. in recent years. I personally and/or my family am not paid
by any of the following companies mentioned in this interview. I was not paid
by Streetwise Reports for participating in this story.
The
Energy Report
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