passing the first hurdle · 2015. 2. 9. · 2 february 2015 empire oil and gas nl research note –...

Research Note

RESEARCH NOTE – PATERSONS SECURITIES LIMITED 1

All information and advice is confidential and for the private information of the person to whom it is provided and is provided without any responsibility

or liability on any account whatsoever on the part of this firm or any member or employee thereof.

EMPIRE OIL AND GAS NL

PASSING THE FIRST HURDLE

• We have updated our price target for Empire Oil & Gas (ASX:EGO) following the recent decline in global oil prices, the fall in the AUD/USD exchange rate, a reserves upgrade, the move to 100% ownership of the Red Gully Gas Plant and the EP 389 permit. The most impactful to our valuation is EGO’s recent revision to Red Gully’s B-Sand reserves estimate, which saw 2P reserves increase by 46% to 14.53PJ.

• EGO’s current management has continued to progress on a number of initial steps in realising the Company’s strategic objectives since our initiation in November 2014, in a difficult operating environment.

• As discussed in our Initiation Report, in order to achieve its strategic objectives and realise the value of the Company’s assets, management needs to recapitalise its Balance Sheet. The first part of the process involves buying its joint venture partner, ERM, out of the pair’s Perth Basin joint venture assets.

• At the AGM held on 11 December 2014, shareholders voted overwhelmingly in favour for the Company to:

- Buy out ERM’s stakes,

- Issue 769,655,443 shares to ERM, increasing the stake held in EGO by ERM and its associates to 19.99 percent and raising $3.8m, which will be used to repay an existing credit facility provided by ERM.

• Once approved by the Department of Mines and Energy, and Red Gully’s gas customer, Alcoa of Australia, EGO will be able to market the entire Red Gully Gas Plant, which would potentially attract a much better price than just part of the Gas Plant. Similarly, EGO would also be able to attract quality farm-in partners/investors to fund the exploration of its extensive acreage in the Perth Basin due to a simpler ownership structure.

• On the operational front, in December 2014, EGO signed a letter of intent with a WA-based drilling contractor for up to three wells and a contract to acquire aerial 2D survey over its extensive acreage in the Perth Basin. The drilling program will be carried out in two phases. The first phase involves drilling of a development well in the EP 389 permit. Success in this development well alone would not only increase the Company’s proven reserves but also further enhance the value of the Red Gully Gas Processing Plant.

• The second phase of the drilling campaign is planned to be carried out in late 2015, after EGO has reviewed the results of the aerial survey. Significant upside can be realised should EGO successfully de-risk its vast Perth Basin acreage by proving up contingent resources and reserves through the 2D aerial seismic survey and the drilling program.

• There are a number of catalysts in the next 6 – 12 months:

- Successful farm-in from a quality partner;

- Successful development well in the EP 389 permit;

- Discovery of large prospect(s) as a result of the 2D aerial seismic survey in the Perth Basin;

- The sale of the Red Gully Gas Plant for a fair price;

• The next hurdle for EGO to overcome is to raise sufficient funds to carry out planned activities in the first half of 2015.

2 February 2015

12mth Rating HOLD

Price A$ 0.006 Target Price A$ 0.011

12m Total Return % 80

RIC: EGO.AX BBG: EGO AU

Shares o/s m 7,064

Free Float %

Market Cap. A$m 42.4

Net Debt (Cash) A$m 11.6

Net Debt/Equity % 23%

3m Av. D. T’over A$m 0.02

52wk High/Low A$ 0.01/0.01

2yr adj. beta na

Valuation:

Methodology DCF

Value per share A$ 0.011

Analyst: Anh Dang

Phone: (+61 3) 9242 4059

Email: [email protected]

An investment in this company should be

considered speculative and note assumptions

employed are contingent on broader market

conditions remaining buoyant. These can

change at short notice. Recommendations are

current at the time of publication.

12 Month Share Price Performance

Performance % 1mth 3mth 12mth

Absolute -8.3

-21.4

-50.1 Rel. S&P/ASX 300 -1.9 -0.6

-36.0

2 February 2015 Empire Oil and Gas NL




EMPIRE OIL AND GAS LIMITED (EGO)

Reserves Upgrade

In late January 2015, EGO announced a major upgrade in Red Gully-1 well’s B-sand reserves. As a part of production management and to improve the understanding of the reservoir, EGO continued to monitor the performance of the B-Sand reservoir closely and commissioned RISC to review the performance of the B-Sand only 2 months after RISC released the technical specialist report. Following RISC’s updated independent reserves report, the Red Gully-1 B-sand’s 1P and 2P reserves have increased by 35% and 46%, respectively.

Figure 1: Red Gully B-Sand Reserves (PJ) Gross

1P 2P 3P

Reserves as at 1 Oct 2014 7.0 10.8 15.7

Revision 2.2 4.6 2.1

Production 0.70

Reserves as at 1 Jan 2015 8.4 14.5 16.9

Source: Empire Oil and Gas

As discussed in our Initiation Report, we believe the current management has the appropriate skill sets and experience to run EGO’s unique set of assets. This reserves upgrade is a demonstration of such skill sets and experience. The additional reserves increase the revised value of the Red Gully Project from $32.5m to $39.8m, on a 100% ownership basis, maintaining the value of the Red Gully Project despite oil prices halving since the previous valuation.

The largest acreage holder in the prospective Perth Basin

With the acquisition of all ERM’s interests in the pair’s joint ventures, EGO is now the holder of the largest and the most extensive net acreage and operated position in the highly prospective Perth Basin. EGO’s production licenses and production permits encompass more than 12,000 km2 and represent more than 50 percent of the currently granted acreage in the Perth Basin.

Management believes that a simple ownership structure of the Perth Basin acreage is likely to attract high quality farm-in partners and corporate investors to fund the exploration program which aims to unlock the potential of this prospective basin.

Figure 2: Perth Basin Operated Acreage (km2)






Preparation for the Drilling Campaign

Beside securing shareholder’s approval for the acquisition of ERM’s assets, management has also made a number of arrangements in December 2014 in preparation for delivering the Company’s strategic goals, namely signing a letter of intent with a WA-based drilling contractor for up to three wells and a contract to acquire aerial 2D survey over its extensive acreage in the Perth Basin.

On 8 December 2014, EGO announced that the Company has signed a Letter of Intent (LoI) with Enerdrill for drilling up to three wells, subjected to successful fund raising.

Enerdrill is a WA-based land drilling contractor with three land rigs and a workover rig. Enerdrill is the only large rig contractor that is owned and headquartered in Australia. One of the advantages of securing a local drilling contractor is that EGO will benefit from low mobilisation and demobilisation costs. On the other hand, the main drawback of working with a small drilling contractor is the procurement and logistic support risks.

The first of these wells will be within the EP 389 permit which hosts the Red Gully Gas and Condensate Processing Plant. There are two drill-ready prospects, Gingin and Gingin East, within a short tie-back distance of the Gas Plant.

Gingin has estimated 2C contingent resources of 11.7 Bcf of gas and 140,000 bbls of condensate and Gingin East has estimated 2C contingent resources of 7.5 Bcf of gas and 330,000 bbls of condensate.

The locations of the remaining two wells will be determined after EGO has reviewed the results of the geophysical survey. We estimate that each well will cost c.$10m to drill.

Figure 3: Gingin and Gingin East locations


The Largest Gradiometric Gravity Survey in the Perth Basin to Date

In December 2014, EOG announced that the Company has signed a contract with CGG Aviation (Australia) to acquire geophysical survey over the Company’s Perth Basin acreage. The survey data will be used to identify strong exploration leads and prospects for drilling.





The survey will comprise of 12,775 line kilometres across approximately 10,000 square kilometres of Perth Basin tenements and will commence from late March to May 2015. The interpreted results are expected to be available the September Quarter, 2015.

The survey, which is subject to regulatory approval, will be flown over the entirety of EPs 368, 426, 389, 440, 454, 430, 480 and 416.

Figure 4:


The advantages of using airborne gradiometric survey are:

• Cheaper, • Faster, and • Lower environmental and land owner impact.

Work Program and Funding

EGO has a busy work program for 2015 in which the Company has started the preliminary preparation steps as discussed above.





Figure 5: Forward High Level Work Plan With Key Milestones


Funding and Program Costs

As a part of the recapitalisation program, EGO intended to raise up to $7.5m from ERM through a share placement and rights issue, as well as up to $10m from a rights issue offering to all of its shareholders.

EGO achieved $3.8m from ERM from the share placement as a part of the ERM’s asset acquisition, which is earmarked for funding the Company’s operations and repayment of an existing credit facility provided by ERM.

The $10m to be raised from the rights issue is planned to be used to fund the activities in the first half of 2015, as shown in the table below.

Figure 6: Funding requirements for the first half of 2015

2D Aerial Seismic Acquisition and 2D/3D Seismic Re-processing $4.0 m

Planning and Long Lead Equipment for EP389 well $2.0 m

Stamp duty and petroleum registration costs on ERM transaction $0.5 m

Working capital (Red Gully Gas Plant and other) $3.5 m

Full rights subscription $10.0 m


For the drilling of the EP389 well and two other exploration wells, EGO plans to fund it through one of the following methods:

- Debt finance; - Farm-in; - Investor placement, - Equity raising, or - Proceeds from the sale of the Red Gully Plant (lower ranked option).





EGO Valuation

Figure 7 below shows our revised risked sum-of-the-parts valuation of EGO which takes into account the 100% ownership of the EP 389 permit and the Red Gully Project, the recent reserves upgrade for the B-sand, the latest forward curves of oil & gas prices and AUD/USD exchange rate. This underpins our A$0.011 price target.

The most impactful to our revised valuation is EGO’s recent revisions to Red Gully’s B-Sand reserves estimate, which saw 2P reserves increase by 46% to 14.53PJ.

Figure 7: Sum of Parts Valuation

Asset NPV Risked (A$m) NPV ps Risked

EP-389 and Red Gully Project

Red Gully Project 39.8 0.006

Contingent Resources 13.5 0.002

Bootine Deep Prospect 5.6 0.001

Wannamal Prospect 15.8 0.002

Exploration Assets 17.8 0.003

Total Asset Valuation 92.5 0.013

Cash 5.7 0.0008

Debt 17.3 0.0024

Total Enterprise Value 80.9 0.011

Source: Patersons Estimates





Investment Risks

The key investment risks for EGO include:

Commitment risk – a number of its assets require minimum commitment such as exploration, drilling, production to keep. A component of EGO’s strategy is to seek out farm-inees for the Perth Basin permits and to sell down part or all of its Carnarvon Basin permits. Each of these permits have a minimum level of work commitments, which include the drilling of an exploration well. If EGO is unable to secure a farm-inee for one or more of these, then it will risk losing the permit(s).

Geological risk – the actual production characteristics of an oil reservoir may differ significantly from initial interpretations and expectations.

Timing risk – the ability of EGO to secure quality drilling and completion services in a timely and cost effective manner can lead to cost and time over-runs.

Capital expenditure & operating risk – the risk that capital and or operating costs exceed budget and/or exhaust available funding due to unforeseen circumstances before project completion and before further exploration drilling, and reduce the profitability and free cash generation of the project.

Commodity Price and Exchange Rate risk – as with most oil and gas exploration companies, commodity price and exchange rate risk should also be considered.

Liquidity Risk – the ability of EGO to pay its coupon and interest from its cash generation.

passing the first hurdle · 2015. 2. 9. · 2 february 2015 empire oil and gas nl research note –...

Documents