The Snake is the sixth sign of the Chinese Zodiac, which consists of 12 Animal Signs. 2013 is the year of the black Snake and began on February 10th shortly after the New moon in Aquarius, the humanitarian of the zodiac.
The lucky directions of the Snake are: Southwest and Northeast
The lucky numbers of the Snake are: 2, 4, 7 and 9 I’m generally not the superstitious type, but what the heck, it can’t hurt to have some luck on my side as an investor. As the year of the Snake was commencing I found myself looking at a little Mississippi Lime oil and gas producer Austex Oil Limited (ATXDF.PK and ASX:AOK) and noticed the following:
- Austex’s primary asset is the 5,500 acre SNAKE RIVER project in Oklahoma
- Virtually every one of Austex’s well licenses begins with “lucky number two”
- Austex’s Snake River Project is situated in the Northeast corner of Oklahoma All of Austex’s wells are located in Section 20-29 Township 25 North, Range 1 East
Perhaps the signs are telling us that the year of the Snake will also be a good year to be a shareholder of Austex Oil Limited. At the very least it can’t hurt to have a little luck on your side.
Austex Oil Limited – The Business/Properties
AusTex is an Australian listed exploration and production company with operations in the USA. It holds 23,000 net acres of prospective Mississippian Lime property in Oklahoma and Kansas, with the sweetest piece being the 5,500 acre Snake River Project.
The Mississippian Lime play is a shallow carbonate oil play which covers some 17 million acres from Northern Oklahoma, extending into Kansas. The play targets the oil and liquids rich bearing Mississippian limestone formation.
This area has historically had a great deal of conventional oil and gas drilling activity dating back over 100 years. Thousands of vertical wells have been drilled through the upper “chat” section of the play.
Improvements in horizontal drilling, fracturing and in the ability to handle large volumes of water production have reinvented the area by making additional oil commercially recoverable from the lower less permeable carbonate reservoir.
Importantly for a small company like Austex the Mississippian formation is at a relatively shallow depth (3,000 to 6,000 feet) which means wells are not expensive to drill ($650,000) and the high liquids content allows for a fast payout period (return of capital). This smaller amount of up-front capital outlay (a Bakken well for example costs $7 million) and fast payback period allow for cash to be recycled quickly and limits the need for external financing.
According to Global Hunter securities the economics of the Mississippi Lime rank near the top of American unconventional resource plays:
The most profitable play in the graph above is the Mississippian near Hemaha Ridge. Austex’s Snake River Project is located (see image below) right in the sweet spot.
By far the two largest holders of Mississippi Lime acreage are Sandridge and Chesapeake Energy. But we also find some of the other usual suspects such as Apache, Encana, Range Resources and Shell with decent sized land positions as well.
Sandridge has drilled an industry leading 600 wells to date and the image below shows that the majority of the drilling done by Sandridge has taken place in the Grant and Alfalfa counties which are right next door to Austex’s Snake River project.
It certainly looks like the Snake River Project is located in the prime portion of the Mississippi Lime based on both where Sandridge is focusing its drilling and from the economics presented by Global Hunter. Range Resources offers further confirmation of that (image below) in its most recent presentation which shows that the highest level of oil production in the play is located where the Snake River Project is.
Austex has been developing the Snake River Project using a two well per month vertical drilling program.
As noted earlier these vertical wells are relatively inexpensive at $650,000 per well and at the rates experienced by Austex offer at least a 50% return on investment. To fully develop the Snake River property would require 275 wells at 20 acre spacing. With 100,000 barrels of estimated recoverable oil equivalent from each well that is 27.5 million barrels of oil that could be produced.
Ideally though, this acreage will be developed using horizontal wells that cost more up front but offer a higher return on investment. Range Resources has drilled 300 vertical wells into the play and recently switched to horizontal development.
The horizontal wells that Range has been drilling cost a lot more to drill ($3.4 million) but offer a much higher return (100% IRR). At 80 acre spacing it would take 69 wells to develop the property which at 600,000 boe recoverable per location means 41 million boe could be recovered over the long term.
Mississippi Lime – Kansas Acreage
Austex also has 17,500 acres of Mississippi Lime property in the northern extension of the play into Kansas. At this point there is considerable “de-risking” to do before any conclusions can be made about this northern acreage, but Sandridge and Apache have considerable land positions in the area, with Apache surrounding Austex’s acreage.
Valuation
Share Price - $0.125
Shares Outstanding – 432 million
Market Cap - $54 million
Net Cash - $7 million
Enterprise Value - $47 million
1)Valuation Based On Acreage Position
As demonstrated earlier, Austex’s Snake River acreage is clearly in the absolute heart of the Mississippi Lime play.
Austex has 5,500 acres at Snake River. The two most recent transactions in the Mississippi lime involving Equal Energy and Eagle Energy selling property are detailed below:
Being in the heart of the play where the liquids weighting is the highest, the 5,500 acres at Snake River would likely command a premium multiple. The Equal Energy sale involved property that was “gassier” than what Snake River is, so valuing Snake River using the $9,412 price is conservative.
That would peg the value of the Snake River acreage as 5,500 x $9,412 = $52 million.
The value of Snake River alone is more than the Austex’s current share price which means that investors get another 17,500 acres of northern Mississippi Lime acreage for free.
At this point the value of that acreage is difficult to determine as the northern boundary of the play is still being de-risked, but the activity and interest of Sandridge and Apache is clearly noteworthy.
If that acreage turns out to be worth half of what Snake River is worth ($4,700 per acre) it would add 17,500 x $4,700 = $82.5 million which by itself is 150% of the current share price of Austex. That is on top of the Snake River property which is also likely worth at least the current share price.
2) Value Based On Production
Valuing these early stage resource play producers is very much a combination of art and science. Each and every well that is drilled comes on at a high rate and then declines (as expected) rapidly. The result being very lumpy production figures because every single new well being drilled represents a material addition to production before declines set in.
Additionally, much of the value of these companies resides in undeveloped (but de-risked) acreage within the defined boundaries of the resource play.
Austex’s production reached 740 barrels per day in December but will likely be back down closer to 600 barrels per day now before the next few wells are placed on production.
- At 740 barrels per day Austex is trading for $47 million / 740 = $63,500 per flowing barrel.
- At 600 barrels per day Austex is trading for $47 million / 600 = $78,000 per flowing barrel
All of this production is from the Snake River project which has a high liquids weighting. Transactions involving liquids weighted production in recent months are generally well in excess of these metrics, so at the very least again this would suggest that the market is valuing the Snake River property only and giving shareholders the 17,500 acres in Kansas for free.
3) Value Based on Reserves
The NPV10 value for Austex’s reserves is $158 million vs the current enterprise value of $47 million. There are no reserves booked for the Kansas property and that reserve figure is from June and will need to be increased for subsequent drilling.
Looking at the company in this manner makes it appear like a real bargain, but to access those reserves is going to require a lot of capital along the way. Using this figure to value Austex is likely not appropriate, but does provide a good idea of why larger companies are eager to get their hands on acreage in the Mississippi Lime.
My experience is that these small producers are typically valued by the market based on production, are acquired at a level suggested by the acreage valuation and have long term potential as suggested by the reserve valuation.
Balance Sheet – Financing
Financing the development of a resource play is tricky business for the capital constrained small energy producer.
Austex completed a capital raise late last fall that brought in $12.5million and leaves the balance sheet in good shape with a net cash position. This capital should see the company at least through mid 2013 at it continues with its vertical well development program at Snake River.
Austex has recently agreed to a farm-in arrangement with Range Resources to drill a couple of horizontal Snake River wells. Deals such as this could be part of the financing of development going forward.
As production and cash flow ramps up there is also room for Austex to take on some low cost bank debt using its significant reserve value as backing.
At this point Austex hasn’t indicated how much of Snake River will be developed using vertical wells and how much will be developed using horizontal wells. The vertical wells at $600,000 each are a good fit for a small producer, but the horizontal wells may have higher returns on invested capital and recover more oil.
Catalysts
There are a few things that should drive the share price of Austex higher in the coming months (and years):
- Continued development at Snake River will drive production, cash flow and reserves higher
- Only two Snake River producing wells were included in the 2012 reserve figures, since then nine additional wells have been drilled and will significantly add to reserves
- Initiation of drilling and de-risking of the Kansas acreage which is three times the size of Snake River the value of which is currently ignored by the market
- Competitor (Apache or Sandridge) drilling and de-risking of acreage around Austex’s Kansas land
- A North American listing is in the works for Austex and should happen in the first half of the year
- A larger player in the Mississippi Lime acquires Austex for its undervalued land position
- Positive results from competitors drilling into the Woodford Shale which lies beneath the Mississippi Lime
- Additional analyst coverage by firms joining the current coverage of Austex by GMP Securities and RBS Morgans
- Other value focused hedge funds taking positions beside current Austex shareholders Iroquois Capital, Young Capital Partners and K2 Capital
Risks
There are plenty of risks involved in investing in a junior energy producer trying to develop a resource play:
- Every well being drilled uses a significant amount of the capital available, which means that a lot is riding on the performance of every well.
- Fluctuating commodity prices make predicting near term and future cash flows difficult
- Obtaining financing is much more difficult for a small producer and may not be available at attractive terms
- Specific to Austex, the Kansas acreage is still unproven. While the activity of Apache and Sandridge nearby is encouraging there is considerable de-risking to be done
- Austex is a bet on one play, the Mississippi Lime
Directors / Top Management / Largest Shareholders
Richard Adrey—Executive Chairman and Founder
Mr. Richard Adrey was an investment and merchant banker with Andreasen & Co., Kohlmeyer & Co., Mabon Nugent and a private investment company, Coastline Financial Partners, for 30 years with specializations in mergers, financings and in turnarounds of distressed assets. He has been involved with numerous private and public companies, such as Piper Aircraft, Cynocom Corp, Telechips, Medisys, Versatech, VacationBreak, Fairfield Communities and Greystone Medical. Mr. Adrey holds a B.S. in finance and held Officer and Board seats in several companies as an advisor.
Kwang Hou Hung—Non-Executive Director and Deputy Chairman
Mr. Hung qualified as a Chartered Accountant with KPMG, United Kingdom, in 1982. He is a member of both the Institute of Chartered Accountants in England & Wales (“ICAEW”) and the Malaysian Institute of Accountants. He has extensive experience in line and corporate management, having served in various senior management and director positions in companies listed on the Bursa Malaysia (formerly called the Kuala Lumpur Stock Exchange). Mr. Hung is also a past Chairman of Rocklands Richfield Ltd, an ASX-listed company.
Dan Lansky—Managing Director and Founder
Mr. Lanskey has been involved in senior management positions of Australian companies for over 10 years. He has also been involved in a number of companies which have developed international contracts and joint ventures in Asia, Europe and the USA.
Luis Vierma—Non-Executive Director
Luis Vierma holds a Bachelor's Degree in Chemistry and a Master's degree in Geology (Geochemistry of Petroleum). He is a partner in New York based Iroquios Capital Opportunity Fund LP (ICO Fund).Prior to joining ICO Fund, he was formerly the Deputy Chairman of OPEC Long Term Strategy, Deputy Director Hydrocarbons at the Energy Ministry of Venezuela, President of CVP, an affiliate of Petroleos de Venezuala S.A. (PDVSA), and Director and Chairman of CITGO. Mr. Vierma was also the Vice-President of Exploration and Production PDVSA, President of PDVSA Research Centre and Professor of Chemistry at the Univesidad Central de Venezuela. He has 32 years of global experience in the oil and gas industry.
Kay Philip—Non-Executive Director
Kay Philip is a geophysicist whose background embraces project acquisition, financial analysis of resource projects and companies, mining exploration and management. Ms Philip has worked in the securities industry, conducting courses in Australia and South East Asia and also has experience in the financial markets, involving rights issues and other capital raisings. She is an Honorary Associate at the School of Physics, University of Sydney, and has been a director of a number of listed and unlisted companies in the financial and oil and gas sectors.
Ms Philip is a Senior Fellow of the Financial Services Institute of Australia ("FINSIA"), Member of the Australian Institute of Physics ("AIP"), Member of the Australian Society of Exploration Geophysicists (M.ASEG.), and Secretary of the Australian-French Association for Science and Technology ("AFAS").
Russell Krause—NonNon-Executive Director
Mr. Krause has over 25 years experience in Stockbroking and Investment Management with a primary focus on the resources sector. He has held a number of Directorships and Senior Management positions with a number of Australia’s leading firms. For the past ten years he has worked on a number of North American Oil and Gas projects in relation to Capital Raising and Corporate Advisory.
