Substantial Potential Flagged For Karoon Gas

This story features KAROON ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: KAR

-Several upcoming catalysts
-Strong cash backing
-Willingness to recycle capital
 

By Eva Brocklehurst

Karoon Gas ((KAR)) seeks to move early on prospective oil and gas exploration, building up an inventory of targets and using these to secure farm-in partners. This strategy has been deployed so far in Australia and Brazil and the company is looking to replicate its success in Peru.

Morgans has taken the opportunity to initiate coverage of the stock, with an Add rating and $3.24 target. The broker likes the upside potential for investors, with exposure to existing discoveries in Brazil. The company also has a number of exploration targets across various geographical plays which all have potential.

The company’s exploration team has successfully uncovered hydrocarbons in both the Browse Basin, Western Australia, and the Santos Basin, Brazil. Last year Karoon Gas sold its interest in two Browse Basin blocks to Origin Energy ((ORG)) for US$600m and could receive up to US$200m in additional payments. This is a sign, in the broker’s view, the company is willing to recycle capital with a view to building value. The payment will allow it to undertake more exploration activity in its other targets.

Morgans considers upcoming catalysts could drive significant re-ratings in the year ahead. These include drilling of the Levitt-1 well which, if successful, could open up a new type of play in Western Australia’s Carnarvon Basin. Morgans also expects contingent resources and pre-FEED (front end engineering design) updates in Brazil, and a potential farm-out in both Brazil and Peru, are promising catalysts.

Non-exclusive farm-out negotiations are currently in progress on the offshore Peruvian acreage. The company has identified 18 leads and prospects following interpretation of seismic surveys. Morgans expects any farm-in will likely result in a multiple well program, and also, perhaps, involve a repayment of some of the capital spent on the project to date.

Risks? Exploration failure is obviously one but also currency and commodity prices. Macquarie noted back in March that despite the Kangaroo West-1 well coming up empty, Karoon Gas benefitted from a lower Australian dollar to a point where it now had cash backing of $2.64 per share, and the market was not pricing in any value for that well anyway.

Valuing exploration is highly subjective, Morgans acknowledges. To maintain consistency in valuing exploration assets across companies and regions, the broker applies a risked net present value (NPV) per barrel of oil. This is calculated on a three-year forward average oil price and the reserve/resource classification of the asset.

In Karoon’s case, as with many, there are significant unrisked prospects. Morgans ascribes no value to this notional upside but prefers to look at defined prospects which will be drilled over the next few years. In Citi’s view, the supply/demand balance for oil remains weak, forecasting a low point in oil prices to occur in the second half of this year. That said, Citi retains a Buy but High Risk rating on Karoon Gas.

A couple of months ago flow tests on Karoon’s Echidna-1 well were positive and, unconstrained, UBS estimates the reservoir could be capable of flowing at more than 8,000 BOPD (barrels of oil per day).

On the back of this potential UBS increases its valuation of the Echidna target and retains a Buy rating on the stock. Morgan Stanley, noting Echidna-1 flowed oil of good quality, also considers Karoon Gas is an undervalued explorer on a long-term view.

Karoon Gas has six Buy ratings on FNArena’s database. The consensus target is $3.83, signalling 65.8% upside to the last share price. Targets range from $3.20 (UBS) to $4.98 (Citi).
 

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