Small Caps | Apr 03 2018
Brokers remain confident Sino Gas & Energy can prevail amid tough negotiations with joint venture partners in Linxing, China.
-China's need for foreign expertise should ensure a successful outcome to negotiations
-Main area of contention is the definition of exploration and development costs
-Stock may underperform in the near term although overdue payments should be forthcoming
By Eva Brocklehurst
Sino Gas & Energy ((SEH)) is in the process of concluding commercial negotiations with its SGE joint venture partner, CUCBM, and an in-principle agreement to the overall development plan has been received.
2017 results missed expectations because of higher costs at the operations in China. Macquarie considers this a minor hiccup and the prevailing wheeling and dealing more about the company entering the final hard part of negotiations.
In the short term, Sino Gas still plays a critical role in supplying gas in China for the future. Maintaining a conservative outlook for production, the broker envisages substantial upside through extended terms.
The ongoing dispute involves a subsidiary, SGE, in which Sino Gas holds a 49% interest, and China New Energy 51%, and resulted in US$7.8m in gross gas sale payments from CUCBM being overdue at the end of 2017.
This is expected to increase by an additional US$9.8m over the first quarter of 2018. The main area of contention has been the differentiation between exploration and development costs.
Given different recovery calculations apply, depending on whether costs are applied to exploration or development, this has had a bearing on the valuation of the project and initial cash flow for Sino Gas.
Amid negotiations, CUCBM, which has a 30% stake in Linxing, withheld gas sale proceeds from the joint bank account maintained with SGE, which has a 64.75% stake. (CBM Energy has 5.25%). Sino Gas has now received assurances from CUCBM that US$8.6m will be paid once the cost allocation principles have been finalised.
Macquarie believes Sino Gas desires to, at least, maintain the value of its holding in the project, which relates to the expiry of the Linxing PSC and the SGE working interest, as well as the aforementioned delays to payments. The broker retains an Outperform rating and 20c target.
Gas Demand
Chinese gas demand was up 15% in 2017 and growth is not expected to slow materially in 2018 as coal to gas switching continues, Canaccord Genuity observes.
The company has extended its gas services agreement at Linxing by another year at US$7.23/mcf, up from US$6.4/mcf. This was slightly ahead of the broker's expectation in US dollar terms, despite a stronger renminbi.
Production for the March quarter averaged 24mmscf/d. The company has signalled that it still expects commissioning of Linxing North in the September quarter.
Previous Negotiations
Citi, maintaining a Buy rating and 27c target, notes the last time a partner withheld payment the Sino Gas share price declined to 3c per share. That particular instance was characterised by a dispute about whether SGE should be paid at all for Sanjiaobei pilot production, and the stalemate resulted in production being shut in.
This time the dispute centres not on whether a payment is warranted, but rather on the precise mechanism to release payments. Citi observes deteriorating sentiment could mean Sino Gas underperforms in the near term but suspects payment will be forthcoming over the coming months.
Canaccord Genuity believes perceptions of heightened sovereign risk are offset by the progress being made at both Linxing and Sanjiaobei as well as the company's previous success in dealing with its SGE partner (PetroChina) at Sanjiaobei. Prior gas shortages in winter and China's need for foreign capital and expertise to increase indigenous gas supplies are also supportive of a successful outcome.
Liquidity is not considered at risk, given existing cash flow and undrawn debt from the Macquarie facility. Sino Gas finished the year with US$28m in cash and US$1.6m in joint venture cash balances. The US$100m facility with Macquarie is drawn down at just US$10m.
Canaccord Genuity believes it is too early to tell whether there will be any tweaking of the Macquarie facility as a result of the negotiations at Linxing. The broker retains a Buy rating and 24c target.
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