Australia | Mar 20 2008
By Greg Peel
When last we spoke of oil producer/explorer Australian Worldwide Exploration ((AWE)), it was all about a paradoxical change in tax treatment. In short, under the new method, AWE’s earnings would fall as the oil price rose. (See “Tax Confuses the Issue for AWE”; Australia; 03/03/08)
The bottom line, if you pardon the pun, is that AWE is now provisioning for its sovereign royalty obligations up front, whereas before it paid the royalties as a tax on earnings. So whereas previously AWE would produce oil, sell it, take a profit, and then hand over a royalty to the Australian or New Zealand governments as the case may be, it now projects its production and puts away a provision to account for what it will have to pay down the track. This provision is marked to market, and so as the oil price rises, AWE needs to top it up.
Ergo – higher oil price, more provision, lower earnings per share.
It’s all an illusion of course, as when AWE finally books its earnings on sale of its oil it can keep all the profits and pay the governments out of that provision. Swings and roundabouts.
But the oil analysts were not thrilled with the idea. Given they set share price targets on a 6-12 month basis, the immediate EPS effect is negative. Reduce EPS, reduce valuation, reduce target. The analysts were all swings and no roundabout. And in some cases a reduced valuation means a mandatory ratings downgrade.
UBS was one broker to downgrade AWE back on March 3 when the first half result came in well short of expectations for the very reason discussed above. The downgrade had nothing to do with whether the Tui oil field was powering along or that Cliff Head was looking good too. Well, today UBS is back upgrading AWE to Buy once more.
No, AWE has not changed its mind on accounting methods. It has simply decided its time to upgrade the reserve estimates at its Tui oil field, which is located in the Taranaki Basin off New Zealand. Tui is proving to be All Black Gold.
Tui averaged gross production of 44,000 bbl/day over February, which was better than expected and has led the company to upgrade its FY08 production guidance from 12 to 13mmbbl. AWE is 45% owner and operator of Tui.
Given such a strong performance, management has decided it’s time to initiate a further review of potential reserves lying in the Tui fields. This is largely what analysts have been expecting, and the general expectation all round is that the results – which are expected to be out by June this year – will be positive.
GSJB Were also made note of the potential reserve upgrade this morning, and has raised its target slightly as a result. Weres maintains a Hold rating however, as production at AWE’s fields, including Tui, is not expected to grow much beyond FY08. (Unless, one presumes, the reserve review uncovers something they missed). The good news is, nevertheless, that all this cash AWE is collecting from oil revenues has allowed it to pay down debt, leaving it in an enviable position to tap into existing credit lines and make an acquisition without blowing out gearing.
The other good news is that given some analysts are concerned about the tax treatment (Credit Suisse and JP Morgan both have Sell ratings), one presumes that if the oil price pulls back, as it may very well have already begun to do, AWE’s EPS will rise and the next result might be a cracker!
This seems like a fun one to play. The current B/H/S ratio in the FNArena database is 4/2/2, with Aspect Huntley having upgraded to Buy last week from Accumulate. The average target is $3.74 against a last trade of $3.13 – down 1.5% in early trade on the back of a 4.5% fall in the oil price. (Silly market doesn’t realise AWE’s EPS is rising as we speak).