Australia | Jun 11 2009
By Greg Peel
Back when James Dean was an oil baron (well, in character anyway), the cattle ranches of Texas and the cornfields of Oklahoma and Kansas saw mushrooms sprouting overnight in the form of ever-pumping oil derricks. The great US oil boom was on, neatly coinciding with the post-war rise of US consumerism and a love affair with the automobile.
The oil rush saw wildcatters coming out of the woodwork to rip out corn as high as an elephant’s eye and turn farming land into an oversized pin cushion of drill holes. To this day, Australians living 24 hours from Tulsa, OK, are taken aback to find the city centre still surrounded by oil rigs within spitting distance. But when old technology finally began to exhaust its extraction capacity in the Midwest of the fifties and sixties, someone found oil just off the Gulf of Mexico coast and within a heartbeat everyone packed up and left for the new frontier. Only the diehards remained, knowing full well there was still plenty of oil left behind, both in reserves only partially recovered, and in reserves yet to be found.
Those diehard old Midwest oil men are now in their seventies and eighties, but still get excited by the smell of crude. A handful remain to provide a wealth of unquantifiable oil experience to US companies such as the International Energy Corporation of Oklahoma and Castle Resources of Kansas.
The twenty-first century commodity price boom has brought all manner of new technology aimed at recovering reserves proven but long ago abandoned due to technological or commercial limitations or both. These include everything from capturing coal seam gas – once considered a hazardous waste product – to extracting gold from ore using biological organisms. Another such advance is radial jet enhancement technology which, to cut a long story short, is a water jet which slips down a bore hole, turns horizontal and cuts through to unsuspecting wells of oil.
It was this patented technology a junior Australian oil company called AusTex Oil ((AOK)) pinned its hopes on when it listed in January last year having raised $18.5m. In a “coals to Newcastle” style venture, AusTex planned to exploit existing oil leases in Oklahoma and Kansas and explore for more prospective projects in an area that US Big Oil had long ago moved on from. To that end, it acquired 100% of aforementioned International Energy Corporation and 50% of Castle Resources.
The radial jet technology was not an immediate success. The simple truth was that the diameter of most US bore holes is less than that for which the system was designed. At the same time, AusTex’s timing proved unfortunate when the price of oil fell out of bed only six months later. A junior start-up oil company’s share price is closely correlated to the price of oil, and as such AusTex saw its share price mostly plummet – from a high of 30c to a low of 5c a year after listing.
Thanks for coming.
But AusTex was undeterred. New technology aside, it was indisputable that opportunity still lay in the region. While China might be spending billions to fund deep-sea drilling off the coast of Brazil, and Big Oil might be flocking like hungry seagulls to the LNG reserves of Australia’s North West Shelf, a clutch of junior companies have been happily exploiting not only the supply of oil remaining in America’s heartland, but its ridiculously low comparative cost of extraction. It’s all there – the equipment, the experience, decades of geological study, hundreds of once-operating wells and bore holes, and millions of barrels of proved, probable and possible oil reserves lying not far underneath billiard table-flat farmland.
With six long term lease locations in Oklahoma (as operator) and four lease locations undergoing exploration and development in neighbouring Kansas (Castle Resources as operator), AusTex’s audited reserves amount to 5.6m barrels proven (1P), 7.4m barrels proven and probable (2P), and 13.7m barrels proven, probable and possible (3P). FNArena was invited to attend a lunch presentation by the company CEO, Daniel Lanksy, earlier this month.
Not only did the collapsing oil price signal a premature end to any market interest of note in AusTex, but as a start-up operation the company had to endure extensive capital expenditure from the outset to facilitate production, including electricity generation infrastructure, upgrading of salt water disposal systems, and the satisfying of strict state environmental requirements. Actual production and exploration had to wait. As Hanuman Private Wealth Analysts note, AusTex spent most of its cash in 2008 on anything other than oil production.
The risk for investors is that AusTex would purely cash-burn its way into trouble, but the good news is that start-up capital spend is now complete and the company still has $5m cash in the bank, no debt, and is underway producing and selling oil and spudding new wells. In the meantime, its oil and gas footprint has increased from an initial 1,000 acres to around 32,000 acres.
AusTex’s “lifting cost” of US$8 per barrel is at the very low end of oil production cost. At a West Texas Intermediate oil price of US$70 per barrel the company is making a gross profit of US$48.88 per barrel net of royalties, Hanuman calculates. And this actually is West Texas Intermediate. The delivery point for WTI is in Flushing, Oklahoma (think of the transport cost savings). In March the company sold over 1500 barrels (most recently disclosed) but April was apparently better.
Looking at it another way, AusTex’s current share price is 11c. Using a popular, rule of thumb oil company valuation, which takes the enterprise value (market cap less cash at bank) and divides it by the company’s 2P reserves, Hanuman calculates an investor is buying into Austex’s oil assets at A$1.41 per barrel at a 12.5c share price. That’s US$1.76/bbl at an Aussie of US$0.80.
That may seem an incredible bargain, and in short, it is. Hanuman calls it a “compelling risk reward prospect” and noted in May that shares in peer Aussie junior Red Fork Energy ((RFE)), with a similar project in Oklahoma and only marginally more production than AusTex, were trading at 54c.
Today they are trading at 96c.
Potential investors must, nevertheless, appreciate that such low equivalent oil prices also reflect risk. Hanuman reiterates AusTex has only just turned around from a high rate of cash burn, and production, while accelerating, is as yet low. Low production means that only one well going offline due to unforeseen circumstances can have a major impact on total production. AusTex is also clearly beholden to the oil price, and despite its significant margin the company chose to stockpile production when oil hit US$30/bbl last year. A rising Aussie dollar will also dampen the benefits of a rise in oil price.
But such standard risks are ameliorated by the fact AusTex is not operating in the wilds of some inaccessible terrain known only to anthropologists, nor is it beholden to some volatile third world dictator, under constant threat of attack from separatist rebels, or reliant on plumbing dangerous ocean depths. It’s in the land of Dorothy and surreys with a fringe on top, in the good ol’ US of A. It is not subject to Gulf hurricanes but AusTex’s operations are, unfortunately, right in the middle of Tornado Alley.
Nevertheless, it was valuation upside potential that blew Hunaman Private Wealth away.
