Small Caps | Jun 12 2013
-Strong contender in the US shale plays
-Substantial upside to investment
-Farm-out deals to support future plans
By Eva Brocklehurst
Austin Exploration ((AKK)) has become a strong contender in the US unconventional oil and gas stakes. The strategy is simple: focus on US shale gas assets and quickly establish resources. The focus is on some highly prospective, and underexplored, areas which are on the trend of proven shale/gas.
The company has taken on partners for a high impact drilling program with five wells to be drilled over the next year. Two wells are expected to spud by year-end and could, if successful, provide material cash flow by the end of the second quarter in 2014. Farm-outs have occurred in the Eagle Ford shale at the Birch project, Gulf of Mexico, Texas, and in the Niobrara shale at the Pathfinder project, Rocky Mountains, Colorado. The partner on the Eagle Ford has not been disclosed until the transaction is binding, but the company has indicated it is a large energy company. The transactions have resulted in funding of US$36 million for Austin's plans. The company also has 50% working interests in acreage in Kentucky and Mississippi.
Austin released an independent resource report in August 2012 taking account of data from Birch and Pathfinder, but not including the recent Pathfinder horizontal well. The Birch project acreage is in the north east section of the Eagle Ford trend, in close proximity to the developed Giddings Austin Chalk field. Austin was able to secure the acreage for US$400 per acre because of the immature play in the region at the time. Austin will maintain an equity interest of 30% in the project. Austin has drilled three wells – two Eagle Ford and one Austin Chalk – at Birch and all intersected hydrocarbons. Importantly, the two Eagle Ford wells provided valuable technical information which de-risked the further drilling.
The terms of the farm-out require the farm-inee to fund the cost of the next there Eagle Ford wells. At completion, the farm-inee will earn 70%. The three horizontal wells are expected to cost US$8m per well. The agreement covers 4,295 acres while Austin retains a 645 acre parcel. Austin will receive a US$1.95m up-front payment for an 18-month exclusivity option over the block during the drilling program. DJ Carmichael thinks this is a compelling endorsement of the work program to date, valuing the deal at US$8,650 per acre which would provide a 20 times return on Austin's original investment.
The Pathfinder project involves an 85% interest (65% net revenue interest) in 11,500 acres of high quality shale assets. The remaining 15% is held by JV partner Thomasson Petroleum. The acquisition cost was US$200 per acre. The first Niobrara well has been completed to 5,920 feet. It was the first to be drilled through the Pierre shale formation and the first into the Niobrara in the Florence field. It flowed oil and natural gas to surface at 403 boepd . Despite the results the market reaction was non committal. DJ Carmichael suspects this is because of the higher-than-expected gas ratio, as the market was expecting primary oil. Of note, this was the first well drilled in a relatively greenfield area and the broker expects further appraisal, that will be funded by the recent farm-out, could unlock significant value.
Austin will farm out 30% of its 85% working interest, retaining 55%, and be carried for the drilling costs of the next two horizontal wells. Austin will remain the operator. DJ Carmichael values the deal at US$3,480/acre, which would represent a substantial return on the entry cost. The potential upside is seen as substantial if the future development wells deliver in line with the nearby Wattenberg wells being drilled by Anadarko. Austin will sell the gas at the well head from Pathfinder to Mercator Energy, having signed a Heads of Agreement last month.
Mercator Energy will fund the development of the gas infrastructure and retain a percentage of the NYMEX natural gas price component of the final price that Austin receives. Construction of stage one is expected to be completed in six to nine months. This should allow the greater portion of the gas that is being produced from the Pathfinder horizontal well to be sold and on line in time for the completion of the next horizontal well, expected to spud in the fourth quarter of 2013. The company has also completed a buy-out of the third commitment well required to spud by June 30 2013. The forward commitment will be to drill a further two wells by June 2014.
DJ Carmichael believes the stock is a speculative buying opportunity. The farming out of the key acreage reduces funding risk and provides leverage to a drilling program which could unlock material reserves. There are a number of near-term catalysts for the stock. The Birch project farm-out will be finalised at the end of this month and Pathfinder at the end of August. A reserves report is expected by the end of the September quarter. The broker values the stock at 2.6c a share.
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