Minefield: Six shale stars

PORTFOLIO POINT: As the shale oil and gas boom kicks off locally, there are six Australian explorers that are ticking the right boxes.

Any doubts about the shale oil and gas revolution sweeping the world were blown away late last week when it was reported that the US exported more petrol, diesel and other fuels than it imported for the first time since 1949.

News of that event from the US Energy Department confirmed what investors had suspected – that oil and gas extracted from rock once regarded as unproductive is re-energising the US economy. Separately, China has entered the ring with an important announcement last week from the Resources Ministry in Beijing that preliminary surveys show there are 25.1 trillion cubic metres of explorable gas reserves across the nation – enough to meet China’s gas needs for the next two centuries! No wonder the rush of activity is causing some observers to predict the end of the Peak Oil debate.

A more likely prognosis is that the debate has been postponed for the day when the world reaches its natural peak of producing non-renewable fossil fuels, but that is a discussion for geologists, not investors who are looking far beyond the US for the next hot shale patch, which could be Australia.

The ASX-listed companies most likely to succeed in the Australian shale hunt are:

'¢ Beach Energy (BPT).
'¢ AWE Ltd (AWE).
'¢ Norwest Energy (NWE).
'¢ Buru Energy (BRU).
'¢ New Standard Energy (NSE).
'¢ Senex Energy (SXY).

Other companies are joining the hunt, but the six listed above are a starting point because they tick the right boxes: having exploration tenements in the right location, and possessing either an infrastructure solution to get any discoveries to market, or a major partner to help solve the marketing question later.

With geology that bears similarities to that encountered in the US, Australia has the potential to be a major producer of oil and gas from shale and other so-called unconventional rock sources.

The major difference between Australia and the US is time, with exploration for shale gas and oil in Australia just starting, whereas the US has been developing the technology to find and extract hydrocarbons in impervious (hard) rock over the past 20 years.

Some hurdles remain to be cleared in Australia, including convincing government regulators that oil and gas can be extracted from shale without damaging the environment, or causing earth tremors when deeply-buried rocks are fractured to liberate trapped oil and gas.

Last week, just as the US Energy Department was telling the world about exports overtaking imports, an important “environmental” step forward was taken in the Australian shale exploration game when the all-clear was awarded for testing of one of the more promising projects, the Arrowsmith discovery well in WA.

Two ASX-listed companies are exposed to the Arrowsmith project – AWE Ltd (44.25%) and Norwest Energy (27.9%). If they succeed, the entire Perth Basin, which stretches along the southern portion of the west coast, will be re-examined for its shale potential.

Success at Arrowsmith and other wells earmarked for fracture testing in the historic Dongara gasfield means the Perth Basin will join the central Australian Cooper Basin as a known source of shale gas, supported by long-established infrastructure such as nearby pipelines, necessary to generate quick cash flow.

For investors, the Australian shale revolution is just starting, with four key factors to be considered:

'¢ Proof that oil and gas is in the shale being targeted, which means drilling.
'¢ Demonstrating that the shale can be fractured and the oil and gas can flow to the surface.
'¢ Obtaining government approvals to first test and then extract the oil and gas.
'¢ Securing a market, which means access to infrastructure such as pipelines.

Shale explorers to watch, with either a green or amber rating, are:

Beach Energy (BPT)

Well-established in the Cooper Basin, Beach has been an early mover in unlocking the shale potential in its extensive tenement position, with two wells drilled and tested and two trillion cubic feet of gas “booked” as a contingent resource.

Both the Holdfast No.1 and Encounter No.1 wells delivered precisely what Beach shareholders wanted to hear – that the shales penetrated were thick, gas-saturated and will flow gas once fractured.

With one of the biggest tenement positions in the Cooper Basin, and with shale intersections of up to a whopping 1000 metres, Beach’s shale-gas hunt could require the introduction of a major oil and gas partner to provide the capital and technical know-how to accelerate commercial development.

Beach chief executive Reg Nelson hinted at the possibility of a partner last week when discussing the company’s half-year profit result (a record $51.8 million). He told the Australian Financial Review that it made “sound logic” to farm-out its shale assets.

“If the right party were to make a good offer, then of course we would entertain it,” Nelson said. “There’s a huge amount of interest but there’s every reason for us to try and lock away more value with this big exploration campaign we’ve got going first.”

International interest in the work of Beach in the unconventional oil and gas hunt should increase this week, with the company presenting at a Citi oil and gas conference in London today and tomorrow, and at a Goldman Sachs conference in New York later this week.

Theoretically, Beach’s unconventional shale-gas assets in one permit alone (PEL 218) can be measured at 300 trillion cubic feet, which is more gas than currently known in all of Australia’s conventional oil and gas basins.

As exploration continues, and as Beach develops a commercial plan for its extraction (with or without a partner) the stock will continue to be upgraded.

Since the start of 2012, aided by high oil and gas prices (and interest in the shale gas work), Beach’s share price has risen from $1.23 to $1.56.

AWE (AWE) and Norwest (NWE)

Like Beach, AWE has an existing, profitable oil and gas business, which means its exploration for shale gas is well-funded and it is exploring in locations with proven oil and gas reserves.

Norwest represents a riskier exposure, but with the potential for a much sharper share-price reaction should their testing of wells already drilled, such as the Arrowsmith No.2, prove successful.

A hint of the potential in the Norwest share price came earlier today, when the stock jumped by 34% to 5.9c as investors digested the news about the environmental all-clear for rock-fracturing tests.

Located in the Dongara gasfield north of Perth, Arrowsmith will almost certainly flow gas when subjected to hydraulic fracture stimulation in the next few months, because measurements taken during the drilling of early wells in the region during the 1970s and '80s indicated gas in shales, but testing was not conducted because the technology to extract the gas had not been developed.

What remains to be seen is how shale in the Perth Basin reacts to fracturing, and whether gas in the shale can be extracted profitably.

Norwest chief executive Peter Munachen said after receiving government approval for the Arrowsmith testing that: “This decision is critical in paving the way for Norwest to finally prove the shale gas potential at Arrowsmith No.2.”

On the market, AWE has risen from $1.30 at the start of 2012 to $1.77, largely because of the high oil price.

Norwest is up from 3.1c to 5.9c, with a successful testing of the Arrowsmith area potentially triggering a major re-rating of the stock.

Buru Energy (BRU)

Focussed on the remote Canning Basin of northern WA, Buru has succeeded with conventional oil and gas discoveries and has attracted a major partner in its hunt for unconventional (shale) resources.

Oil discovered in the Ungani well should be easy to develop and truck to the port of Broome for export, ensuring ongoing cash flow for Buru.

More importantly, the oil discovery reconfirms the prospectivity of the region for both oil and gas production, and helps explain why a major Japanese company, Mitsubishi, has agreed to spend $40 million to earn a 50% share in Buru’s exploration tenements, and why Buru had previously negotiated a gas supply agreement with the aluminium producer, Alcoa, which needs cheaper gas at its alumina refineries in WA’s south-west.

Buru’s highly-credentialed management team, led by Eric Streitberg, rates the Canning Basin as “the most exciting exploration province onshore in Australia”.

Streitberg could be right in terms of discovering oil and gas. The challenge will be in developing any discovery in such a remote location, which is nowhere near a market nor close to infrastructure.

It is the remote location which explains why major partners are required, and it is the potential for a major discovery which explains why big companies have teamed up with Buru.

On the market, Buru shares have risen from $1.23 at the start of 2012 to $2.13.

New Standard (NSE)

Like Buru, New Standard has chosen the Canning Basin for its exploration, and like Buru it has attracted a major partner, the US oil giant ConocoPhillips.

Over the next few years, ConocoPhillips has committed to spending up to $US109.5 million exploring New Standard’s Canning Basin tenements, earning itself a 75% stake in any discovery.

Three exploration wells are scheduled for 2012, with a key development announced last week securing a drilling rig which is expected to be on site around midyear.

New Standard is less advanced than Buru in the Canning Basin shale-gas hunt, but has teamed up with Buru in a number of areas.

The key project for investors to watch will be drilling in the Goldwyer shale formation, which New Standard management says has the potential to “host a substantial hydrocarbon resource with a high component of liquid hydrocarbons”.

“Should this prove to be the case, the potential development economics would be significantly enhanced,” New Standard management said in its December quarter report.

“In this regard, the Goldwyer project is potentially similar to the very attractive North American shales being aggressively developed, including the Bakken and Eagleford plays, both of which have been very successful projects for ConocoPhillips.

On the market, New Standard has risen from 29.5c at the start of 2012 to 49c.

Senex Energy (SXY)

Senex, which is already a successful oil and gas producer – its production is heading towards 700,000 barrels in the current financial year – is slowly getting around to a shale-specific oil and gas hunt in its Cooper Basin tenements.

Encouraged by positive results last year from its Vintage Crop well, Senex is planning to drill three wells seeking unconventional oil and gas this year.

The first of the shale wells, Sasanof No.1, was spudded in early January, along with early-stage rock-fracturing tests to “assist with the design of commercial scale fracture stimulations at the three dedicated unconventional gas wells.”

News flow from conventional oil and gas work has drowned out Senex’s unconventional work, but that could change as the shale work accelerates.

On the market, Senex has risen from 63c at the start of 2012 to recent sales around 99c.