AWE: BassGas costs balloon (again)

It’s the single most important asset in AWE’s basket. After announcing a second cost blowout during a scheduled expansion, the BassGas project, off the Victorian coast, has also become the most troublesome.

Joint venture partners Origin Energy and AWE announced that development costs at BassGas would rise from $490m to between $550-580m. The Mid-life Enhancement project (MLE) was originally budgeted to cost just $345m but costs could rise further than even this revised amount; drilling has yet to even take place.

Bad weather and equipment delays have now blown the schedule out to next year. So, instead of higher production from next quarter, BassGas will amble along for months with a restricted output. No wonder the price has fallen 34% since a recent high of $2.00 a share on April Fool’s Day.

Is this, then, the time to abandon this long-standing and so far unsatisfying speculative play?

BassGas produces oil, gas and condensate (a light, high value liquid) at high rates and low cost. The MLE was to install new equipment to extend the life of the project and increase production rates but events have conspired to delay work. Origin blames bad weather, currency movements and higher labour costs.

For AWE, there is a simpler explanation; it’s Origin’s fault. While the two partners assign blame and express disappointment, investors need to weigh up the situation for themselves.

Back to Bass-ics

The latest cost increase will cost AWE about $50m. Luckily, the company carries a cash buffer of over $150m so the direct cash cost will hurt but won’t bring the company undone. The real test is whether this impairs the overall value of the BassGas asset.

Whilst a cost overrun doesn’t destroy the economics of the project—it will continue to generate cash—it does lower the rate of return and therefore, value. In this light, AWE’s decision to offload project equity last year appears shrewd.

We previously valued AWE’s stake in BassGas at about 80 cents per share. Last year, the company sold 11.25% of the project to Toyota Tsusho for $80m, a price that implied a valuation of about 65cps. The lower price reflected the fact that Toyota was required to immediately contribute cash for the MLE. With costs rising markedly since then, it’s time to re-examine that valuation.

BassGas produces highly prized light oil and significant volumes of gas, currently supplying about 10% of Victoria’s gas needs. We’ve lowered the net present value of the oil produced to $15 per barrel and the value of the gas to $4 per barrel of oil equivalent (boe). With lower production in the short term and higher costs, that delivers a new valuation of about $0.50 per share for BassGas.

It’s a significant downgrade, suggesting the need for writedowns in Origin’s and AWE’s full year accounts. For Origin, it’s a small matter. For AWE, it could be far more significant.

Assets still cheap

Does that mean you should sell? To make that decision, let’s first assess what the rest of the business is worth. Table 1 summarises the current valuation of AWE’s remaining assets.

Production from the Perth Basin, the Tui oilfields and US shales is relatively small but highly lucrative; high gas prices in Western Australia, high quality oil from Tui and cheap, liquid heavy output from the Eagle Ford Shale all contribute to strong cashflow. These projects are valued at $0.50 per share. Along with BassGas, production from these areas should continue to contribute about $200m in operating cashflow each year, for years on end.

The development of the large but low quality Ande Ande Lamut oilfield could substantially lift that sum. AWE has already booked 43m barrels of fresh oil reserves, which we’ve valued at less than cost. Successful development, however, will increase that sum markedly. 

In the Perth Basin, AWE’s experiment with shale gas could also be large and lucrative. Test results from fracking have not yet concluded so it’s impossible to judge how valuable the project could be, but high gas prices and nearby pipelines suggest large numbers. We’ve currently assigned no value to this shale potential.

AWE has been a poor speculation since we first recommended it on 24 Dec 09 (see AWE: The sequel begins (Speculative Buy - $2.71)). Exploration dusters, reserve downgrades and depleting production have all contributed to a poor performance. Today’s low share price owes much to past misdeeds, but it also undervalues tomorrow’s potential.

Oil and gas in the ground conservatively valued at around $1.60 per share is available today for $1.325. Significant blue sky is possible for the patient, although risks remain, especially surrounding oil prices and development costs, which is why we’re keeping the portfolio limits to 2%. We’ve also lowered our recommendation guide slightly to account for the cost increase at BassGas. But today’s price is cheap enough to maintain a SPECULATIVE BUY.

Note: The Growth portfolio owns shares in AWE.