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Elk’s Production Growth Offers Attractive Entry

Small Caps | Sep 25 2012

 – Elk An attractive entry to Enhanced Oil Recovery market
 – DJ Carmichael initiates coverage with a Buy rating
 – Sees significant upside potential from production growth in coming years

By Chris Shaw

Elk Petroleum ((ELK)) is an emerging oil and gas company, with a focus on Enhanced Oil Recovery (EOR) projects in the US. At present Elk has two main projects, Ash Creek and Grieve, both of which have been brought to development status with first production at both due in the next two years.

EOR refers to technologies used to extend the life of a depleted oil field, DJ Carmichael noting a common process is to inject CO2 into the well to mix with the existing oil, which then expands and moves towards the production well. Attractions of EOR include low geological risk, proven technology and high recovery rates.

DJ Carmichael has initiated coverage on Elk with a Buy rating, seeing current share price levels as offering a cheap entry point into substantial near-term production. Over the next three to five years, Elk is expected to generate a production increase from 1,000 barrels of oil per day to 5,000 barrels per day.

Looking at the two projects, DJ Carmichael notes that at Grieve a farm-in agreement with US-listed Denbury Resources means Elk is fully funded to first oil production. As well, Denbury's role substantially de-risks the project's execution in the view of the broker.

Production at Grieve is forecast to commence by the middle of 2014, DJ Carmichael noting the project is estimates to recover between 12-24 million barrel of oil. Elk's 35% project share implies 6.5 million barrels to the company and the broker notes CO2 injection is planned to commence in November of this year.

On DJ Carmichael's numbers, the Grieve project alone is worth double Elk's current market capitalisation assuming a mid-case reserve estimate of 18.6 million barrels of oil. Grieve also offers expansion potential, as Elk holds more than 4,000 net acres of Niobrara shale overlying the Grieve muddy reservoir where previous drilling has returned oil shows and elevated gas readings.

The Ash Creek Development, where Elk has a 100% stake, offers near-term production upside. Studies have indicated two to three million barrels of oil are recoverable from a chemical injection process. This process is scheduled to start in the first quarter of 2013. 

DJ Carmichael sees scope for production to increase from a current rate of around 25 barrels per day to more than 100 barrels per day as a result of the first phase chemical injection. Further expansion could see production increase to as much as 500 barrels of oil per day.

Based on these expectations, DJ Carmichael values Elk at $0.47 per share. This includes conservative project risk assumptions and equity dilution from capex at the Ash Creek project as well as potential new venture acquisitions.

In the view of the broker, the discount to valuation with respect to Elk's shares is due to the market not fully valuing EOR projects. This implies the current share price is an attractive entry point for Elk, as the expected growth in production is weighted to liquids and offers low risk growth given little exposure to any exploration risks.

Shares in Elk today are weaker in a lower overall market and as at 11.10am the stock was 1.5c lower at $0.26. Over the past year the shares have traded in a range of $0.115 to $0.30. 

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