Australia | Mar 08 2012
– Karoon has extensive upcoming drilling program
– Company will target gas in Australia, oil in South America
– Funding of the program an issue, rights issue a possibility
By Chris Shaw
When Karoon Gas ((KAR)) failed to proceed with an IPO of its Brazilian assets more than a year ago the market predictably reacted in a negative way, but Moelis expects an extensive drilling program over the next 12 months will allow the market to move forward on the stock.
As Moelis notes, drilling in coming months will address contingent resources of 4.5 trillion cubic feet net in the Browse Basin and 2.6 billion barrels of oil in South America. The former will begin with 5-8 exploration and appraisal wells over the next 18-24 months.
In South America a rig has been contracted for a 6-9 month drilling program in Brazil, but a farm-out is needed before the program begins. Karoon has developed 16 prospects and leads in offshore Block Z38 in Peru, a high risk but potentially high reward play in the view of Moelis.
The risk is the block is an a relatively unexplored offshore margin though in a proven oil basin, while Moelis notes the reward is a prospective 0.7 to 4.2 billion barrels. The Peruvian program will also be expensive as Moelis expects drilling costs of $1 million per day for what could be 60-day wells. Rig mobilisation and de-mobilisation costs will run around $40 million.
Moelis notes the high risk and high reward nature of the Peruvian assets may tempt Karoon into drilling a well on its own. This would not be a good move in the broker's view given the frontier nature of the basin.
Adding up proposed exploration work this year, Moelis estimates Karoon could be facing a minimum budget of $480 million and a maximum budget of just over $700 million. Allowing for cash of $260 million, Karoon is likely to need additional funding of between $180 to $413 million. This could be cut to a minimum of $70 million assuming some farm-ins, leading Moelis to suggest a rights issue may be required.
Assuming a rights issue at $6 per share Moelis estimates Karoon could raise from $240-$540 million, which would be dilute existing shareholders by 18-40%. Any drilling success in the upcoming program suggests to Moelis a rights issue would not be difficult to get away in the market.
One issue for Moelis is Karoon may spend $150-$300 million in proving up enough gas for an LNG development, which would then be at the end of a long queue of such developments. While Conoco, Karoon's partner, can afford to warehouse gas reserves, Karoon requires a quick commercialisation in the view of Moelis.
Based on Karoon's 75% stake in the Tumbes Basin in Peru and the prospectivity of the region, Moelis has lifted its net asset value estimate to $10.81 from $8.97. Target price stands at $8.50, while Moelis has a Speculative Buy rating on Karoon.
This supports the speculative nature of Moelis's recommendation, as there remains uncertainty as to how Karoon will finance its upcoming program and how successful the drilling will be. Others in the market covering Karoon also see some uncertainty, as evidenced by BA Merrill Lynch's Buy, High Risk rating.
The FNArena database does show brokers to cover Karoon are as positive on the drilling program as is Moelis, as Karoon scores a perfect four-for-four Buy ratings. The consensus price target according to the database is $8.40, which is broadly in line with that of Moelis.
Shares in Karoon today are higher and as at 10.15am the stock was up 20c at $5.70. This compares to a trading range over the past year of $2.60 to $7.54. The current share price implies upside of a little more than 50% relative to the consensus price target in the FNArena database.
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