Senex Energy Steps Up Capex And Hedging

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As oil production declines in its main area of focus, Senex Energy is leveraging its balance sheet to step up capital expenditure on exploration.

-Increased exploration may offset further declines in production but cash could decline in the interim
-New hedging strategy welcomed by brokers as it underpins positive operating cash flow 
-Further appraisal required in the Western Surat Basin gas project
 

By Eva Brocklehurst

As oil production declines across its main area of focus, Senex Energy ((SXY)) has stepped up its capital expenditure plans alongside moving ahead with its gas project in the Western Surat Basin. Oil production continues to decline across the Cooper Basin, the main area generating cash for the company, as a result of reduced investment. No new oil wells entered production and oil production was down 5% in the September quarter.

As the oil price recovers management appears more willing to use the balance sheet to increase capital expenditure on exploration, which Macquarie expects may offset further declines in production. Senex has identified the first two exploration wells for drilling in PEL 182, to commence by the end of the year. It will also drill the Spartan-1 and Hoplite-1 exploration wells in conjunction with Beach Energy ((BPT)), targeting Namur oil on the western flank.

In conjunction with increased investment in the Cooper Basin, Senex has commenced construction of the surface facilities at the Western Surat gas project. De-risking through further appraisal drilling and de-watering is expected to have a positive impact on Macquarie's core valuation and Senex expects to have a number of pilot production wells online by the end of the year. The broker forecasts the company will increase capital expenditure to $58m in FY17, up from $28m in FY16.

The company has announced results from its unconventional Ethereal-1 gas well in the Cooper Basin, which appear to be below expectations. Another exploration well in the north of the basin will be drilled towards the end of the year. Importantly, Morgan Stanley notes Senex remains free-carried in this program by Origin Energy ((ORG)). The de-risking of the Western Surat continues but the broker believes further appraisal is required to understand the economics and extent of development over time.

Morgan Stanley expects cash will continue to decline as investment in exploration outstrips operating cash flow for a period. The broker's earnings forecasts decrease marginally on the back of updated production and hedging strategies.

The company outlined a new hedging strategy for the second half of FY17. Senex has locked in a price minimum of US$55/bbl for oil using swaps and preserved its exposure to price action above US$60/bbl via call options. Morgans believes this is a good move, given the hedge is above consensus oil forecasts for FY17 and at a lower cost compared with previous hedging.

The broker has a positive view on the company's position in the Surat Basin and its ability to patiently appraise acreage before kicking off with a full scale development. Given its balance sheet strength the broker suspects Senex can avoid some of the operational pitfalls which have impacted on its larger CSG peers, which rushed through appraisal to get going with developing their large-scale CSG-LNG projects. Morgans retains an Add rating and considers exploration and oil prices remain the key risks.

Citi is forecasting oil prices of US$55.5/bbl and estimates the hedging cost will result in a slight earnings downgrade. Still, as the company has essentially ensured positive operating cash flow in FY17 the broker considers this prudent, given a high degree of volatility in the oil price. The broker also notes the Ethereal-1 well performed below expectations, with nitrogen now being pumped into the tubing to help flow back the fracture fluid, which should mean gas rates increase from current levels. The results demonstrate to Citi that unconventional gas prospects take time to unlock.

The broker's base business valuation is 27c a share. a 2% premium to the current share price. Net cash alone constitutes over 30% of the market capitalisation in Citi's estimates. The broker believes, at this level, investors gain cheap exposure to hedged production, leverage to the oil price recovery and a free option on growth.

FNArena's database shows four Buy ratings and two Hold for Senex Energy. The consensus target is 29c, suggesting 11.5% upside to the last share price. Targets range from 25c (Deutsche Bank, Morgan Stanley) to 33c (Citi).
 

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