Elk Petroleum — Rockies CO2 EOR consolidation

Elk Petroleum — Rockies CO2 EOR consolidation

Elk Petroleum (ELK) is an ASX-listed oil and gas producer and developer with a focus on enhanced oil recovery (EOR) from mature fields. The company’s current focus is on CO2 EOR projects in Wyoming, US, where it’s first EOR development project, Grieve, is due on stream in late 2017/ early 2018. Grieve, combined with the recent acquisition of a c 14% interest in the Madden gas field is due to turn ELK into a producer and material CO2 resource owner. We visited both Grieve and Madden in July 2017, which helped highlight a number of opportunities management is actively engaged in targeting. These include resource upside at both Grieve and Madden, numerous high IRR infrastructure optimisation opportunities and CO2 EOR opportunities in the vicinity of ELK’s operated assets. Our valuation of ELK reduces from A$0.11/share to A$0.09/share due to a reduction in Edison’s long term oil price assumption from $80/bbl (2022) to 70$/bbl.

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Written by

Elk Petroleum

Rockies CO2 EOR consolidation

Company outlook/site visit

Oil & gas

14 August 2017

Price

A$0.07

Market cap

A$60m

US$0.8/A$

Net debt (US$m) at June 2017

65.4

Shares in issue

854.0m

Free float

57.5%

Code

ELK

Primary exchange

ASX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

4.5

9.5

(8.0)

Rel (local)

5.0

12.7

(10.3)

52-week high/low

A$0.1

A$0.1

Business description

Elk Petroleum’s Grieve project in the US is expected to start production in late 2017/18. The recently acquired Madden asset will provide CO2 for projects and generate strong cash flow from methane sales.

Next events

Grieve first oil

Late 2017/early 2018

Analysts

Sanjeev Bahl

+44 (0)20 3077 5742

Ian McLelland

+44 (0)20 3077 5756

Elk Petroleum is a research client of Edison Investment Research Limited

Elk Petroleum (ELK) is an ASX-listed oil and gas producer and developer with a focus on enhanced oil recovery (EOR) from mature fields. The company’s current focus is on CO2 EOR projects in Wyoming, US, where it’s first EOR development project, Grieve, is due on stream in late 2017/ early 2018. Grieve, combined with the recent acquisition of a c 14% interest in the Madden gas field is due to turn ELK into a producer and material CO2 resource owner. We visited both Grieve and Madden in July 2017, which helped highlight a number of opportunities management is actively engaged in targeting. These include resource upside at both Grieve and Madden, numerous high IRR infrastructure optimisation opportunities and CO2 EOR opportunities in the vicinity of ELK’s operated assets. Our valuation of ELK reduces from A$0.11/share to A$0.09/share due to a reduction in Edison’s long term oil price assumption from $80/bbl (2022) to 70$/bbl.

Year end

Revenue (US$m)

EBITDA
(US$m)

PBT*
(US$m)

Net (debt)/
cash (US$m)

Debt
(US$m)

Capex
(US$m)

06/16

0.0

(4.5)

(4.5)

(2.7)

(16.1)

(2.2)

06/17e

6.3

(2.4)

(4.5)

(61.7)

(76.9)

(57.9)

06/18e

31.0

14.0

(2.9)

(73.9)

(82.9)

(7.5)

06/19e

49.7

29.4

7.2

(55.9)

(64.9)

(1.8)

Note: *PBT is normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. Note the change in reporting currency to US$.

Asset optimisation and inorganic growth

With ELK’s Grieve EOR project nearing completion and the acquisition of a 13.6% interest in the prolific Madden gas field, ELK is well placed to set its sights on asset optimisation opportunities and incremental inorganic growth. Low-hanging fruit includes unlocking resource upside at both Grieve and Madden through subsurface studies and facility optimisation. Inorganic growth is likely to include the acquisition of additional CO2 resource/midstream infrastructure as well as upstream EOR candidates. Previous transactions have demonstrated ELK’s ability to originate value-accretive transactions that offer synergies with current operations.

Valuation: Compares well to US peers

Our NAV-based valuation for ELK is split A$0.17/share for Grieve, A$0.06/share for Madden and a total NAV of A$0.09/share (NPV10) after deducting net debt and admin costs. Given ELK’s US onshore focus, we make valuation comparisons to similarly located and sized US E&Ps. ELK compares favourably on a number of these metrics including EV/1P ($/boe) and EV/flowing barrel. Our ELK valuation is sensitive to numerous factors including resource recovery and timing of the Grieve development, Lost Cabin Gas Plant (LCGP) plant life/gas recovery, asset integrity and uptime. We note that ELK is not exposed to cost overruns at the Grieve development given its contractual arrangements with operator Denbury.

Investment summary

Elk Petroleum (ELK) is an ASX-listed oil and gas producer and developer with a focus on enhanced oil recovery (EOR) from mature oil fields using established technology. Its current projects involve CO2 EOR, where CO2 is injected into a mature oil field at pressure and temperature conditions at which it becomes miscible with oil, enabling previously immobile oil to be recovered. The company’s first project, Grieve, is close to delivering first oil and ELK recently acquired a 14% interest in the Madden Gas Field and Lost Cabin Gas Plant (LCGP) in Wyoming from Freeport-McMoRan, affording it access to a prolific CO2 source. Net cash flow from Madden and the near-to-completion Grieve project will have a material impact on group operational cash flow and earnings in calendar year 2018. The precise shape of the company’s earnings growth profile will depend on the timing of Grieve first oil, commodity prices and plant uptime.

Grieve nears completion; Madden provides strategic CO2

The Denbury-operated Grieve project is rapidly approaching first oil, with the operator targeting late 2017 or early 2018. 41.2bcf of CO2 has been injected at Grieve and the field is now fully repressured, with average reservoir pressure well above the minimum miscible pressure required for CO2 to go into phase with the remaining oil in the field. Critical items at Grieve include transport of larger pieces of process equipment and the workover of remaining injection and production wells prior to site access potentially becoming restricted in the winter. ELK expects the planned well programme to be complete by the end of August 2017 and major equipment on site before end September 2017. Given the substantial CO2 requirement to establish an EOR project and its importance in securing financing, ELK regards vertical integration and CO2 supply ownership as essential to underpin its future acquisition and development strategy and provide a long-term competitive advantage. ELK believes the investment approach it took at the Grieve EOR project is highly repeatable and is actively looking at further oil field CO2 EOR candidates, CO2 sources and compression/ transportation infrastructure. Across the Rockies, the CO2 EOR opportunity is estimated at 2-6bnbbls by the Department of Energy (DoE).

Numerous upside opportunities

Alongside field operators Denbury and ConocoPhillips, ELK management has identified numerous field optimisation opportunities with high risk-adjusted returns (many in the 50-100% IRR range). These include shooting 3D seismic over the Grieve to better define the structural/stratigraphic closure in order to identify volumetric upside. Material resource upside exist if ConocoPhillips is able to extend plant life beyond current NSAI 2P assumptions, helped by recent operational data that suggest a shallower decline rate than previous operator forecasts. Risks to our assumptions include timing slippage at Grieve and/or well or facility integrity issues at Madden. We address these risks later in this note.

Valuation and financials

Our NAV-based valuation for ELK is split A$0.17/share for Grieve, A$0.06/share for Madden and a total NAV of A$0.09/share after deducting net debt and admin costs. Gross production from Grieve is expected to be c 3-4kbod in calendar year 2018, with ELK owning a 49% interest. Combined revenues from Grieve and Madden in FY18 (July 2018 to June 2019) are estimated at US$31m, generating operating cash flow of US$3.9m before working capital movements. We forecast net debt to reduce rapidly even at spot oil prices once Grieve is in production.


ELK: Accessing low-hanging fruit

ELK is close to delivery on its first CO2 EOR development at Grieve and with the acquisition of Madden CO2 resource is looking to pursue further EOR projects in Wyoming. Grieve and Madden cash flows should enable ELK to pay down project debt (last reported net debt of US$65.4m at 30 June 2017) and pursue inorganic growth. We expect management to continue to pursue acquisitions such as incremental CO2 source gas and associated infrastructure, as well as EOR opportunities in close proximity to the company’s Wyoming asset base. ELK has identified a number of opportunities including infrastructure assets being divested by majors and EOR opportunities that lie below the radar of larger peers.

What is CO2 EOR?

CO2 EOR has been used as a method of tertiary oil recovery for over 40 years, and the prevalence of suitable reservoirs as well as CO2 supply has driven utilisation of the technique across the US. There are over 120 successful CO2 EOR projects in the US across multiple basins – the application of CO2 tertiary recovery is generally viewed as low risk. During a CO2 flood, CO2 is injected into the reservoir where, under the correct conditions, it will mix with the residual oil to become a single phase, ie it becomes miscible. This allows the CO2 to displace the oil from the rock. As the CO2 dissolves in the oil, it swells the oil and reduces its viscosity. This improves the efficiency of the displacement process. The oil forms an oil bank, which is then swept towards the producing wells. Once recovered at surface, the produced fluids are separated, with the CO2 separated from the produced gas stream, recompressed and reinjected.

Group strategy – CO2 EOR development and consolidation

ELK is on the verge of completing its first EOR development project at Grieve and over the last three years has gained considerable experience in CO2 EOR project management and execution from operator Denbury. ELK’s strategic goal is to source CO2, which it has done successfully through the acquisition of the Madden field. The company’s immediate strategy is to focus on short-term asset optimisation opportunities and incremental inorganic growth.

Management

ELK’s management team is formed of a number of former Drillsearch Energy directors. ELK’s managing director and CEO, Bradley Lingo, was CEO of Drillsearch where he oversaw a more than eightfold increase in market cap over a six-year period. Alexander Hunter, CFO, was previously general manager of business development at Drillsearch and David Evans, COO, was formerly Drillsearch’s chief technical officer. The company’s Denver-based US management team has extensive US onshore development experience. J Scott Hornafius, president of ELK’s US subsidiary, was formerly president of Mega Energy where he developed a Marcelles shale gas play. Brian Dolan, COO of ELK’s US subsidiary, has over 26 years of engineering, management and operations experience including the development of US shale resources across four different plays.


Grieve CO2 EOR project update

ELK has a 49% working interest in the Grieve CO2 EOR project located in the Wind River Basin, Northern Rockies, Wyoming. Denbury Resources operates the development with a 51% operated interest, and a fixed time and cost construction contract with ELK minimising ELK’s exposure to cost or time overruns.

The Grieve project is now over 80% complete and first oil is expected in late 2017/early 2018. We visited the Grieve project in early July 2017 and were able to view site progress, and discuss schedule and project expectations with senior management. We highlight some of the key construction milestones that have been met and the remaining construction scope below.

Key milestones delivered at time of site visit

41.2bcf of CO2 injected and Grieve field now fully repressured ahead of first oil.

Average bottom hole pressure now 3,189 PSI, as of 7 July 2017 and well above minimum miscible pressure as shown in Exhibit 1.

Civil works: facility foundations and building footings in place.

Production test separator installed in existing process building.

Low- and high-pressure compressors delivered and installed.

Partial installation of major heat exchanger facilities.

Installation of LACT unit for measurement and export of crude oil.

Electrical works commenced to connect power from completed substation.

Grieve-31 well workover complete.

Exhibit 1: Grieve bottom hole pressure survey

Exhibit 2: Grieve-31 workover and re-completion

Source: Elk Petroleum

Source: Elk Petroleum

Exhibit 1: Grieve bottom hole pressure survey

Source: Elk Petroleum

Exhibit 2: Grieve-31 workover and re-completion

Source: Elk Petroleum

Denbury is making good process on site and the operator appeared to be comfortable with a late 2017/early 2018 first oil based on the current project schedule. In our view, critical items include ensuring delivery of all larger outstanding process equipment and tank storage to site as well as completion of well work ahead of winter weather potentially restricting site access from late September 2017. Denbury is currently in the process of enclosing new process buildings around newly installed equipment in order to weather proof the project in order to mitigate against weather restrictions. Our forecasts assume an early 2018 start-up broadly in line with management guidance. We note that while there would be a time value impact of delays as ELK net cash flows are deferred, the direct cost of delays is minimised through ELK’s contractual arrangements with operator Denbury.

A site layout of the Grieve project is provided below, showing key newbuild facilities highlighted in yellow. This can be compared against an aerial photo of the Grieve site taken at the time of our site visit on 10 July 2017.

Items remaining prior to first oil

Installation of oil and produced water storage tanks.

Construction of CO2 recycle compression building.

Installation of process piping and instrumentation.

Liquid pumping and VRU building.

Tie-in to export pipeline.

Workover and recompletions of seven existing wells and drilling of one new oil producer.

Plant commissioning.

Exhibit 3: Grieve site layout

Source: Elk Petroleum

Exhibit 4: Site view (10 July 2017)

Source: Elk Petroleum

Our Grieve oil recovery and production profile forecasts are in line with management’s 2P projections, assuming incremental recovery of 12.3mmbbls taking total recovery of original oil in place to 63% from 50%. We note that Denbury has publically disclosed a slightly lower gross recoverable figure of 10mmbbls (5mmbbls net). Elk management believes there is material upside beyond current projections of 2P reserves through the optimisation of the CO2 EOR and potentially through shooting a 3D seismic survey (cost estimated at $1.5m) to fully delineate the Grieve field and to position future producers/injectors to target volumetric upside. Given the sunk capex, the economics of incremental oil recovery are likely to be extremely attractive.

The exhibits below outline our projections of production and net cash flow from Grieve (calendar years) based on current 2P production profiles and assuming first oil in early 2018.

Exhibit 5: Grieve gross production profile (calendar years) – pre-royalty

Exhibit 6: Grieve net cash flow profile (post royalty and tax)

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 5: Grieve gross production profile (calendar years) – pre-royalty

Source: Edison Investment Research

Exhibit 6: Grieve net cash flow profile (post royalty and tax)

Source: Edison Investment Research

Grieve pipeline update

ELK has a 100% operated interest in the Grieve pipeline, which transports crude from Grieve to the Spectra oil storage tank farm and connection to the Enbridge-operated Platte River Crude Oil Pipeline, a 933-mile interstate crude oil transportation pipeline that currently transports c 150kbod. Recently acquired intelligent pigging data confirmed the pipeline to be within operational wall thickness tolerances and cathodic protection has been installed in order to maintain pipeline integrity. Enbridge is now installing the reconnection of the crude oil pipeline to the North Platte Interstate Transmission crude oil pipeline. The only pipeline works remaining are the Denbury connection of the Grieve production facility to the Grieve pipeline, followed by packing the line with crude oil ahead of first oil export.

Madden and Lost Cabin Gas Plant

In line with ELK’s strategy to become integrated along the CO2 EOR value chain supporting the acquisition and development of further enhanced recovery projects, it acquired Freeport-McMoRan’s 13.6% interest in the Madden Gas Field for US$17.5m. In addition to being a prolific methane producer, Madden also produces a significant sour gas component, giving ELK access to a material CO2 resource. The acquisition, which had an effective date of 1 January 2017, elevates ELK to producer status. ELK estimates attributable free cash flow of US$7m in 2017 from Madden.

Current proven developed reserves of CO2 in the Madden Gas Field are approximately 220bcf. The total recoverable resource potential of raw gas is over 1tcf. The raw gas stream has a CO2 content of 20%, methane and ethane (68% combined) and hydrogen sulphide or H2S (12%). The LCGP is designed to separate raw gas into pipeline specification methane, a purified CO2 stream, and elemental sulphur for sale to the fertiliser market. Operations began in 1995 and, after a number of major expansions, the plant consists of three gas processing trains with total capacity of 310mmscfd. The Madden Gas Field is the second largest supplier of CO2 into the Northern Rockies CO2 gas transmission and supply pipeline network.

The Madden Gas Field is a conventional gas field located in the Wind River Basin in Wyoming. It was discovered in 1968 and is one of the state’s largest gas fields. The field sits on the Madden anticline and covers an area of 518km2.

The field produces from multiple reservoir units ranging in depth from 1,500m to 7,600m.

Deep wells: the majority of current gas production comes from the fully developed deep Carboniferous (Mississippian) Madison Formation from only eight production wells. The Madison Formation reservoir is continuous over a 103km2 structure with a continuous gas column that extends over 365m. Production from the existing deep wells remains strong and there are no current plans to drill additional wells in the Madison Formation. The majority of Madison Formation reserves acquired by ELK are classified as PDP. Under the Society of Petroleum Engineers reserve classification guidelines, no additional capital investment is required to develop or produce hydrocarbons under this classification. These deeper wells have produced over 1.1tcf since commencement of production in 1995. Initial well production rates have ranged from 45mmscfd to 60mmscfd. Individual wells have produced 21-225bcf each, making them prolific producers.

Shallow wells: shallow gas production comes from multiple, discontinuous, stacked fluvial sandstones in the Upper Cretaceous to Early Tertiary Lower Fort Union, Lance and Cody formations. Gas is produced from 165 active gas wells. Shallow gas production is currently very limited at prevailing gas prices. The make-up of these shallow producing sands is similar to the primary gas-producing intervals in the Cooper Basin in central Australia. ConocoPhillips has identified additional development potential within the shallow units from undeveloped zones across 4,500m of gas-bearing intervals through well completions, vertical infill drilling and horizontal drilling. We note that the auditor at the time of acquisition, NSAI, had assumed that the shallow horizons of the Madden field would be shut in and facilities decommissioned. However, the field operator ConnocoPhillips has plans to continue to operate this facility, improving economics through well workovers and facility optimisation. Our current model excludes value for the Madden shallow horizon, in line with NSAI’s last published reserve report, which assumes zero production beyond 2017. We expect to update our valuation and assumptions once NSAI has re-evaluated Madden shallow based on the operator’s latest production and forecasts which suggest up to 90mmbbls gross recoverable behind-pipe resources that can be commercially exploited subject to commodity prices. We expect this asset to have a modest positive NPV at current gas prices.

Madden CO2 access and opportunity

As part of the CO2 supply arrangements, Denbury Resources (DNR:NYSE) constructed a CO2 receiving and compression facility adjacent to the LCGP and the 373km Greencore CO2 gas pipeline. This has an ultimate capacity to transport 725mmscfd of CO2 for EOR projects in Wyoming and Montana. This implies total annual capacity of approximately 260bcf CO2. By way of comparison, ELK expects that a total of approximately 52bcf of CO2 will be injected into the Grieve field within the first 12 months of first oil production.

ELK is looking at options of using Madden CO2, which is currently being vented and is unutilised. Short-term options include the reinjection of CO2 into the Madden reservoir to improve methane recovery and capture tax credits. Longer term, the expectation is that CO2 will be sold to Denbury under an existing long-term contract for export into the Greencore pipeline.

Exhibit 7: Lost Cabin Gas Plant

Exhibit 8: Lost Cabin Gas Plant Sulphur recovery unit

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 7: Lost Cabin Gas Plant

Source: Edison Investment Research

Exhibit 8: Lost Cabin Gas Plant Sulphur recovery unit

Source: Edison Investment Research

Plant and well integrity a key consideration

Due to the sour gas nature of the Madden gas field and the acid gasses process at the LCGP, facility integrity and maintenance is an important consideration when considering plant life and ultimate gas recovery. ELK’s and Edison’s production forecasts assume regular plant turnarounds (every 18-24months) and maintenance spend to ensure asset integrity. In our view, our key considerations include monitoring and maintenance of Madden deep production tubing, casing strings and field pipelines to ensure integrity of the field’s valuable well stock (deep wells can cost up to $120m to drill and complete due to the exotic metallurgy used for sour gas service) over field life. ConocoPhillips began a well integrity programme in 2016, and a total of three of the eight producing wells have been inspected to date with corrosion evaluation work ongoing.

Maintenance of the LCGP sour gas processing facilities, in particular the sulphur recovery train, is also an important consideration in ensuring the facility meets regulated and permitted emissions targets. Facility integrity and uptime is optimised through regular plant turnarounds that include cleaning out process equipment and equipment repairs. The EPA has set a stringent one-hour SO2 standard and the LCGP has a monitoring station immediately south of the plant operational since 1 January 2017. The plant operator is working to identify operating and mechanical modification to reduce the risk of emissions exceeding regulated levels.

Exhibit 9: Madden gross production profile (calender years)

Exhibit 10: Madden net cash flow profile (post-royalty and tax)

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 11: Madden gas field and pipeline connectivity

Source: Elk Petroleum

Management

Neale Taylor, Chairman: Dr Taylor has extensive technical, operating and commercial experience in oil and gas exploration and production with Esso Australia, Nexus Energy and Cambrian Oil & Gas. He is a former non-executive director of Terra Gas Trader, former non-executive chairman of Tap Oil, a former managing director of Cambrian Oil & Gas and director of various subsidiaries of Xtract Energy. He is a member of the Society of Petroleum Engineers and a Fellow of the Australian Institute of Company Directors.

Bradley Lingo, Managing Director and CEO: Mr Lingo is an experienced international resource and energy executive with a proven track record of successfully building companies in the upstream and midstream oil and gas energy sectors. Recently, Mr Lingo was MD and CEO of Drillsearch Energy, where he oversaw a more than eightfold increase in the share price and market cap over a period of six years, helping build that company into one of Australia’s leading onshore oil and gas producers. He held previous roles in business development, new ventures, mergers and acquisitions and corporate finance with Tenneco Energy and El Paso Corporation in the US and Australia, and was senior VP and head of oil & gas at the Commonwealth Bank of Australia. His skills include leadership, ability to build market confidence, financial and technical skills, organisation building, business development and funding capability, and entrepreneurship. His experience also includes equity and debt capital raising, project and transaction financing and structuring to achieve attractive financial, tax, accounting and legal treatment for complex commercial, project and financing transactions, similar to ELK’s current needs.

Alexander Hunter, CFO: Mr Hunter has over 10 years’ experience in resources sector M&A and capital raising, and previously worked for 10 years in construction and infrastructure project management. He was most recently general manager of business development at Drillsearch Energy, where he helped to rationalise and grow the business leading various successful takeovers, divestments and capital raisings. He holds an MBA from the University of Southern California Marshall School of Business, a Bachelor of Engineering and postgraduate qualifications in corporate finance and business law.

David Evans, COO: Mr Evans is a geologist with 30 years’ upstream global oil and gas development, production and exploration experience, with significant exposure to Brownfield redevelopments and EOR projects. He joins ELK from Drillsearch, where over a six-year period he held the positions of chief technical officer and acting chief operating officer.

Valuation and sensitivities

Our valuation of ELK and its core assets, Grieve and Madden, is based on discounted cash flows (NPV10) adjusted for group net debt and administration costs. At this stage, we do not include incremental value for potential value-accretive inorganic growth. Our base case assumptions and commodity price sensitivity are provided below.

Oil and gas price scenarios

Gas base case: EIA Short-Term Energy Outlook (STEO), July 2017. Forecast of US$3.1/mcf for 2017 and US$3.4/mcf for 2018 and escalated by 2.5% pa from 2019 reaching $3.8/mcf in 2022.

Gas hedging: ELK has initiated gas price hedging for 80% of the next 12 months (August 2017 to July 2018) forecast Madden PDP production at an average price of $2.93/mmbtu and 40% of PDP production for the following year at an average price of US$2.82/mmbtu.

Oil base case: we have used Edison’s oil price forecasts to value the Grieve project. These are highlighted in the table below and reflect our new long-term oil price of US$70/bbl WTI in 2022. Please see our recently published macro note for more detail.

Oil hedging: to reduce downside risk, a comprehensive oil price hedging programme was put in place at the same time as ELK’s term loan facility to underwrite the Grieve project. As such, 75% of forecast oil production from the Grieve project during calender years 2018 and 2019 has been hedged with put options at a floor of 45$/bbl. ELK retains oil price upside.

Exhibit 12: Oil and gas price forecasts

2017

2018

2019

2020

2021

Oil price (WTI) (US$/bbl)

49.0

49.6

57.9

62.9

66.4

Gas price (Henry Hub) (US$/mcf)*

3.1

3.4

3.5

3.6

3.7

Source: Edison Investment Research. Note: *Uses conversion factor of 0.9756 to convert US$/mmbtu to US$/mcf.

CO2 production

CO2 assumed to be sold at cost.

Direct ownership of CO2 production provides leverage to negotiate acquisitions and the availability of CO2 for development EOR projects.

Expected cost differential of own low-cost CO2 production vs potential higher cost of on-market purchase of CO2. There is a risk that third-party purchases of CO2 are not possible at the quantities or to the schedule required.

Sulphur production

The Lost Cabin Gas Plant produces 1,200-1,400t/day of sales-grade sulphur (gross). The majority is transported by rail to Tampa, Florida to supply the fertiliser market. The remainder is transported to a local fertiliser plant in south-west Wyoming.

Sulphur assumed to be sold at cost – margin neutral.

Cyclical periods of shortages may lead to occasional periods of high prices.

Decommissioning

The Lost Cabin Gas Plant is a sizeable and complex plant, which will incur a material decommissioning expense at the end of field life. We include estimates for the cost of mothballing Train 1 (2033) and decommissioning the entire plant at the end of field life in line with NSAI 2P projections.

NAV valuation summary

We have used our base case oil and gas prices (Exhibit 12) in our valuation of ELK’s 2P asset base, which stands at A$0.09/share. We see material upside in the event of higher commodity prices and/or resource recovery in excess of audited 2P estimates. In particular, we flag that ConocoPhillips holds significantly greater estimates than NSAI for Madden 2P reserves within its own operator estimates. Our base case valuation breakdown is provided below.

Exhibit 13: ELK base case valuation*

 

Country

Diluted

Recoverable reserves

Net risked

Value/share

Asset

WI

CoS

Gross

Net

NPV/boe

value

risked

 

 

%

%

mmboe

mmboe

$/boe

US$m

A$/share

Net (debt)/cash: December 2017 inc convert

100%

100%

(80)

(0.12)

SG&A - NPV of 2 years

100%

100%

(8)

(0.01)

Production

Grieve 2P

US

49%

100%

12.3

5.3

21.7

114.7

0.17

Madden Deep 2P

US

14%

100%

1,057.6

143.8

0.3

38.6

0.06

Core NAV

 

 

 

 

 

 

65

0.09

Source: Edison Investment Research. Note: *All assets discounted from 1 January 2018.

To quantify commodity price sensitivity we provide a 2P NAV sensitivity to both long-term oil price and gas price assumptions. As can be seen in the table below, ELK is highly sensitive to both oil and gas pricing given its operational and financial leverage. Our-long term assumptions are assumptions are $70/bbl WTI (2022) and $3.85/mcf Henry Hub (2022).

Exhibit 14: NAV sensitivity to oil and gas price (A$/share)

Long-term gas price from 2022 (US$/mcf)

Long-term oil price from 2022 (US$/bbl)

40

50

60

70

80

3.00

0.01

0.03

0.05

0.07

0.09

3.85

0.04

0.06

0.08

0.09

0.11

5.00

0.07

0.09

0.11

0.13

0.15

6.00

0.10

0.12

0.14

0.16

0.18

Source: Edison Investment Research

With the current share price implying that long-term commodity prices remain below current spot levels and with a significant amount of oil production hedged over the next two years, commodity price-driven downside is largely protected. Nevertheless, company-specific operational risks centre around ELK’s ability to recover reserves in line with audited 2P estimates, maintain high levels of operational uptime/plant integrity and minimise the NPV of decommissioning liabilities associated with large capital items such as the Lost Cabin Gas Plant.

Valuation versus US peers

ELK’s current asset base is concentrated in the state of Wyoming, US and as such lacks a suitable comparable peer group on the ASX. In this section, we compare ELK to a number of US onshore conventional and unconventional producers that operate similar US onshore assets in comparable basins. These comparisons are based on data available in company SEC filings, Bloomberg and publicly available data. We focus on metrics commonly used in US equity markets for the mid-cap onshore exploration and production sector.

ELK currently trades at a distinct discount to US onshore peers on an EV/1P $/boe basis at just 7.0$/boe.

Exhibit 15: ELK vs US peers EV $/1P boe

Exhibit 16: ELK vs US peers – EV/EBITA vs net debt/ EBITDA

Source: Bloomberg, Edison Investment Research

Source: Bloomberg, Edison Investment Research

Exhibit 15: ELK vs US peers EV $/1P boe

Source: Bloomberg, Edison Investment Research

Exhibit 16: ELK vs US peers – EV/EBITA vs net debt/ EBITDA

Source: Bloomberg, Edison Investment Research

ELK also stands out when looking at valuation on a flowing barrel basis (EV/bbd) despite leverage (net debt/EBITDA) close to the peer group average, however $/acre multiples remain substantially higher than US peers. Elk focuses on production rather than exploration assets and we would expect the company’s developed acre multiple to fall once behind-pipe resource at Madden shallow (90mmbbls gross) is included.

Exhibit 17: EV/bbd versus net debt/EBITDA

Exhibit 18: EV/developed acre vs net debt/EBITDA

Source: Bloomberg, Edison Investment Research

Source: Bloomberg, Edison Investment Research

Exhibit 17: EV/bbd versus net debt/EBITDA

Source: Bloomberg, Edison Investment Research

Exhibit 18: EV/developed acre vs net debt/EBITDA

Source: Bloomberg, Edison Investment Research

ELK’s realisations per barrel are towards the lower end of the peer group given its gas bias on a volume basis. However, realisations are robust given the hydrocarbon mix. Lifting costs and finding and development (F&D) costs are among the lowest in the peer group. Operating costs at Grieve are c US$10-13/bbl and Madden at c 10$/boe.

Exhibit 19: Realisations across peer group

Exhibit 20: Lifting costs and F&D* costs across peer group

Source: Bloomberg, Edison Investment Research

Source: Bloomberg, Edison Investment Research. Note: *Edison estimates for ELK.

Exhibit 19: Realisations across peer group

Source: Bloomberg, Edison Investment Research

Exhibit 20: Lifting costs and F&D* costs across peer group

Source: Bloomberg, Edison Investment Research. Note: *Edison estimates for ELK.

Financials

To date, ELK has used a combination of debt and equity to fund growth. We expect operational cash flow from Madden and Grieve in late 2017/early 2018 to enable ELK to significantly pay down debt over the course of 2018-2020 and fund further expansion. We discuss the company’s balance sheet in further detail below.

Earnings

The effective date for the Madden gas field acquisition is 1 January 2017. From this date, ELK became a producing oil and gas company and begins to generate operating earnings from gas sales. Expected first oil production from the Grieve CO2 EOR project is expected in late 2017/early 2018.

The earnings forecasts in Exhibit 23 use Edison oil price forecasts and EIA gas price forecasts, as shown in Exhibit 12. Almost all the Madden gas is sourced from the Madden Deep wells, where future capital expenditure requirements are low as no new wells are required to underpin the company’s 2P reserve profile.

Cash flow

Assuming January 2017 consensus gas price forecasts, ELK has estimated positive attributable net free cash flow of approximately US$7m for CY17 from Madden. At the outset of production, our pre-tax cash flow forecasts for Madden are broadly in line with this figure.

Balance sheet

ELK’s capital structure consists of several debt lines ranging in cost and asset security. Key elements are highlighted below:

Benefit Street Partners facility totalling US$58m conventional term loan for oil field development financing available to fund ELK’s outstanding capital requirements to first oil at Grieve. US$56.3m was drawn as of 30 June 2017. We expect the remainder of this to be drawn down over the course of the next quarter.

US$10m convertible loan with a three-year term maturing on 31 March 2020, 11% annual interest and convertible to shares at A$0.103/share.

Additional US$4.5m convertible loan facility with term of three years maturing on 31 March 2020. Holders have the option to convert to shares at A$0.103/share.

ELK has made a final payment of US$5.5m for the acquisition of Madden. To fund this payment, ELK secured a US$6m credit facility with Oklahoma-based CrossFirst Bank with an annual interest rate of US prime plus 2%, with a three-year, straight-line amortisation.

FY17 saw a material increase in debt as ELK drew down on the Benefit Street Partners loan and took on an additional US$10m of convertible debt to fund the Madden/Lost Cabin transaction. We expect this to be paid down rapidly from cash flow once Grieve is on stream even at spot oil prices.

Exhibit 21: Debt reduction – Edison base case

Exhibit 22: Debt reduction – US$50/bbl long term

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 21: Debt reduction – Edison base case

Source: Edison Investment Research

Exhibit 22: Debt reduction – US$50/bbl long term

Source: Edison Investment Research

Exhibit 23: Financial summary

 

 

A$'000 to FY16 then US$'000

2016*

2017e

2018e

2019e

2020e

Year end June

 

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

48

6,257

30,967

49,662

47,462

Cost of sales

(317)

(3,622)

(11,966)

(15,229)

(13,576)

Gross profit

(269)

2,635

19,002

34,434

33,886

General & admin

(4,762)

(5,052)

(5,052)

(5,052)

(5,052)

EBITDA

 

 

(5,031)

(2,417)

13,950

29,382

28,834

Depreciation

(175)

(1,512)

(8,402)

(13,095)

(11,259)

Operating Profit (before amort. and except.)

(5,206)

(3,928)

5,548

16,286

17,575

Intangible amortisation

0

0

0

0

0

Exceptionals

(1,483)

0

0

0

0

Other

0

0

0

0

0

EBIT

(6,689)

(3,928)

5,548

16,286

17,575

Net interest

(479)

(556)

(8,449)

(9,115)

(7,153)

Profit Before Tax (norm)

 

(5,685)

(4,485)

(2,901)

7,171

10,421

Profit before tax (FRS 3)

 

(7,168)

(4,485)

(2,901)

7,171

10,421

Tax

0

(188)

(1,612)

(3,552)

(6,656)

Profit After Tax (norm)

(5,685)

(4,485)

(4,512)

3,619

3,765

Profit after tax (FRS 3)

(7,168)

(4,485)

(4,512)

3,619

3,765

Average number of shares outstanding (m)

263.2

826.7

854.0

854.0

854.0

EPS - normalised (c)

 

(2.2)

(0.6)

(0.5)

0.4

0.4

EPS - normalised fully diluted (c)

(2.2)

(0.6)

(0.5)

0.4

0.4

EPS - (IFRS) (c)

 

(2.7)

(0.6)

(0.5)

0.4

0.4

Dividend per share (c)

0.0

0.0

0.0

0.0

0.0

Gross margin (%)

-564.2

42.1

61.4

69.3

71.4

EBITDA margin (%)

-10,553.4

-38.6

45.0

59.2

60.8

Operating margin (before GW and except.) (%)

-10,920.4

-62.8

17.9

32.8

37.0

BALANCE SHEET

Non current assets

 

41,926

98,273

97,367

86,108

75,936

Intangible assets

41,768

46,175

46,175

46,175

46,175

Tangible assets

158

52,099

51,193

39,933

29,762

Investments

0

0

0

0

0

Current assets

 

19,904

17,095

10,971

12,851

12,397

Stocks

0

0

631

1,258

1,106

Debtors

1,801

1,801

1,262

2,515

2,213

Cash

18,103

15,294

9,078

9,078

9,078

Other

0

0

0

0

0

Current liabilities

 

(13,570)

(13,570)

(5,052)

(10,065)

(8,856)

Creditors

(13,565)

(13,565)

(5,048)

(10,061)

(8,852)

Short term borrowings

(4)

(4)

(4)

(4)

(4)

Long term liabilities

 

(25,476)

(80,325)

(86,325)

(68,313)

(55,132)

Long term borrowings

(22,095)

(76,944)

(82,944)

(64,932)

(51,752)

Other long term liabilities

(3,381)

(3,381)

(3,381)

(3,381)

(3,381)

Net assets

 

 

22,784

21,473

16,961

20,580

24,345

CASH FLOW

Operating cash flow

 

(4,286)

(3,161)

(4,720)

19,848

14,269

Net interest

0

0

0

0

0

Tax

0

0

0

0

0

Capex inc acquisitions

(3,365)

(57,859)

(7,496)

(1,836)

(1,088)

Other

0

0

0

0

0

Equity issued

24,328

3,362

0

0

0

Dividends

0

0

0

0

0

Net cash flow

16,677

(57,658)

(12,216)

18,012

13,181

Opening net debt/(cash)

 

20,949

3,996

61,655

73,871

55,859

HP finance leases initiated

0

0

0

0

0

Other

276

0

0

(0)

(0)

Closing net debt/(cash)

 

3,996

61,655

73,871

55,859

42,678

Source: Company accounts, Edison Investment Research. Note: Elk Petroleum reports in US$ for FY17 (year ending 30 June 2017). *As reported in A$000.

Contact details

Revenue by geography

Exchange House
Suite 101, Level 1
10 Bridge Street
Sydney NSW 2000
Australia
www.elkpet.com

Contact details

Exchange House
Suite 101, Level 1
10 Bridge Street
Sydney NSW 2000
Australia
www.elkpet.com

Revenue by geography

Management team

CEO: Bradley Lingo

CFO: Alexander Hunter

Mr Lingo previously held roles in business development, new ventures, M&A and corporate finance with Tenneco Energy and El Paso Corporation in the US and Australia and head of oil and gas at the Commonwealth Bank of Australia. More recently, he was MD and CEO of Drillsearch Energy, during which time the company rose eightfold in value over a six-year period.

Mr Hunter has over 10 years’ experience in the resources sector M&A and capital raising and previously worked for 10 years in construction and infrastructure project management. Alex was most recently general manager of business development at Drillsearch Energy.

COO: David Evans

Mr Evans is a geologist with 30 years’ upstream global oil and gas development, production and exploration with significant exposure to EOR projects. He joins ELK from Drillsearch, where he held the positions of chief technical officer and acting chief operating officer.

Management team

CEO: Bradley Lingo

Mr Lingo previously held roles in business development, new ventures, M&A and corporate finance with Tenneco Energy and El Paso Corporation in the US and Australia and head of oil and gas at the Commonwealth Bank of Australia. More recently, he was MD and CEO of Drillsearch Energy, during which time the company rose eightfold in value over a six-year period.

CFO: Alexander Hunter

Mr Hunter has over 10 years’ experience in the resources sector M&A and capital raising and previously worked for 10 years in construction and infrastructure project management. Alex was most recently general manager of business development at Drillsearch Energy.

COO: David Evans

Mr Evans is a geologist with 30 years’ upstream global oil and gas development, production and exploration with significant exposure to EOR projects. He joins ELK from Drillsearch, where he held the positions of chief technical officer and acting chief operating officer.

Principal shareholders

(%)

Republic Inv Management

19.2%

Robert Anthony Healy

6.3%

Rich Trend Ventures

5.6%

Maxwell Graham Begley

2.6%

Tracey Leanne Marshall

2.0%

Seng Chye Chng

1.8%

Bradley Lingo

1.8%

Companies named in this report

Denbury, ConocoPhillips

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

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London +44 (0)20 3077 5700

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United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

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Sydney +61 (0)2 8249 8342

Level 12, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Elk Petroleum and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt t
o effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Is Yatirim Menkul Degerler — Increasing estimates again

Is Yatirim (ISY) produced a very strong result in H117 against the backdrop of an improved political and economic environment in Turkey, which has seen a strong improvement across capital markets. With the benefit of leading market positions, ISY has seen revenues increase across all product areas with particular strength in interest and trading. Meanwhile, costs have been kept under tight control and below the level of inflation, which is running in excess of 9% pa. We have significantly increased our forecasts for the current year, while prudently making little change to FY18 given the inherently uncertain nature of capital markets.

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