Drilling to Determine If Karoon's Value Is Justified

Bonaparte Basin Projects
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SYDNEY (Dow Jones Newswires), Jul. 23, 2009

Karoon Gas Australia Ltd. became a A$2 billion company Thursday, showing how explorers drilling for oil and gas at a time when rivals are hoarding cash won't necessarily be penalized by the market.

Karoon's shares have more than tripled in value since the start of this year, after an exploration well in the Browse Basin offshore Western Australia state struck a 200-meter gas column.

Although many industry analysts say mid-cap energy companies should consider using their cash to buy producing oil and gas assets rather than spending millions on exploration wells that may turn up dry, Karoon shows how a major discovery can transform a company's value.

Its success mirrors those of London-listed peers Cairn Energy PLC and Tullow Oil PLC, which were catapulted into the ranks of the FTSE 100 Index on the back of major oil strikes in India and Ghana, respectively, in recent years.

Analysts reckon Karoon and partner ConocoPhillips could be sitting on one of Australia's biggest gas resources, noting the proximity of its Poseidon discovery to other major finds like Inpex Holdings Inc.'s Ichthys field.

Karoon Chief Executive Robert Hosking says it's possible the discovery will rival Woodside Petroleum Ltd.'s initial North West Shelf discovery, which feeds Australia's biggest LNG export terminal.

By 0534 GMT Thursday, Karoon shares were up 7.5% at A$11.63, giving it a market value of A$2.0 billion, after they touched a record A$12.04 in early trade. The shares started the year at A$3.63.

Credit Suisse energy analyst Andrew Williams on Wednesday doubled his price target on Karoon shares to a heady A$17.00.

Others analysts, however, are warning investors not to get too carried away, saying the next well in the exploration program, Kontiki-1, could disappoint.

Investors shouldn't have to wait too long to find out as Karoon said Thursday drilling has just begun.

BBY energy analyst Scott Ashton says there's expectations the "moderate risk" well will indicate a gas resource of 7 trillion cubic feet. Four trillion cubic feet is commonly accepted to be enough to underpin a single LNG processing train.

"If Kontiki-1 is below expectations, with say less than one-to-two tcf of gas, this would be a volume difficult to monetize and insufficient to underpin a standalone LNG development," Ashton says.

The analyst has gone against the flow of many others and downgraded Karoon to a Hold recommendation with a A$9.50 price target.

Even Credit Suisse's Williams qualified his A$17.00 price target by saying it reflects a "success outcome" at Kontiki-1. He also noted full testing data wasn't completed at the first exploration well, Poseidon-1, because a tool got stuck in the drill hole, forcing it to be plugged and abandoned.

"Indirect indications from (Poseidon-1) are very positive and point to a potentially large gas accumulation," Williams said.

"However, we see Kontiki-1 as needing to deliver a measurable result in a timely fashion and on budget, or the market will be entitled to start thinking a commercial outcome may be too difficult and too expensive."

Appraisal Awaits

ConocoPhillips' confidence in the prospect was underlined by its willingness to commit to drilling in 2009 even though it was cutting planned spending across the company by 18.3% on-year to $12.5 billion.

On May 27, ConocoPhillips Chief Executive and Chairman Jim Mulva said the trend area in which the JV has its permits contains at least 16-20 tcf of gas.

However, company officials are also trying to balance their enthusiasm with cautious remarks.

"While we are encouraged by the results of our discovery, Poseidon is a large, complex feature that will require a series of appraisal wells to determine both size and commerciality," a ConocoPhillips spokesman said.

Karoon's Hosking has said the JV will need to drill more wells to make any solid statements of fact about the size of the resource. But at the same time, he also says Karoon's shares are "grossly undervalued".

He drew a comparison between Karoon and U.S-based Hess Corp., which he said has more than one billion barrels of oil equivalent and a market capitalization over US $15 billion.

When asked how Karoon might fund its share of production costs if the discovery prompts the construction of an LNG facility, he said the company would seek customers willing to take equity stakes in the project.

He also wouldn't rule out Karoon becoming a takeover target. "Well, maybe, maybe not. We'll see how the game goes," he said.

Soon after the JV's watershed discovery, Merrill Lynch analyst Mark Hume said corporate activity was a possibility.

"In a resource-constrained industry, we believe Karoon would screen up as a possible M&A candidate, giving the shares some downside support in our view," Hume said.

Apart from the North West Shelf, Australia's only other operational large-scale LNG terminal is in Darwin and owned by ConocoPhillips.

That means gas from the find could feed an expansion of ConocoPhillip's existing LNG plant, or help support some other LNG plants planned for construction in Australia's north west by 2015.  

Copyright (c) 2009 Dow Jones & Company, Inc.

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