The New Criterion: two different approaches to oil and gas extraction

Tim Boreham

Leigh Creek management must be feeling like Fortescue Metals founder Andrew Forrest on opening his Cloudbreak mine, after an analyst earlier opined he would safely lie on the railway track to the site because the mine would never be built.

A South Australian underground coal gasification (UGC) developer, Leigh Creek faced similar scepticism because of the misadventures of Peter Bond’s now-defunct Linc Energy at its Chinchilla UCG site in Queensland.

The market had been betting the Croweater government – which changed hands on March 17 – would not approve the company’s crucial environmental permit.

Yet the paperwork was signed on April 8, around the time Linc was found guilty of causing serious environmental harm at Chinchilla (the defunct company was later fined a record $4.5m).

Now, the company has started drilling the first holes to demonstrate first gas in the September quarter, while building a 30 megawatt pilot power plant.

The second stage envisages a full-scale bade load power plants, or other options such as urea (fertiliser), methanol, diesel or ammonia production..

The first stage will be supported by a capital raising of $8.7m, by way of an oversubscribed placement. The company will also raise up to $3m in a share purchase plan (both are 16c a share, an 18 per cent discount).

Situated 550 kilometres north of Adelaide – a.k.a. Woop Woop – the open-cut Leigh Creek coal field had provided the black stuff for Port Augusta’s power station over 60 years. The mine closed in 2016.

Apart from its remoteness and its geological features that make it amenable to UCG, the site was chosen because it has oodles of coal. Translated into gas produced, it has a certified 2C (best-estimate contingent) resource of 2964 petajoules, 8 percent of the country’s onshore and offshore 2C gas reserves.

It’s envisaged the company will be able to upgrade at least 2000PJ to the more confident 2P status, which would leapfrog the reserves of that of the $4 billion market cap Beach Petroleum.

UCG, or in-situ gasification involves converting coal to synthetic gas (syngas) by injecting air at pressure down one hole and igniting the coal. When the coal reaches the sweet spot of 1200 degrees it converts to gas, which is extracted via a second joining hole.

Leigh Creek brandishes the South Australian government’s assessment report, which directly compared Leigh Creek with Chinchilla.

While Leigh Creek was “closely engaged with the regulator and general public with high level of transparency”, Linc’s Queensland regulator had “limited engagement with the company and restrictive reporting triggers”.

Furthermore, the Leigh Creek resource is deep (at least 200 metres) and the low permeability of coal reduced fracturing risk.

Chinchilla was – you guessed it – shallow at 125m, close to an aquifer and porous.

“It is unreasonable to draw an association between these projects due to material differences related to site suitability, operational practices and the level of regulatory oversight,” the report says.

However the company did have to spend $3m on extra drilling to show a suspected fault line did not exist.

Having had its Twiggy Forrest moment, Leigh Creek needs to prove that the project is not only environmentally safe and technically viable, but a commercial goer as well.

Until it does, the company’s reserves will be valued at a lowly 2c per gigajoule compared with an average valuation for its peers of 73c GJ.

Globally, UCG has been deployed across 100 or so projects over the last 40 years, so at least the ‘technically viable’ box should be ticked.

Elk Petroleum (ELK) 7.6c

A year ago, the oil price was around $US45 ($59) a barrel and Elk chief Brad Lingo would have given the “Darryl Kerrigan” response to anyone predicting the sludgy commodity would rebound to $US60 ($86).

The oil bulls weren’t dreamin’ after all. By January 1 this year oil indeed had hit sixty bucks and thanks to Donald Trump’s Iranian sanctions. The price hit $US72 in mid May but now the world’s most valuable commodity is hovering around $US66 a barrel.

For Elk, this has made backing a horse called Aneth – its acquired asset in the Rocky Mountains -- a provident bet indeed. Aptly, the $137m deal was sealed on Cup Day.

“With oil prices where they are you might call it one of the buys of the decade,” says chief Elk Brad Lingo.

Strictly speaking Elk acquired 63 percent of Aneth, an old field in the wilds of Utah where westerns used to be filmed.

Elk also has a smaller oil field called Grieve and a gas project called Madden/Lost Cabin, both in neighbouring Wyoming cowboy country.

Elk’s point of difference is that it’s applying is enhanced oil recovery (EOR) techniques to what it dubs the “oiliest” of US oil fields.

First deployed by Shell in the 1960s, EOR involves injecting carbon dioxide down the well to make the hydrocarbons flow to the surface. Rather like WD40, it loosens the whole thing up.

In Aneth’s case, the field produced close to 500 million barrels over its life time, but only one third of its reserves base. Because the oil is pretty much known to be there, EOR is 90 per cent successful which can’t exactly be said for your typical wildcat well.

On Elk’s sensitivities, a $US1 a barrel rise in the oil price adds $US20m to Aneth’s net present value, which values the project at around $400m.

Last month Elk raised $13.5m in a placement and up to $7m more in a share purchase plan, partly to fund a $US16.4m expansion at Aneth.

This will increase Aneth’s reserves from 30 million barrels to 50 million and boost attributable output by 30 per cent, to 7500 barrels of oil per day.

Overall, Elk expects to chug out 10,000 bopd, with “potential” to increase this output to 14,000 bopd by 2022.

In the meantime, Elk strips CO2 from its Wyoming gas facility and sells it to other EOR producers. In fact, it’s a bigger earner than the gas itself.

The former head of Drillsearch, Lingo says Australian investors have been focused on US shale production, which can look deceptively productive. The shale fields go gangbusters initially, but in some cases production has declined by 90 percent within three months.

In contrast, Aneth has a 3 percent annual decline rate. “When I started I was determined to build a different company to what Australian were familiar with – production and engineering rather than exploration,” he says.

“We’re talking about long life, low risk profitable oil producing assets that are almost like annuities.”

The only downside of the higher oil price is that Elk needs to stump up a $US10m contingent payment to Aneth’s vendors as part of the sale terms.

But as this amounts to only a fraction of the oil price upside, Elk is happy to share.

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Tim Boreham authors The New Criterion

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.


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