NZEC – what you know and who you know
December 13, 2011
Disclosure: I hold a modest quantity of shares of New Zealand Energy Corp. (NZ.V).
Know the jockey
Through my acquaintance with John Proust (CEO of my favourite investment, Southern Arc Minerals – SA.V), late last year I became aware of a new venture, targeting oil and gas in New Zealand. Cautious to jump the gun with a story that may not materialize, I’ve held off writing about it, watching developments and waiting to see something of substance. Stories are one thing. Results are quite another. The substance has now arrived. More on that in a moment. First, a bit of history.
Beginning in early 2010, Proust expanded his existing base of contacts in New Zealand, with an aim to identify, qualify, and acquire highly prospective permits. The Company now holds an impressive nearly two million acres of prospects, including 152,000 acres in the Taranaki Basin. The balance is held in the East Coast Basin, a topic which I will hold for another time.
My focus here will be on recent developments in the two Taranaki Basin permits, the Eltham and the Alton, with particular attention to the Eltham. These permits are located on the west coast of the north island, some 220 km NNW of Wellington. NZEC holds a 50% interest in the Alton permit and a 100% interest in the Eltham permit.
Backing out for a moment, the Taranaki Basin is currently the only producing region for New Zealand, with 55,000 bbl/day in crude oil and 460 million cf/day in natural gas, for a BOE/day of 130,000 (2009). The Eltham and Alton permits are surrounded (stress that word, 'surrounded') by producing fields, with approximately 18,000 BOE/day.
Know the path
The Eltham permit comprises about 92,000 acres, of which about 32,000 acres is offshore (with an approximate water depth of 20 metres). The acquisition of this permit is sweet in itself, like the oil. The permit was at risk, with incomplete drilling work as per the previous holder’s agreement with the Crown. Explorers and producers in the region were all sitting quietly, waiting for the permit to expire so they could bid on it. Proust and friends chose a different path. Rather than engaging in a bidding competition, they approached the holder of the permit, and with approval of the Crown, agreed to drill and complete the well in question. This would satisfy the activity requirement with the government and relieve the permit holder of a question mark beside his name. While all the major players in the area sat on the sidelines waiting, Proust’s team completed the well on time (against all predictions), and had the permit signed over. The cost? NZ$10 for the permit plus the cost of drilling and completing the well. Hmmm… sweet indeed.
Know the people who know
NZEC established contact with Ian R. Brown Associates, specialists in seismic exploration for oil and gas, and based in Wellington. IRBA had developed an extensive proprietary seismic database for the region, including both available prospects and producing fields (see the image, below). This element is key, as it allows the firm to study comparative findings for neighbouring producers, and to guide drilling activity toward matching data. Rather than engage IRBA as a contractor, NZEC opted instead to acquire the firm, its database, and the services of key employees, including Ian Brown. In exchange, $400,000 and 2 million shares in the newly formed company changed hands.
In late August of this year, NZEC announced an initial 48 hour test of its Copper Moki-1 well, showing 1,100 barrels per day and 855 mcf natural gas. The extended production test revealed 521 barrels of oil and 508 mcf of natural gas per day.
Know your neighbours
TAG Oil is a Canadian-listed explorer/producer (TSX: TAO), operating exclusively in New Zealand. Market capitalization is approximately $400 million (about four times that of NZEC – this defines investor target number one, I should think). Their corporate presentation cites exposure to 100 million bbls OOIP (Original Oil In Place) for Taranaki. Compare this to 730 million bbls OOIP reported for the combined NZEC Eltham and Alton permits. While OOIP is not a reliable predictor for what you're ultimately going to extract from the ground, it is a reliable data point for making relative comparisons across properties. Better still, when the comparisons are drawn from same-source data (in this case, AJM Petroleum Consultants), these comparisons are of significant value.
TAG Oil’s Taranaki onshore permits comprise approximately 23,000 acres, in comparison to 120,000 for NZEC. Acknowledging that land size is just land size, I would suggest that we’re not talking about moose pasture here. Remember… the two NZEC Taranaki permits are surrounded by currently producing fields.
TAG’s Cheal discovery is immediately to the northwest of NZEC’s Copper Moki-1 well. Not coincidentally, I suspect, with the August announcement of that well’s success, TAG drilled its own new Cheal B-5 well, just 3 km away.
For a look at the formations from TAG's perspective, see the link: http://www.tagoil.com/popup.asp?id=cheal_formations.
On December 5th, TAG announced the extended production test results from their Cheal B-5 well: 1,700 barrels of oil and 1.0 million cubic feet of gas per day.
On first blush, you may say that TAG hit the better well, compared to Copper Moki-1 (1700 barrels versus 521 barrels). If you were watching TAG's stock price, you would have seen it rise from $5.04 on the trading day previous to the announcement to a high on December 9th of $7.68, settling to $7.10 for the close. $7.10 represents a gain on the week of 40.9%. In sympathy, NZEC rose 16.5% on the week, from $0.91 to $1.06 at the close on the 9th. Clearly, somebody saw the coattails action at work between the two.
Know the math
Given the higher production test results, it makes sense that TAG would rise more strongly in share price than NZEC. Well… the devil is in the details, as always. The flow rate of liquid through a tube is a function of two factors, pressure and diameter of the tube. TAG’s Cheal B-5 well was tested using a pipe diameter of 40/64". The Copper Moki-1 well was tested with a pipe diameter of just 20/64".
Time for a refresher in high school math. This difference is not a factor of two, as in, 40 is twice 20, but rather, a factor of four. The flow through the pipe is restricted by the area of the opening… the area of a circle. Area of a circle, you'll recall, is Pr2 (pi times the square of the radius). In other words, since radius is ½ of diameter, the area of TAG's pipe opening was 3.14 x ((40/64)/2)2, or 0.3066 square inches. In comparison, NZEC's pipe opening had an area of 3.14 x ((20/64)/2)2, or 0.0767 square inches. This provides for a significantly more restricted flow in the testing procedure. To be precise, TAG's pipe opening (all other matters being equal) would quadruple the measured flow rate. Now, all other matters are not equal, of course. That would be too easy. As the circle's area rises, the flow pressure declines. Think of playing with the garden hose and your thumb in the back yard. So… knock a bit off (this is what you call a thumbnail calculation) of the quadruple (2080 barrels/day) and you'll see Copper Moki-1 coming in at perhaps 1900 barrels/day.
I would stress that this is not my area of expertise… but – running with the narrow choke diameter can offer significant protection against the invasion of water into the production flow. Water is your worst enemy in this process. Using a wider choke diameter could allow water or natural gas to flow preferentially into the wellbore, and places the value of what is produced at risk as a result. Moreover, in extreme cases, the entire well could be placed at risk. Once water infiltrates, there's no going back. Just saying.
Having spoken just this morning with NZEC president, Bruce McIntyre, I can say that the plan is to proceed with caution in the weeks ahead. With continued success and consistent pressure, flow will be opened up gradually. We'll just have to wait and see what happens to the daily count. This said, I'm encouraged by the conservative approach taken by management.
My point? Things aren't always as they seem.
Where does that leave us in consideration of this investment? Well, the immediate next-door neighbour has a stated target of producing 2,500 bbls a day by year-end and they're sitting on a market cap at four times that of NZEC. A couple of weeks ago, I read that they were producing 1,000 bbls per day. If I'm reading recent NRs correctly, the Cheal B-5 well result is included in their report of current production at 2,700 bbls a day. NZEC has just one well, now in production at 580 (using a more restricted flow, as described above), and a same-basis land package five times as great and OOIP exposure seven times as great. The upside for this investment is huge. No way around that.
To summarize the comparison:
1. - TAG Oil has a market cap of about $400 million
- NZ has a market cap of about $100 million
2. - TAG Oil's corporate presentation estimates daily production by year end (2011) of 2,500 BOE. Current levels need to be confirmed.
- NZ just announced its first well in production conservatively at 580 BOE.
3. - TAG Oil has 23,000 onshore acres in Taranaki.
- NZ has 120,000 onshore acres in Taranaki.
4. - AJM Petroleum Consultants estimates TAG Oil to have 100 million barrels OOIP in Taranaki.
- AJM Petroleum Consultants estimates NZ to have 730 million barrels OOIP in Taranaki.
Do the math. Looking at these numbers, one might be forgiven for suggesting a factor of between 20 and 28 times current share price for NZ.V (4x5 or 4x7)… that is, if TAG is fairly priced in the market. Safe to say that I'm holding on to my shares.
It's early still, with two more wells in the works for the first quarter of 2012.
Infrastructure is in place with oil trucked to Shell's large facility 45 km from the site. As for the natural gas, Methanex has 60% unused capacity at its nearby production facility, with room for another 120 million cf/day. Maybe there's an opportunity there.
With oil sold at a premium to the Brent reference price, let's imagine the Company estimates of near-term operating netbacks in excess of $90 per barrel (see this morning's NR) as close to the mark. Forgetting about the natural gas component altogether, for the sake of conservatism, and forgetting about the conservative initial production flow rate compared to that of TAG Oil, we're talking about $19 million in annual net cash flow from the first well alone (The natural gas component would put this over $20 million per year.). Not a bad return for a company with a market cap in the range of $100 million and a land package to die for. Show me well numbers two and three (Q1/2012) matching with well number one and we're talking about a self-financed explorer/producer, operating in a country where you can be in profitable production within five months of your IPO (August 4, 2011).
Oh, and let's remember. We're not even beginning to think about the Company's 1.8 million acres in the East Coast Basin. This would include its Castlepoint permit where, after walking the grounds, you may need to wash the oil off your boots.
Just a little something to think about.
Best,
Kevin Graham