28 May 2019
Reach Markets publish the notes from our analyst meetings with company management. They should be read in conjunction with the research we’ve completed. Reach Markets endeavour to provide self-directed investors a seat at our investment meetings. We publish these notes in a conversational format to get these out as quickly as possible for your consumption.
We recently had a one-on-one meeting with David Maxwell, Managing Director of Cooper Energy Ltd (COE). Cooper Energy is an S&P/ASX 300 listed energy company which generates revenue from the discovery, commercialisation and sale of gas to south-east Australia and low-cost Cooper Basin oil production. Below are the key points from our discussion.
Seven years ago, the company saw an opportunity on the eastern seaboard to acquire assets which were not material to the big players. COE’s key acquisition criteria was that the asset had to be at bottom end of the cost curve, had to be in production or capable of being in production within 5 years and it also had to be something that could add value to the company, on which Mr. Maxwell noted (in the words to the effect of), “we are not going to look at unconventional gas and not look at stuff in Northern territory which is miles away from our pipeline…today we have this position in offshore Otway, offshore Gippsland and we have now got exclusive access to another gas plant which plugs straight into the markets and we have got production project under development and other development and exploration opportunities to grow around those two hubs…gas cost in 2020 should be A$9-11/GJ which assumes a 10% rate of return on sunk capital”.
The company could potentially generate A$120-140m of free cash flows before financing per year from Sole, once the project comes online in July 2019, thus moving from A$30-40m FCF to A$150-170m FCF. The contracts which have underpinned the financing are indexed 100% to CPI and investment grade customers like Origin Energy, AGL and Energy Australia underpin the financing and the contracts are priced between A$7-8/GJ. COE has two wells for Sole project and each well has the capacity to meet 100% of the contractual agreements on which Mr. Maxwell noted (in the words to the effect of), “we are less than 9 months away now from going through this massive change in production and cash flow…Sole project which is the key part of that was 74% complete at the end of September 2018 and everything else that needs to be done on the project is on other partner’s balance sheet like APA, Subsea 7 and Technip…in Otway we have existing production, we have got developments and we have low risk high probability of success exploration into a gas plant which we will own together with Mitsui 50-50 and very low operating costs”.
COE has onshore oil production in Cooper Basin which the company could look to divest given its immateriality going forward.
Sole gas project fully funded:
The Sole project was 100% funded at the time COE committed it on the base of P90 cost/P90 schedule to A$395m debt and equity. The P50(target cost) was A$355m, which is A$40m less than the secured funding. At the moment, including contingencies and having not used all of the contingencies and allowances, the company forecasts the project cost to come in under A$355m. The fact that equity piece is on the balance sheet and the debt facility is much bigger than what is required gives us increased confidence that the project is de-risked.
The long-term gas contracts that the company enters into are standard and are 90% take or pay contracts, where the customer regardless of the quantity taken, must pay for 90% of gas in a year but can vary their volume on a day +/- 10% (take up to maximum 110% per day or down to 90%). The contracts have a price review mechanism where at the end of year four either the buyer or the seller can call for a price review. The uncontracted gas has short term contracts which range in 1-3-year range. When the company enters into a contract with a customer, they can supply to that customer from anywhere in its portfolio of assets depending on where the buyer is, which reduces the cost and increases margins. The transport of the gas is managed by the customer and not COE.
Other opportunities worth noting:
1. The company has a known resource asset called Manta, which would come after Sole and COE is planning to drill the Manta well in 2020 and will be in production in 2023. Below Manta reserve is an undiscovered resource called Manta 3 which is about 100pj and if that converts to 2P after the exploration, it would increase the total capacity of Manta to 400pj.
2. Offshore Otway is a 50-50 partnership between COE and Mitsui, where current production is from fields called Casino Henry and that production goes into a gas plant called the Iona gas plant for processing for which the company pay a tariff of A$2/GJ to owners of that gas plant.
3. Minerva, which is a JV with BHP is at the end of its life and should shop in next few months and the company has already agreed that its JV with Mitsui would acquire the gas plant from its JV with BHP for a consideration of A$10m, which would incur a replacement cost of A$300m. The plant has surplus capacity so if COE makes additional discoveries they have a plant straightaway. Moreover, the inlet pressure of the plant is lower than the Iona plant which increases the quantity of gas (you are pushing against less pressure), thus decreasing the operating cost to A$1/GJ from A$2/GJ in Iona. When COE’s gas is going through the plant the company generates A$8/GJ FCF.
Maxwell noted in the words to the effect of, “we are fully funded for everything we want to do so liquidity is there…the finance facility that we have got for Sole, we can refinance that at any point of time with no penalty…once Sole is in production we will make it a corporate facility, which means we will be flexible to do what we want…the only time we would go back to market for equity is if there was an acquisition opportunity that met all of our three criteria and we couldn’t do it within our existing funding capability or if we want to accelerate some exploration because you don’t do exploration with a debt you always do exploration with surplus cash flow or equity funds…come 2021 we will be in a place where we’ve got to seriously consider paying the dividend…it may start small and we would only start it once we are certain that we can keep paying it going forward…we might also consider a share buyback program”.
Contingent resources and the ability to convert them:
Contingent resource is a resource which the company knows is present, but they can’t put it in reserves because putting it in reserves is contingent on something like approvals, funding or development plant. Bulk of the contingent resource in Otway is Black Watch field, for which Beach Energy and COE have both applied for a production licence to produce. Mr. Maxwell also noted (in the words to the effect of), “The rest of the contingent resource is in Casino Henry…the inlet pressure in Iona gas plant is higher than the inlet pressure in the Minerva gas plant and when we move from the Iona plan to Minerva plant there will be a reserve uplift…about 106pj in Manta is contingent on us until we commit