Over the course of the last few months many investors have been holding on to Linc Energy Ltd (LNCGY.PK) in the hopes that the company's potentially massive shale oil discovery in the Arckaringa Basin of Australia would pay off. The following will explore the potential upsides and downsides of owning a position in Linc Energy despite the prevalent difficulties and costs international natural gas companies are presently facing.
At the beginning of this year, Linc Energy reported a discovery of what was predicted to be anywhere from 3.5-233 billion barrels of recoverable oil under 16 million acres of land owned by the company. Though the costs of recovery may be rather costly, due to the expenses behind hydraulic fracking (the necessary drilling process to obtain shale oil) the amount of recoverable oil still has a minimum value of $359 billion and maximum value, which is estimated to be upwards of $20 trillion. It is expected that the initial costs involved in enabling production are around $300 million. That being said, the costs to begin production are irrelevant when juxtaposed with the potential gains in the region. If the reports analyzing the discovery of the shale oil reserves are confirmed through drilling, then the gains will be enormous with relation to the company's stock value. In addition, the confirmation of such a discovery would put Australia on par with Saudi Arabia with regards to oil production in the global marketplace. However there are certain issues that may hamper the company's progress in the future that should be considered.
Despite the fact that there is a plethora of shale gas reserves around the globe, no other country except the United States has successfully transformed those repositories into a booming natural gas industry. The following will explain the primary reasons why fracking has failed to take off overseas and address how it could hinder Linc going forward. Firstly, the United States booming natural gas industry is founded on the country's lax regulatory framework with regards to oil and drilling companies. Additionally, the United States has an infrastructure (pipelines and terminals) already in place near shale gas plays, which bring the gas to market and reduce costs considerably. Another factor to consider is that natural gas prices have dropped significantly since their peak of $12 per million BTU's in 2008, thereby drastically reducing profit margins for new companies. Fracking is also a highly cost and expertise oriented practice, which since the 1990's has been developed mainly in the United States. Making the transfer of resources and technology difficult for foreign companies and countries. This can be evidenced by a statement from the head of Energy and Power at Wells Fargo with regards to China's interest in America's Fracking resources:
"There was a huge concern when the Chinese became very active here in the states around the issue of technology transfer… However the ability to transfer that from Eagle Ford to a shale formation in China is a pretty difficult thing to do."
Kipp's statement is regarding China's recent attempts to export American fracking expertise and technology to help develop a natural gas economy in mainland China. However this problem can easily be overcome if Linc were to partner with an American company. Currently, Australia along with many other countries around the globe maintain rather stringent energy and mining taxes, which make the drilling and the development of new wells highly cost intensive. That being said, the new Australian PM, Tony Abbott, has just promised the immediate repeal of the country's carbon tax. If this occurs, then Linc Energy could stand to gain in value tremendously. Another factor that bodes well for Linc Energy is that they are the sole proprietors of the land in the Arckaringa Basin. This is important because in the United States drilling companies typically have to form partnerships with individual landowners to obtain the drilling rights/licenses for specific plots of land, which then detracts from their revenue.
In examining Linc's other prospects, the company has already made strides in developing key partnerships to further explore other potential revenue streams. One example of this can be noted with their recent joint venture with Hong Kong-based Golden Concord Ltd. which purchased more than 5% of Linc for $120 million, a large premium when compared to the company's stock price. The joint venture will pursue underground coal gasification opportunities in China. Underground coal gasification involves burning coal deep underground and tapping reserves as a means of producing gas for fuel production, electricity generation, and or as a material to be used in chemicals. Billionaire Roman Abramovich's Ervington Investments Ltd. also recently reached an agreement with Linc Energy to explore projects in northeastern Russia. Linc, which maintains a UCG plant in Uzbekistan, intends to work with Ervington Investments to help the Chukotka region of Russia decrease its reliance on imports, assuming they find viable coal resources.
Fundamentally, Linc Energy has a relatively healthy balance sheet, which, considering their potential assets in the Arckaringa Basin, makes the company tremendously undervalued. Linc Energy's CEO Peter Bond recently announced that they have reduced the number of potential oil partners to two companies. Even though an agreement has not been reached with either group, Linc intends to move ahead with its drilling plans in the Arckaringa Basin and expects to start a five-well drilling program in February at the initial cost of $14 million. That being said, 2014-2015 will be a key period for the company, as it will determine whether Linc can turn its massive assets in southern Australia into the extremely profitable operations many investors are hoping for. In conclusion, Linc Energy is developing strategic operations throughout the east and these operations in tandem with their possibly enormous assets in the Arckaringa Basin, make the company's potential upside far greater then its potential downside. With regards to the issues of infrastructure, technology and expertise currently facing Linc energy, these problems will most likely be resolved with their pending partnership with a key oil company.
Based on current analysts expectations, the forecast of the median stock price is currently 88.1% with a high of 184.2% and a low of 57.4%.
Disclosure: I am long LNCGY.PK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.