FX Energy: Exploring The Underdeveloped Polish Natural Gas Market

May.13.14 | About: FX Energy, (FXEN)

Summary

FXEN participates in the oil and gas exploration market in Poland, an uncrowded market.

Polish regulation and laws have caused some of the big oil and gas explorers to pull out, but Poland has vowed to improve regulation and tax laws.

Poland is a net importer of natural gas, mainly from Russia, and pays a premium on the imports.

FX Energy Inc. (NASDAQ:FXEN) recently saw its stock take off due to the successful drilling and positive tests of the Tuchola-4K well. Over the past month, the stock has climbed almost 75% from a low of $3.25 to a high of $5.65, before resting around $4.50.

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As with all oil and gas exploration companies, the value lies in the rights to fields with potential jackpots. For FXEN, it has chosen to focus on the relatively underdeveloped territories of Poland. The company was founded in 1989, and is headquartered in Salt Lake City, Utah. While it does have rights and producing wells in the US, the company primarily focuses on the exploration of Rotliegend sandstones in the Permian Basin, Poland. It estimates oil and gas proven reserves of 42.0 billion cubic feet of natural gas and 0.5 million barrels of oil, or a combined total of 44.8 billion cubic feet of natural gas equivalent.

Polish Natural Gas Industry

The exploration of oil and natural gas within Poland has not been as fully developed as the rest of Europe. The Iron Curtain kept all but state-owned exploration out of Poland until the fall of the Soviet Union, while the Free Market invited exploration in the rest of the region. Polish Petroleum and Gas Mining (PGNiG) is the primary operator, and has been a close partner of FXEN since it entered the Polish market.

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(Source: Company presentation)

Oil and Gas Market in Poland

Due to the infancy of the Free Market system in Poland, there is a lack of customers for FXEN to market to:

The prices at which we sell gas in Poland to PGNiG are determined pursuant to published tariffs for gas sold to wholesale consumers. Such tariffs are determined, in part, by reference to the cost of Russian imported gas, the price of which, in turn, is based, in part, on trailing oil prices. The trailing impact of lower oil prices may have a depressive effect on such tariffs, and so may reduce the price that we receive for our gas from PGNiG. Conversely, because the tariffs are determined, in part, by trailing prices, increases in oil prices may result in higher tariffs for the gas we sell in Poland. Changes in the mechanism for determining the applicable tariff may also result in lower prices for gas that we may sell.

Substantially all of our natural gas currently produced in Poland is sold to a single purchaser, PGNiG, or its affiliates.

We currently sell substantially all of the natural gas we produce in Poland to PGNiG or one of its affiliates. If PGNiG were to fail to perform its obligations under contracts with us, it would most likely have a material adverse effect on us. The market for the sale of gas in Poland is open to competition, but there are not yet many market participants. While our contracts provide us with the ability to market gas to other purchasers, including those outside of Poland, we do not expect to diversify our gas purchasers in the foreseeable future.

The lack of multiple customers is not a bad thing for the company, since Poland is a net importer of natural gas, mainly from Russia. There is speculation the company could cash in on the Russian-Ukrainian conflict. Russia and the US are currently the leaders in natural gas production, each producing around 670 billion cubic meters. Depending on how long the Russia-Ukraine conflict lasts, and the degree to which Russia attempts to manipulate the prices and use it to influence the European Union, FXEN may be able to profit.

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(Source: Company presentation)

FXEN has been able to secure licenses for 2.5 million acres in Poland across six different blocks. The company owns 100% interest in all but the Fences (49%) and Warsaw S. (51%) areas.

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(Source: Company presentation)

The Fences area has been the primary target of the company over the past ten years. PGNiG originally developed the area between 1974 and 1985, but when FXEN entered the area, it brought techniques for seismic mapping that allowed the company to identify additional gas targets at deeper depths. The company currently has 11 wells, with estimated proven gross recoverable reserves at 12.7 Bcf. The average initial gross production rate for these 11 wells is approximately 4.5 MMcfd.

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(Source: Company presentation)

The Edge block has been the source of the recent price gains in the stock. The company began drilling the Tuchola-4 well on February 19th, located approximately 800 meters west of the company's Tuchola-3K well that tested at a rate of 5 Mcfd at a depth of approximately 2,700 meters. The company reached gas and conducted initial testing with 11 Mcfd from a 28/64ths-inch choke. The company now plans to drill and core below 2,810 meters to examine a secondary target in the Upper Devonian.

Tuchola-4K Well Flare (Source: Company website)

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(Source: Company presentation)

Financial Status

FXEN has forecasted it will spend $55 million in capital expenditures during 2014. While the company has partners in some of the areas it plans on developing, it had just over $11 million at the end of FY13.

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While the company does have access to other forms of funding that could be used for the capital investment, the company may have to issue more shares to fully execute the plan it has for more drilling and 3D seismic mapping.

Cautions

  1. After initial enthusiasm in developing Polish Gas, many of the larger oil and gas exploration companies threw in the towel and quit when Polish regulations became unfriendly to development. Exxon Mobil (XOM, Talisman (NYSE:TLM) and Marathon Oil (NYSE:MRO) all exited. While the country has promised to ease regulations and impose investor-friendly tax breaks, nothing is set in stone yet, and the larger companies are still wary of the country.
  2. The company currently has a market cap of around $250 million. Current proven reserves total 44,778 MMcfe, with a valuation of around $150 million. This implies the market is valuing the company at almost double its current proved reserves.

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(Source: Company 10K)

The recent price spike and pullback has renewed interest in the company and the prospects for Polish gas. The industry average Price-to-Book ratio for the oil and gas drilling and exploration sector is around 3.5.

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(Source: Yahoo Oil and Gas Drilling and Exploration list)

While not all those companies listed participate in the Polish sector, and some are offshore drillers, the company is currently valued at a higher price-to-book value than the industry as a whole. This may be justified, based on the prospects the company has, however, investors should be cautious.

Conclusion

FXEN is participating in an uncrowded gas exploration business in Poland. While the Polish regulation and taxation issues remain, the company has been able to drill producing wells and has positive prospects. With an expected $55 million CAPEX this year, the company may have to get creative with financing, partnering or issue more shares, but that should only help to continue the exploration and production.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.