Linc Energy - Nearly A 'Sure Thing'?

 |  About: Linc Energy, Ltd. ADR (LNCGY)
by: Leo Soong


Current US$549 million market capitalization is supported many times over by proven conventional oil and gas reserves in the US.

Just one sale of Australian coal reserves in 2010-11 generated cash of A$500 million, plus an anticipated A$120 million per year of royalties over the first 20 years of production.

Massive potential conventional and shale oil reserves in South Australia.

In early 2013, great excitement resulted from an announcement by Linc Energy Ltd. (OTCQX:LNCGY) of a massive potential shale oil deposit in the Arckaringa Basin of South Australia with possibly hundreds of billions of barrels of oil. The company said that over 80 potential worldwide partners had contacted Linc, and that Barclays Bank had been hired to vet them. The price of the U.S. ADR shares (equal to 10 ordinary shares) more than quadrupled from $6-$7 per share to over $30.

By the end of 2013, the 80 potential partners had dwindled to one U.S. oil service company and one international oil company (see reference). The company announced that it would begin exploratory drilling on its own in anticipation of an agreement being reached in early 2014. Very recently, the company announced that Baker Hughes had done extensive geophysical work, and the company now would be drilling three wells on its own to test various shale zones, do some test fracking, and explore at least one conventional oil prospect; with three more wells to follow toward the end of 2014 (see reference).

The market has taken the above developments as a disappointment. The ADR share price has been fluctuating in the $9-$10 range for some time. All the potential worldwide partners have seemingly evaporated, and many have speculated that the resource is not as good as originally expected. Some geologists have said that any shale oil would be difficult to extract because of the lack of sufficient good quality water in this Australian desert. Others have said that any oil would be difficult to get to port due to the lack of infrastructure in this region (information from private conversations with professional geologists not directly knowledgeable about the Arckaringa Basin, but willing to talk about factors which would reduce the value of any shale deposits there).

In June, however, the company announced that it had found sufficient water in underground aquifers to support shale oil development; and that heavy rail lines are available to bring in materiel and export any oil until sufficient volume justifies the construction of pipelines (see reference). It is the thesis of this report that several recent developments have made it unnecessary to find joint venture partners to fund the first stages of a A$300 million drilling program; and that Linc has decided that it could raise more money on better terms if the Arckaringa resource could be proven by actual drilling and test fracking. The funds necessary are in reasonable prospect internally from successful drilling in the U.S. and from royalties from the Carmichael Coal Mine, which was sold to the Adani Group of India. Adani has recently won approval from the Queensland government for the initial development stages of the mine, railway and port. Much of the information in this report is derived from Linc Energy's exceptionally informative website (see here).

U.S. Conventional Oil

The U.S. drilling program was funded by some A$472 million of borrowings secured in 2013, including a US$200 million convertible debenture. This program seems to have been extraordinarily successful, in spite of a very harsh winter in Umiat, Alaska. A few months ago, the first oil was produced; and the company has announced that an independent consultant, Ryder Scott, has estimated proven and probable reserves of 154.5 million barrels of oil, with a net present value (assuming a 10% discount rate) of US$2.465 billion. They estimate that peak production from this property will be 50,000 barrels per day (see reference).

Some 13 oil fields were acquired in the Texas-Louisiana Gulf Coast area in 2011 (salt domes with multiple pay zones). Production was doubled to 5,000 barrels per day in 2013; and 10,000 barrels per day are expected in 2014.

Finally, an older oil field was acquired in the Powder River Basin of Wyoming, which has already produced 147 million barrels over the years out of 400 million barrels of original oil in place (OOIP). Studies have indicated that another 75 million barrels could be produced by CO2 flooding (a well-known and established procedure for tertiary recovery), and Linc expects potential of producing another 10,000 barrels a day from this property.

Although Linc has not estimated the net present value of these latter two sites, it is obvious that just the US conventional oil resources would support 4-5x the current Linc market capitalization.

Conventional Coal

Linc Energy was founded in Australia in 1996 by Peter Bond, a former coal miner. Over the years, he has pivoted the company to the most profitable activities without regard to any personal affinity (or perhaps aversion) to coal mining. The company has announced that although it has many different coal leases (called tenements in Australia), it has decided to monetize all its conventional coal assets. One example of what this could mean is demonstrated by the Carmichael Coal Mine, which Linc Energy sold in 2010-11 to the Adani Group of India for a cash payment of A$500, plus an inflation-adjusted royalty of A$2 per ton for the first 20 years of production (see reference).

Over A$2 billion is being invested by the Adani Group into this property, and it was recently announced that the government of Queensland has approved the first stages of the mine, railroad and port facilities slated to be finished in 2018. Just the present value of this stream of inflation-protected royalties would justify a large percentage of the current Linc Energy market cap; but more importantly, the coal royalties plus the US conventional oil and gas production will finance most of the initial shale oil development needs in the Arckaringa Basin.

Major Potential in Underground Coal Gasification

In situ Underground Coal Gasification (UCG) is a technology developed 50 years ago in the former Soviet Union. Underground seams of coal are set afire, with oxygen being pumped in to feed the fire. With the proper portions of oxygen pumped in, methane gas (CO) is produced, which can be used to feed power generation plants and coal-to-liquid fuel facilities. The Fischer-Tropsch method of liquid fuel conversion was used in Nazi Germany during WW2 when they lost access to oil fields; by Sasol in South Africa during the apartheid period when it was subject to a worldwide boycott; and is currently being used to convert cheap and abundant natural gas to liquids in the Middle East. (see reference)

Linc Energy owns the only commercial UCG facility in the world. It has produced 1 million cubic meters a day of gas for a power plant in Uzbekistan over the last 50 years (with another 50 years of underground coal remaining in the area). The company has been very conservative in the investment of its own funds into UCG ventures, and has signed joint venture and services agreements providing Linc technical expertise in China, South Africa, Siberia, the Ukraine and Poland. The latter two countries are trying desperately to free themselves of dependence on Russian natural gas. Poland has recently granted initial approval for a Linc Energy project which will produce 10 billion cubic meters per year for the next 80 years.

Arckaringa Basin Shale Oil

Linc Energy owns 100% of the leaseholds in the 16 million acres of the Arckaringa Basin of South Australia. According to a report produced by the well-known geological consulting firm of De Golyer and MacNaughton (D&M), prospective unrisked (without application of discounts for uncertainty) resources were 96 billion barrels of oil equivalents (BBOE); and risked resources were 3.5 BBOE, of which 51% were liquids. According to a second firm, Gustavson Associates, unrisked unconventional hydrocarbons were 223 BBOE, and very encouragingly, conventional oil was estimated at 125 BBOE (see reference). The company announced that the quality of the shale was comparable to that in the Eagle Ford and Bakken shale plays in the U.S.

Obviously, at the high end of the "unrisked" resource estimate, the Arckaringa Basin has potential reserves comparable to the 263 BBOE reserves of Saudi Arabia. Even at the 3.5 BBOE risked resource, Linc Energy would have one-seventh of the reserves of Exxon Mobil, which currently has a market cap of US$437 billion.

Linc Energy Financials and Ownership

LNCGY is still a development-stage company. Revenues from product sales have increased greatly over the last three years to A$124, but except for 2011, which had the benefit of the Carmichael Mine sale, losses have been in the range of A$60 million per year (see reference).

Sales Revenue

2013 - A$124.370 million

2012 - A$57.080 million

2011 - A$3.199 million

Net Profit/(Loss)

2013 - A$(63.825) million

2012 - A$(61.893) million

2011 - A$433.945 million

2013 Selected Balance Sheet Figures

Total Shareholder Equity - A$433.945 million

Cash on hand - A$124.007 million

Current Assets - A$177.426 million

Current Liabilities - A$106.994 million

Total Borrowings - A$477.423 million (vs. A$2.13 million in 2012)

Obviously, the company took quite a risk with huge borrowings in 2012, which fortunately appear to have paid off handsomely in 2013-14 with good conventional drilling results in the U.S. Currently, the company has developed enough assets to carry through for the next few years until the Adani coal royalties can pay for greater development in the Arckaringa Basin.

Late last year, the company moved its primary listing from the Australia Stock Exchange to the Singapore Stock Exchange. The company said that Linc Energy would become the largest energy company on the Singapore Exchange, and it expected to generate a lot more interest in the shares and to attract some new major shareholders. Linc did attract one major new Asian shareholder, Genting Berhad (the Malaysian gambling conglomerate), which currently holds about 14% of the company shares.

Other major shareholders include Peter Bond, with about 35% of the shares, and Credit Suisse (not clear who the ultimate owners of the Credit Suisse shares might be). The public owns about 34% of the current shares (see reference). Having some large and credible corporate shareholders definitely adds to the stability and prestige of Linc Energy. The Singapore Exchange is an excellent exchange on which to be listed, since it is noted for its concern for financial probity and good corporate governance.

Risk/Reward Ratio

Given the more-than-adequate coverage of the current Linc Energy market cap by only the U.S. conventional oil reserves and the Adani coal royalties, I would say that the downside risk of LNCGY shares at the current price is quite modest. It is possible that a 20%-plus general bear market might bring Linc shares down in the short run. However, over the next five years, increased US oil production and reserves, combined with the actual receipt of Adani coal royalties could bring the shares up 3x-5x; while excellent drilling and development results in the Arckaringa and some positive revenue from UCG could bring the shares up many multiples more. I definitely consider LNCGY to be my top pick among the more speculative shares.

Disclosure: The author is long LNCGY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

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