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Carnarvon Petroleum: Macquarie Equities Predicts “Outperform”

Carnarvon Petroleum (ASX: CVN) has drawn an Outperform recommendation from Macquarie Equities with a 12 month price target of $0.15.

This is 150% higher than its current trading price of $0.06. Macquarie also left its estimated Net Asset Value at $0.24 per share unchanged.

The company will soon be participating in the Apache Corporation-operated upcoming Phoenix South-1 and contingent Roc-1 wells offshore Western Australia as well as potential for growth in Thailand oil production

The following is an extract from the Research Report.

Action and Recommendation

At the current share price, CVN offers an attractive option on material gas exploration across the Phoenix gas blocks and increasing production levels across its Thailand assets from historic lows.

Phoenix rising from the ashes

Apache is proposing to deepen the Phoenix-South well by a further 500 metres and is also expect to undertake a more comprehensive testing program, including wire-line logging.

While only 35% of the shareholders participated in CVN's non-renounceable 1-for-5 entitlement offer, raising $3.1 million, the cap on Apache carry for the Phoenix South-1 and contingent Roc-1 well increased to US$70 million from US$50 million.

CVN now appears to fully funded for upcoming drilling.

Despite greater certainty surrounding funding of upcoming drilling activity across the Phoenix gas blocks and near-term exploration activity, the current share price continues to discount this exploration potential.

We conservatively estimate the Phoenix South-1 prospect will target about 1 trillion cubic feet of gas within the lower Triassic reservoirs over an estimated 50 square kilometres of closure.

CVN has also estimated condensate yields could range between 25 barrels and 100 barrels per million standard cubic feet of gas.

This compares favourably to 14.5bbls/MMscf at Pluto and an average 23.9bbls/MMscf across the North West Shelf fields.

Given an estimated 1-2Tcf pre-drill target, commercialisation options appear limited to a liquids stripping project, a domestic gas development, backfill of existing LNG plants.

CVN could also look to swap its 20% stake in a potential gas discovery. Given Apache's operatorship and established position in WA domestic gas projects (including the Varanus Island and Devil's Creek gas processing facilities) this perhaps appears the most logical development route for a discovery.

CVN could also look to sell its interest in a potential discovery ahead of development.

Thailand production continues to prove challenging

With gross production averaging 1,263bopd in the December quarter, production has remained largely flat over the last 18 months

Both operational downtime and the ongoing ALRO regulatory shut-in of 6 wells continues to impact production levels.

Nonetheless results from the water flood program and encouraging initial results from igneous activity could see production turn recover from these low levels.

A water injection program commenced over the WBEXT-1B sandstone fault block in August
2013 helped stem the decline and increased production from 100bopd (barrels of oil per day) to 140bopd.

The WBEXT-2BST2 well encountered good oil shows across two igneous reservoirs and was completed for production late last quarter, with initial flow rates of 175bopd.

The WBEXT-4C well is also drilling ahead with a result expected this quarter.

The JV is planning two drilling campaigns (6-8 wells each) targeting a mix of igneous exploration and development opportunities across the Wichian Buru Extension and Na Sanun East Areas reserve areas and other exploration areas.

Following completion and processing of a 100km2 3D seismic program in the L33/43 concession, the JV is planning a mix of development and exploration wells in early 2014.

Initial results suggest that previous wells have been producing from shallow igneous horizons. However exploration wells are likely to target deeper igneous horizons that have been successful produced further south in the WBEXT area, but remain untested in the L33/43 permit.

Share price trading at a discount to NAV in light of reserves uncertainty

We have made a number of changes to reflect the capital raising, updated funding structure for the upcoming drilling program and a harsher risking adopted across the exploration assets.

This is offset by an assumed higher unit valuation of ~U$6/boe for gas resources across Phoenix gas blocks based upon a standalone domestic gas development.

While our revised NAV of A$0.24/sh is more than four times the current share price, it is clear, in our view, that the market is discounting the reserves base in light of the concerns regarding current production rates and the potential impact on reserves.

With cash balances of A$21m underpinning 3Acps of value and despite assuming that onshore Thailand 2P reserves are ~25% lower than the 12.2mmbbls booked, we believe the current share price is still implying that producing assets are being risked at merely 13%.

Alternatively CVN is now trading at an EV/1P and EV/2P multiple of merely US$8.97bbl and US$2.88/bbl respectively.

Nonetheless, CVN has a 1P reserves life of ~21 years based on current production rates of 1,263opd or (~66 years based on 2P reserves). Conversely, the current share is trading at a FY14 P/FCF multiple of merely 8.0x.

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