FX Energy: Heads I Win Very Big, Tails I Don't Lose Much

| About: FX Energy, (FXEN)
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How would you like to invest in a oil and gas company that has a 10% chance of increasing their reserves by approximately 50 fold in 4 months with very low downside risk if the well doesn't pan out? Currently FX Energy (NASDAQ:FXEN) is trading approximately at its net asset value using its P50 (proved + probable) reserves. Their large, exciting drilling inventory is free. In particular, their biggest prospect, Kutno, is being drilled right now and results are due in May or June.

As of YE2011, FX Energy has the following characteristics that offer downside protection:

  • 94.5 Bcfe of P50 reserves with a PV10% value of $289 million
  • Net cash of $11 million
  • 53.5 million fully diluted shares outstanding

How can such an exciting opportunity exist? The North Sea has been (and is) explored by dozens of companies. The geology of the North Sea extends across Europe and into Poland where, until recently, only one state oil and gas company did all of the exploration behind the iron curtain without the benefit of western seismic advancements. Poland is very underexplored.

Poland is a member of the EU and NATO. Poland is not a member of the Eurozone (i.e. the local currency is zlotys, not euros). Poland has a rule of law so if you find something the government doesn't come and take it away. Natural gas prices are strong in Poland and throughout Europe because the price of natural gas is tied to the price of oil. Every year you hear about Russia playing hardball with some European country's natural gas imports. Poland has made it especially attractive for outside oil and gas companies to come in and invest in production in an effort to escape dependence on Russian imports.

FX Energy has many prospects that are large relative to the size of their currents reserves. Even if you throw out Kutno, FX Energy's prospects have a risked option value which is multiples of its current share price. See the last slide of their latest presentation for a fascinating run down of some their prospects and their risked and unrisked valuations.

While I am excited by all of their prospects, the prospect that really excites me is Kutno. This massive 35,000 acre structure is the largest known structure located onshore in Europe. In September of 1979 the Polish Oil and Gas company initiated drilling of the Kutno structure with a planned depth of 6100 meters. After almost four years of drilling and mechanical difficulties with inferior equipment, the well was abandoned in 1983 at a depth of 5966 meters approximately 150 meters from the objective.

In a 50/50 joint venture with FX Energy, the Polish Oil and Gas Company is currently drilling this prospect again. The chance of success is only 10%, but if successful the range of outcomes resembles a Gaussian bell curve with the mostly likely amount of potential recoverable reserves at 9.5 Tcfe (4.75 net to FXEN). 4.75 Tcfe is over 50x FX Energy's current reserves of 94.5 Bcfe.

Heads, I win big. Tails, I don't lose much.

Disclosure: I am long FXEN.