DJ's believes that Elk provides investors with a cheap entry point into strong near term production from two enhanced oil recovery (EOR) projects in the U.S.
Furthermore, it believes that Elk's current share price represents an attractive buying opportunity before the market wakes up to the potential of EOR.
It adds that having Denbury Resources (NYSE:DNR), an EOR specialist with a US$6 billion market cap., as the operator of the Grieve EOR project has mitigated most of the execution risk.
At current price levels, Elk is trading below its flagship Grieve project and well below DJ's estimated valuation.
The following is an extract from the report.
- World Class operator DNR is one early movers in the EOR space and also one of the leading EOR producers in the US, providing a compelling endorsement of Elk's Grieve EOR project and substantially reduces the execution risk;
- Elk is fully funded to first oil for the Grieve project due to its farm-in agreement with Denbury;
- Elk's current discount to valuation is mainly due to the market's lack of appreciation for EOR which also presents an attractive Buying opportunity;
- Near term catalysts include potential reserves upgrade (Q4 2012); Grieve carbon dioxide injection (November 2012); Ash Creek chemical injection (Q1 2013); Ash Creek first production response (Q3 2013); Grieve first production (mid 2014); and new asset acquisitions;
- Low risk profile with significant ramp up of production during the next 3 to 5 years (1,000 barrels per day to 5,000bpd).
Valuation: A$0.47/sh (12 months)
The key assumptions we have used are the following:
- We have modelled the Grieve EOR project over its estimated 2P reserves life. We have used the mid-case reserves estimate by Ryder Scott of 18.6MMbbls (million barrels).
- We have assumed ELK is fully funded for its share of the Grieve EOR development and have therefore assumed ELK elects to take the second phase Capex funding from DNR on a cost recovery basis.
- We have assumed a first EOR production for Grieve of mid-2014.
- To account for any potential project execution risk for Grieve (Capex increases, reservoir deliverability and schedule delays) we have risked the Grieve project by 70% (i.e. 30% chance of failure).
- We have modelled the Ash Creek EOR project over its estimated 2P reserves life. We have used a reserves estimate of 2MMbbls.
- We have assumed a first EOR production for Ash Creek of Q3 2013.
- To account for any potential project execution risk for Ash Creek (Capex increases, reservoir deliverability and schedule delays) we have risked the project by 60% (i.e. 40% chance of failure).
- Our current long term oil price assumption is US$95/bbl and we have applied this to both projects.
- For ELK s Niobrara shale acreage we have applied a valuation unit of $500/acre to reflect its early stage maturity. For ELK s share of the Hereford gas discovery, we have applied a $1/mcf (thousand cubic feet) valuation.
- We have assigned a nominal NPV value of $5m for the Grieve oil pipeline.
- To account for Ash Creek Capex and potential new venture acquisitions, we have assumed equity dilution of $10m.
What Makes EOR Attractive
- Low geological risk. Ttraditional geological risk of having to find oil is removed;
- Proven technology that has been applied since 1972.
- High recovery rates and significant ramp up of production. CO2 EOR projects recover almost as many barrels as both primary and secondary recovery processes;
- Compelling economics. CO2 EOR projects deliver compelling economics with DNR estimating these projects only require a WTI oil price of $50/bbl to breakeven for a 15% after tax rate of return. This compares favourably to many of the main unconventional plays in the U.S.
Grieve Field Development
The Grieve Field is located in the Wind River Basin and is approximately 30 miles west of Casper in
Wyoming and was discovered in 1954. The field has produced about 30MMbbls of oil and 70 billion cubic feet (bcf) of gas (42MMbbls of oil equivalent) from the Muddy Sandstone reservoir.
It is important to highlight that ELK is fully funded to first oil mainly due to DNR funding the first US$28.5m and providing funding for the second phase Capex of $US34.3m which ELK may elect to utilise by paying back DNR through a cost recovery arrangement.
In addition, DNR will sole own the CO2 processing plant and CO2 supply pipeline (total gross Capex of $US53m) and charge the Grieve project a tariff for utilising these facilities over the life of the project which significantly reduces the gross Capex ELK is required to contribute to from US$100m to $US47m.
By excluding the DNR owned CO2 processing plant and CO2 supply pipeline (total gross Capex of
$US53m) from the upfront Capex, our estimates indicate ELK would only need to utilise US$6.5m of the second phase Capex which would be provided by DNR and repaid by cost recovery. Our modelling estimates these costs would be recovered within one year of production.
We believe ELK offers investors a cheap entry into the growing EOR oil and gas space. Our modelling suggests the unrisked value of the Grieve project underpins its current market cap by almost two times with further upside provided by Ash Creek and ELK s exploration assets.
Furthermore, we like ELK s overall low risk growth profile given the significant ramp up in production during the next 3 to 5 years (1,000bopd to 5,000bopd) underpinned by two projects in development. Investors are able to buy into this production growth with little exposure to exploration risk.
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