By Dr. Michael Green

Post the court ruling in the High Court of Gujarat last Friday it looks like there will be 2 likely outcomes in the weeks ahead for Oilex. We believe both will be highly positive for shareholders as relayed in our blog HERE.

In this piece we have revisited our financial model to see the effect on valuations that these scenarios might create but also add an extra layer of conservancy through increasing the discount rate from 10% to 12%.

Our valuation is based largely on the company’s interests in the Cambay Field Production Sharing Contract  (PSC). We have formulated a model for the Cambay Field PSC based on examining the available published information and from discussions with management. Our analysis covers the period of the current licence and the expected licence extension until September 2029.  The main assumptions are outlined below.

In all, a total of 55 horizontal wells are planned, which covers the period from mid-late 2020 through to the end of 2026. The capital costs are assumed to be US$2.75 million for a vertical well and US$6.5 million for a horizontal well. Both these estimates include the cost of fracking.

Over this ten-year window, it is expected that the 55 horizontal wells will deliver a total of 145 Bcf and associated condensate. These horizontal wells will be drilled in quite quick succession with new gas production coming on stream just as that from the wells drilled earlier are declining. In this way, the production profile appears to be fairly constant over much of the period.

The long-term gas price that Oilex will receive has been assumed to be linked to LNG Asia prices. Gas production from Cambay will be replacing imported LNG and so the price per mmbtu used in our analysis is based on what is, for all intents and purposes, a substitution value. Contracts for LNG imported into India are often benchmarked against Brent crude. We have used a flat current Brent crude price of US$72 per barrel over the life of the project in this analysis. We have used a ratio similar to the terms of a recently renegotiated LNG supply contract of Exxon Mobil. Plus, we added the charges and additional costs which imported LNG attracts, namely US$0.72 for re-gassing and marketing per mmbtu and also allowed for import duty. The price received for condensate was estimated by using a discount with reference to our Brent crude price.

Production costs are assumed to be US$1.30 per mscf, which includes the costs at the well and the processing plant. Enlarging the gas processing facility is planned to be a staged development, initially taking the capacity from the current 1 mmscfd and increasing to 12.8 mmscfd by expanding the existing facility at a cost of US$8 million. This capital expenditure figure covers the cost of the trunk line to the high-pressure pipeline and associated costs. That is planned to be followed by an increase of a further 40 mmscfd at an estimated cost of approximately US$40 million.

The government has unveiled plans to reduce the current level of corporation tax rate from 30% to 25% over a four-year period and we have used these rates over the life of the project. We have assumed that corporation tax can be offset against capital expenditure and on that basis, tax is not likely to be paid until 2025.

We have sought to appropriately risk this development. In order to be conservative, the geological chance of success was risked at 50% before the re-entry well and with the two vertical wells being drilled before the end of calendar year 2019. We then, to add to our conservative status further, choose to carry 50% of that value, before determining Oilex’s share of this valuation. It should be noted that success in the anticipated 2019 program will redress the geological risk and substantially increase the valuation.

Scenario One is the receipt of US$3 million that is claimed by Oilex against GSPC and the current 45% interest. Over the coming months we anticipate that the problems within the ownership of the Cambay Field PSC will be resolved and a new joint venture partner emerge which will likely provide the funding for the planned drilled program, a move which is likely to involve a farm-in deal. We have estimated that as a result, Oilex’s interest in the PSC could be reduced from 45% to 30%.

Scenario Two is gaining a 100% interest in the project in the event of GSPC not meeting the Stay requirements as set out by the court. Should this occur we believe the stage would then be set for the ushering of a new joint venture partner which will likely provide the funding for the planned drilled program through a farm-in deal. We have estimated that as a result, Oilex’s interest in the PSC may be reduced from 100% to say 70%.

Scenario One – Valuation

Scenario One – Per share valuations

Scenario Two – Valuation

Scenario Two – Per share valuations

These potential target prices may look high compared to the current market price, but that is largely, in our view, due to the shares being tremendously oversold and that fears over a drawn out litigation/arbitration process have held the stock back. As per the RNS yesterday, it seems to us that Oilex are now in a strong position and that there will very likely to be political pressure within India to come to a resolution, finally.

We believe by any conventional yardstick that the shares are very inexpensive. We also point out that the true potential at the Cambay Field PSC is a lot higher – the 145 Bcf planned to be produced until 2029 represents just a fraction of the resources here. We in fact see our model and our valuation as actually representing a base case that does not account for further extension or an even larger expansion. An additional government approval would be required to extend the PSC beyond 2029.

We initiated coverage on Oilex in November 2017 with a target price of 1.60p and a Conviction Buy stance. Given the events of recent weeks and the points highlighted here where the base value is near 3 times the stock price and the “blue sky” multiples of this, we believe that the current price now provides an even more attractive risk/reward entry than when coverage was initiated. Accordingly we remain resolute buyers at this level.

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