Tap Oil and AWE 17 Sep 08

A strategic switch from TAP to AWE

Tap Oil has unfortunately not lived up to our optimistic expectations since we introduced the company into our portfolio back in late-2005. Whilst the company still retains its key fundamentals of a strong balance sheet and an aggressive oil exploration programme, these have so far not translated into shareholder wealth. We are therefore recommending Members switch from TAP into AWE, one of our other long-standing petroleum exposures. We believe the company offers Members the same fundamental attractions as TAP, strong financials and active exploration, but with a demonstrated track record of success and growth.

Tap Oil
Tap Oil was introduced into our portfolio on two counts: firstly, its oil and gas earnings would provide some share price stability, as they generated a strong balance sheet position with large cash holdings and no debt; and secondly, the company is one of the most aggressive explorers in the Australian oil industry, hopefully generating exploration excitement and eventual success for our Members.

Unfortunately, Tap Oil has never lived up to our optimistic expectations, and whilst it still retains its key fundamentals of a strong balance sheet and an aggressive drilling programme, this has so far not translated into shareholder wealth. We are therefore recommending Members switch from TAP into AWE, as the company offers Members the same fundamental attractions as TAP, but with a demonstrated track record of success and growth.

But let’s examine recent developments with respect to the company that rationalise our investment decision.

For starters, TAP has not been able to capitalise on this year’s record oil prices due to production disruptions at its key WA oil and gas operations. This has left it seriously behind the eight-ball compared to its competitors. The disruptions look set to continue through to at least the end of this year and have contributed to a breakdown in the charts and the possibility of a protracted deterioration in the company’s stock price.

TAP’s production assets were supposed to be its strong suit, but unfortunately they have proven to be the company’s Achilles Heel. Whilst they have generated solid cash flow over the years, they have seriously underperformed, with production disruptions at the company’s two main operations – Varanus Island and the Woollybutt oilfield.

Tap’s revenue for the six months to 30 June 2008 fell by 41% in comparison to the same period last year. The top-line weakness translated into a loss of $1.3 million for the period, compared to a loss of $0.4 million in 2007. However, the loss would have been far greater had it not been for a tax benefit of $7.3 million.

As Members may recall, the Varanus Island gas explosion shut down production at the Harriet joint venture in early June. Tap holds a 12.2% interest in the project and expectations are for production to resume in December 2008.

Given that the incident occurred in June, Varanus Island cannot shoulder the blame for the company’s weak first-half performance. As shown on the table below, Western Australia’s Woollybutt project was responsible for the majority of Tap’s production shortfall in comparison to the same period last year.

Operations at Woollybutt were suspended in January due to problems associated to the emergency shutdown equipment. Cyclone activity in the area served to prolong the initial shutdown, leaving Woollybutt offline for much of the first half. In fact, production did not resume until June.

The development of Woollybutt South has resulted in the field’s production resuming at around 12,000 barrels per day. This represents growth of 50% in comparison to pre-shutdown production.

Fat Prophets initially recommended buying Tap Oil at $2.72 in November 2005 (Fat Mining 2). Our last review of this stock was in June (Fat Mining 129).

There has been a sharp deterioration in the charting outlook for TAP in recent months. As shown on the chart below, since reaching a high of $2.21 in May prices have more than halved, with the stock recently trading below $1 for the first time since 2001. Despite the oversold stance of numerous technical indicators, prices are yet to form a base or give a clear indication of reversal. In the absence of such signals, we cannot rule out deeper falls in the weeks ahead.

On the positive side, TAP’s balance sheet remains in good health and there is the potential for exploration success to re-invigorate the share price. However, we believe the company’s risk-reward profile is no longer favourable and we find it difficult to find a factor, other than exploration success, that will generate a sustained and substantial recovery for Members.

Accordingly, we recommend that Members sell Tap Oil around 88 cents and switch the proceeds to Australian Worldwide Exploration (AWE).

Australian Worldwide Exploration
In contract with Tap Oil, AWE has benefited from oil’s price strength through the continued out-performance of its Tui oil project, offshore New Zealand. Whilst Tui is set to enter natural decline next year, the field is strong revenue-generator and is throwing off lots of cash that AWE and its partner, New Zealand Oil & Gas, are using to fund aggressive exploration.

But the beauty for AWE is that it is not solely-reliant on Tui: it has three other major petroleum projects that it commissioned over recent years that are currently operating, with a fifth in the development stage. In addition, the recent finalisation of the friendly merger with ARC Energy will further boost the company’s production and exploration portfolio.

As we have previously commented, given that both ARC and AWE share low-risk production assets in Australia and New Zealand, the two companies are an excellent fit in our view. The deal enhances AWE’s scale and competitiveness through additional production and exploration tenements.

Specifically, AWE now holds a larger share (and control) of the Cliff Head oil project offshore Western Australia, which is in addition to a combined 42.5% stake in the BassGass natural gas project, offshore Victoria. AWE’s other major asset, apart from Tui, is the Casino gasfield, offshore Victoria.

AWE has also gained access to mature production in Western Australia’s Perth Basin, as well as additional international exploration tenements in Yemen and Texas. Meanwhile, proven and probable reserves have increased to 78 million barrels of oil equivalent (boe), compared to AWE’s previous 61 million boe.

Fat Prophets initially recommended buying AWE at $2.09 in November 2005 (Fat Mining 3). Our last review of this stock was in June (Fat Mining 129). As evident on the daily chart, there has been a sharp correction in the price of Australian Worldwide Exploration during the past month. Disappointingly, this move has seen prices breach support at $2.77 to hit a low of $2.60.

Despite the recent weakness, downward momentum has slowed in the past week. In addition, a further substantial level of support lies just below current prices, at $2.54. These factors combine to suggest there is potential for prices to turn higher in the weeks ahead.

However, we would prefer to see a sustained lift above $2.77 to ease near-term downside risks and a further break above resistance at $3.08 to signal a revival of near-term upward momentum. Until then, we cannot rule out a deeper retreat.

The Tui field in New Zealand is a great example of how an oil project should be successfully run. Although a relatively short-life field, the project recently produced its 5 millionth barrel of oil and is currently averaging gross production of around 47,000 bopd. Encouragingly, recent modifications to the floating production vessel have enabled daily production rates to increase to around 50,000 bopd.

But even more importantly from a field-life perspective, the strong reservoir performance so far has allowed the Tui joint venture partners to dramatically increase the project’s reserve base. 2P Reserves (Proved & Probable) have been upgraded by almost 50% from 27.9 million barrels to 41.7 million barrels.

There has been further good news on the project front elsewhere, with the joint venture partners in the Henry gas field (AWE 25% stake) pushing ahead with development of the $275 million project. It can be described as AWE’s fifth production asset, although in reality it will be developed by utilisation of existing infrastructure associated with the company’s Casino gas field (also AWE 25% stake), which commenced production in early 2006.

Casino lies just 8.5km away and the joint venture partners sensibly developed the initial Casino sub-sea infrastructure to accommodate future development. First gas production is targeted for the first half of 2009 at flow rates of 120 Terajoules per day from the combined Casino-Henry development. 2P reserves at Henry are estimated at around 150 PJ.

By contrast with TAP, AWE has a strong history of generating exploration success and turning this into commercial success.

A further advantage that AWE has over TAP is the company’s $1.4 billion market capitalisation, compared to TAP’s $140 million. Bear markets are particularly tough on small-cap stocks as investors seek the relative safety of larger companies. This increased level of risk aversion is likely to result in larger companies such as AWE leading the eventual recovery.

Despite the recent weakness, downward momentum has slowed in the past week. In addition, a further substantial level of support lies just below current prices, at $2.54. These factors combine to suggest there is potential for prices to turn higher in the weeks ahead.


DISCLAIMER Fat Prophets has made every effort to ensure the reliability of the views and recommendations expressed in the reports published on its websites. Fat Prophets research is based upon information known to us or which was obtained from sources which we believed to be reliable and accurate at time of publication. However, like the markets, we are not perfect. This report is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore discuss, with their financial planner or advisor, the merits of each recommendation for their own specific circumstances and realise that not all investments will be appropriate for all subscribers. To the extent permitted by law, Fat Prophets and its employees, agents and authorised representatives exclude all liability for any loss or damage (including indirect, special or consequential loss or damage) arising from the use of, or reliance on, any information within the report whether or not caused by any negligent act or omission. If the law prohibits the exclusion of such liability, Fat Prophets hereby limits its liability, to the extent permitted by law, to the resupply of the said information or the cost of the said resupply. As at the date at the top of this page, Directors and/or associates of the Fat Prophets Group of Companies currently hold positions in: ASX-listed Australian stocks: ASX-listed Australian stocks: AAC, AAD, AGO, AJA, AMP, ANZ, APA, APG, AVG, BCI, BHP, BKN, BOQ, BRL, BRU, BTR, BWP, CBA, CCL, CDD, CFE, CGL, CKF, CNQ, CVO, CWN, DLS, DNX, DUE, ELD, ENV, EVN, FID, FMG, FXJ, GJT, GMG, GNS, GOR, GPT, GXL, HUB, IAU, IFL, ILU, IMF, JHX, MFG, MGR, MML, MMS, MND, MNF, MPL, MTR, MTU, NAB, NCM, NMG, NUF, OBS, ORE, OSH, OVH, POS, PPS, PRG, PRT, PXG, QAN,QBE, RIO, RXL, RRS, S32,SDG, SFR, SGP, SIV, SLR, SPK, STO, SUN, SYD, TAM, TEN, TLS, TME, TTN, WBC, WFD, WES, WHC, WOW, WPL, WSA. International stocks 3i Group, Acacia Mining, Amec Foster Wheeler, Anglo American, Archipelago Resources, Arian Silver Corp, Aviva, Avocet Mining, Bank of China, Barratt Developments, BMW, Berkeley Energy, BG Group, BOLSAS Y MERCADOS ESPANOLES,SOCIEDAD, Bovis Homes, BP, Braemar Shipping Group, British American Tobacco, BT Group, Cairn Energy, Centamin Egypt, China Life Insurance, China Mobile, China Overseas, China Taiping, China Vanke, Country Garden, Daejan Holdings, Development Securities, Dragon, Enquest, Esure, Euronext, FedEx, Fresnillo, Ibiden, Infosys, Glaxosmithkline, Glencore International, Goldbridges Global Resources, Google (Alphabet), Grainger, Gulf Keystone Petroleum, Highland Gold Mining, HSBC,ICICI Bank, Ironveld, iShares Physical Metals, J Sainsbury, JKX Oil & Gas, John Wood Group, Kazakhmys, Legal & General, Lloyds, Low and Bonar, Market Vectors Junior Gold Miners, Market Vectors Oil Services, Market Vectors Vietnam, Marstons, Medusa Mining, Mitchells & Butlers, Mitsubishi Tokyo Financial, Mitsubishi UFJ, National Grid, Nippon Telegraph and Telephone, Panasonic, Paragon Group of Companies, Petra Diamonds, Petrofac, Petropavlovsk, PICC Property & Casualty, PPHE Hotel Group, Randgold Resources, Rank Group, Reckitt Benckiser, Royal Dutch Shell, Solgold, Sony Corporation, Standard Chartered, STV Group, Sylvania Platinum, Tata Motors, Tencent, Tertiary Minerals, Teva Pharamaceutical, Toyota Motor, Tullow Oil, Unilever, Vedanta Resources, Vodafone, Walt Disney, Zillow.