CREDIFINANCE SECURITIES LIMITED
Morning Meeting - Equity Research Notes Tuesday, August 4, 1998
PRIMELINE ENERGY HOLDINGS (PEH)(VSE) Recent Price: $1.49
52 Week Range: $2 - 0.49
A MAJOR NATURAL GAS DEVELOPMENT PROJECT OFFSHORE CHINA
PEH holds a 75% interest in and operates Block 32/32 in the East China Sea where detailed evaluation of the October, 1997 Vicky-1 gas discovery gives estimated recoverable reserves of 660 billion cubic feet of natural gas and 7.9 million barrels of gas liquids. Moreover, seismic analysis indicates that the 1.5 million acre block includes ten additional structures with the potential for 4.2 trillion cubic feet of natural gas and 924 million barrels of oil. Block 32/32 is located only 140 kilometres offshore from the fast growing industrial city of Wenzhou in Zhejiang Province. Energy demand in the region is increasing at 14% per annum and electricity is in short supply. Because of severe environmental problems, natural gas is increasingly favoured for electricity generation. PEH is well advanced in discussions with local authorities and western utility contractors toward construction of a gas fired electricity generating plant in Wenzhou. The city has other major markets for natural gas. Subject to successful delineation drilling, Vicky Field development could be fast tracked to be onstream in 2001 with production of 135 mmcf/d envisaged by 2002. Regional market studies suggest a field-gate price of US$4.50 - 5.50 per mcf!
The Chinese fiscal regime for offshore petroleum development is investor friendly. It consists of a production sharing agreement that leaves the contractor with about 30% of net revenue, despite provision for the China National Offshore Oil Corporation to back in for up to a 51% interest in the development phase. Based on capital expenditures of US$20 million for additional delineation plus US$350 million for field development program and a pipeline, the contractor's after-tax present value share of 660 bcf of Vicky gas reserves is calculated at US$259 million and US$140 million, discounted at 10% and 15%, respectively. These values reflect a US$4.50 per mcf gas price with sales commencing in 2001. The gas price and operating costs are escalated at 2.5% per annum.
PEH has exceptional financial backing combined with excellent connections in China. The company is 92% owned by Primeline International Holdings which, in turn, is owned by the wealthy Hwang family of Hong Kong. The family has major investments in construction, real estate, and transportation. It sees China's huge energy market as an attractive growth opportunity. Primeline International owns 100% of Primeline Petroleum which holds the remaining 25% interest in Block 32/32, as well as a 100% interest in Block 4/20 located to the northeast in the East China Sea Basin. Although a relatively new company, PEH has a strong technical team. The Vicky gas discovery was made in an area of the Basin where major international oil companies had drilled fourteen unsuccessful wells.
RECOMMENDATION
PEH shares have substantial upside potential. We appraise the company's 75% interest in Block 32/32 at $13.75 per share, including the Vicky Field plus a risked value for prospective reserves in the other ten structures, as shown on page 3. Even assuming that funds for the Vicky delineation program had to be raised at the current depressed share price, resulting in a 70% increase in shares, we would appraise the company's proforma net asset value at $8.15 per share.
We rate PEH shares a Strong Speculative Buy. There are three caveats: Confirmation of the Vicky Field reserves will require the drilling and testing of two more wells. Timing of the proposed development program could be delayed. With 23.1 million shares outstanding, market capitalization is only $34 million and market float is a minuscule $2.8 million.
EXPLORATION ON BLOCK 32/32
The East China Sea Basin was explored exclusively by Chinese agencies until 1993, when 20 licence blocks were offered in Fourth Round Bidding. By late 1994, 18 contracts had been signed, mainly with international majors. Primeline Petroleum obtained five of these blocks. In June, 1995 PEH acquired 75% of Block 32/32, a 6,000 square kilometre block (30 times the size of a North Sea block), located 100 kilometres from the coastline of southeastern China. The block is in the western sub-basin of the concession area where two wells drilled by the Chinese Ministry of Geology indicated significant hydrocarbon source rocks and good quality oil shows. This contrasts with the eastern sub-basin where 14 wells drilled by major companies were unsuccessful due to the absence of source rocks. Following extensive technical evaluation including analysis of 6,000 kilometres of seismic, PEH selected the Vicky prospect which is an anticlinal structure with mapped closure of over 30 square kilometres.
The Vicky-1 well, located in the northeast corner of the block in 90 metres of water, was spudded on July 25, 1997 and reached total depth of 3,300 metres on September 21. Well logs indicated 543 metres of gross hydrocarbon bearing section and 105.8 metres of net pay. One drill stem test, with 24 metres of perforation over three intervals between 2,250 - 2,283 metres, flowed 9.86 mmcf/d of natural gas and 117 b/d of condensate through a 48/64 inch choke. Subsequent evaluation by PEH's technical staff and a United Kingdom based petroleum consultant led to a calculation of "most likely" recoverable reserves for the Vicky Field of 660 bcf of natural (hydrocarbon) gas and 7.9 million barrels of gas liquids. The estimated minimum and maximum cases for recoverable gas reserves range from 390 bcf to 954 bcf.
The planned delineation program for Vicky will include acquisition and interpretation of 3D seismic by year-end 1998 and the drilling plus extensive testing of two more wells in 1999. Estimated cost of the seismic is US$3 million and of the two wells including testing is US$15-20 million. Once the reservoir is fully delineated, a full field development plan can be prepared and submitted to the Chinese authorities for approval.
Several prospects and leads within a 20 kilometre radius of Vicky-1, that have geological similarity to the discovery, suggest the potential for an additional 4.2 tcf of natural gas which would place Vicky in the "giant"field category. Another series of structures in the southeastern part of the block is estimated to have the potential for 924 million barrels of recoverable oil.
NET ASSET VALUE
We appraise Primeline's net asset value at $13.75 per share, based on its 75% interest in Block 32/32, an after-tax discount rate of 15% and 24.2 million fully diluted shares as shown below. Making the conservative assumption that the company is obliged to raise $25 million of equity at the current depressed share price to fund its share of the Vicky Field delineation program, the number of fully diluted shares would increase to 40.8 million, reducing our NAV to a still robust $8.15 per share. Subsequent field development and pipeline construction is expected to be debt financed with the support of a take-or-pay gas purchase contract from a western utility contractor.
Discounted at 10% 15%
Vicky Field Reserves - Natural Gas 495 bcf US$MM 195 105
- Gas Liquids 5.9 mmbbl 13 7 208 112
Other Block 32/32 Prospects "Risk Adjusted" 110 110
Working Capital at December 31, 1997 (2) (2)
Net Asset Value 316 220
Net Asset Value Per Share - Fully Diluted (1)US$ 13.05 9.10
Cdn$ 19.75 13.75
Proforma Cdn$25 Million Equity Financing:
Net Asset Value Per Share - Fully Diluted (2)US$ 7.75 5.40
Cdn$ 11.70 8.15
Note: (1) Based on 24.2 million shares.
(2) Based on 40.8 million shares.
(3) Cdn$ = US$0.6618
Bill Magee (416) 955-0159
The information and statistical data contained herein have been obtained from sources which we believe to be reliable but in no way are warranted by us as to accuracy or completeness. We do not undertake to advise you as to any change in figures or our views. This is not a solicitation of any order to buy or sell. We, our affiliates, and any officer, director or stockholder or any member of their families, may have a position in and may from time to time purchase or sell any of the above-mentioned or related securities. |
