When investing in oil and gas exploration and production (E&P) companies, my goal is to invest when two desirable factors appear to be converging:
- Cautious or depressed sentiment, leading to an attractive share price
- Imminent good news or material progress with operations and profitability
On the face of it, these two factors appear unlikely to coincide, but it’s surprising how often they do.
Depressed sentiment — and a weak share price — is usually either the result of a wider market malaise tarring all companies with the same brush, or of the cumulative effects of disappointment that things haven’t quite gone to plan so far.
Yet delays, dry holes and (sometimes) cost overruns are an inevitable part of oil and gas projects and do not always equate to failure. In this article I’m going to look at Salamander Energy (LON:SMDR), a company that I believe is likely to deliver substantial profit and cash flow growth over the next two years, which could lead to a re-rating of its share price.
Asian oil and gas
Salamander is focused purely on South East Asia, with operations in three core areas: Greater Bualuang, Gulf of Thailand; North Kutei, Indonesia; and Greater Kerendan, Indonesia. In each of these areas the Group has a material, operated position.
Salamander spent 2012 disposing of non-core assets and refocusing on its three main areas in order to improve its profit margin per barrel. This resulted in production dropping from 18,600 boepd in 2011 to 10,800 boepd in 2012, but its post-tax operating cash flow rose from $28.56/boe in 2011 to $40.22/boe in 2012, suggesting that this approach may be working.
This year, Salamander expects to increase production to between 12,500 – 15,500 boepd and has a busy drilling schedule planned.
Production: Greater Bualang (offshore Thailand) is Salamander’s main producing oil asset and provides its most profitable barrels. Production from the Bravo platform averaged 7,200 bopd in 2012 and is expected to rise to between 11,000 and 14,000 bopd this year, thanks to a 16-well drilling schedule planned to enable maximum recovery from the field.
Salamander is also focused on maximising the profitability of this key asset, and is planning various modifications to the platform that will lower oil production costs over the next year or so.
Exploration: In addition to maximising recovery from the main Bualang field, Salamander also has also matured nine prospects to drill-ready status in its G4/50 licence, which covers the area around in the B8/38 Bualang producing licence.
Salamander aims to drill at least six wells here this year, each with mean prospective resource estimates from 20 – 150 mmbo and chances of success from 15 – 30%.
Greater Kerendan: This is a gas play where Salamander has signed an off-take agreement for 20 mmscfd of gas to be supplied to a new 320MW power plant that is due to start taking gas in July 2014.
The power plant will be able to accept up to 60 mmscfd and Salamander says that there is no other potential gas supplier local to the plant.
The current off-take agreement has commercialised 122Bcf of gas in the Kerendan field, but its wider prospectivity has not yet been fully appraised — Salamander believes that the West Kerendan and Sungai Lahei prospects contain a combined mean prospective resource of 900 Bcf and plans further exploration drilling in the second quarter of 2013.
North Kutei: This is Salamander’s third core area, and in February the company announced that its first well in the North Kutei basin, the South Kecapi-1 (SK-1) well had made an oil and gas discovery.
When tested, SK-1 flowed light oil at 6,000 bopd and 8 mmscfd of gas, but this was constrained by testing equipment and the firm believes it would have flowed 14,000 bopd on an unconstrained basis, although the scale of the potential reserves is uncertain (estimated at between 13mmbbl and 133mmbbl) and will need further drilling to ascertain.
Salamander is currently drilling the North Kendang-1 well in North Kutei, which is targeting mean unrisked prospective resources of 770 Bcf and 91 mmbbl, following which its third target for this year will be Bedug, where it will target 321 Bcf and 80 mmbl (unrisked).
Salamander completed a $212m rights issue in 2012 and ended the year with net debt of $194m and $208m of available cash. This, combined with the growing cash flow from its production, is expected to be enough to fund its drilling and development activities in the coming year, making it self-sufficient financially.
The 2013 outlook for Salamander contains a lot of upside and — with average luck — very little downside. Of course, things don’t always turn out this way, but in my view the company has made enough progress with its core assets to be fairly confident that there is better yet to come — and to have a good understanding of what’s involved in realising that improvement.
Salamander’s strong positioning in the Indonesian gas market is especially attractive, as like most Asian countries, Indonesia has a growing need for gas and is likely to be happy to buy it locally and reduce its dependency on high-priced LNG imports.
2013 may just be the year of the Salamander!
Disclosure: Roland owns shares in Salamander Energy.