Drillsearch's Wet Gas Looks Compelling


-Share price fall creates opportunity, say stockbrokers -Confidence for gas sales extension -Wet gas demand underpinned -Bauer-Lycium on line in April

By Eva Brocklehurst

Oil and gas explorer/producer, Drillsearch ((DLS)), offers a buying opportunity, according to stockbrokers, following a review of the company's production and development forecasts. December quarter production was somewhat below expectations but revenue was up, given strong price realisation and a lift in oil deliveries. The Western Flank oil volume was ahead of Deutsche Bank's forecasts by 44%, as increased capacity trucking became available. The downside was the lack of wet gas production because of a shut-in. However, the Bauer-Lycium pipeline should come on line in April and brokers believe wet gas won't resume until the June quarter. This has led to a reduction in Deutsche Bank's FY13 production forecasts to 1.3mmboe (from 1.5mmboe).

According to Deutsche Bank, the wet gas resumption will be supported by emerging tightness in the east coast domestic gas markets and low break-even prices for the company's resources, which are located in the Cooper-Eromanga Basins in South Australia and Queensland. The broker is confident an extension to the gas sales agreement with the SACB joint venture can be obtained, noting the company says substantial progress is being made. Macquarie says the stock's investment catalyst is hinging heavily on getting this agreement. Over the medium term, Deutsche sees the rationale for Drillsearch's wet gas agreements as compelling, given supply growth will come from the higher cost Cooper unconventional gas. This should give Drillsearch head room as a producer, and the SACB joint venture, as infrastructure owner, sufficient returns to incentivise a long-term gas sale agreement.

Macquarie also finds Drillsearch offers value at current levels and expects material earnings growth as pipeline infrastructure is commissioned and high margin Western Flank production is delivered. However, risks remain until agreements are in place, hence a Neutral rating and steady price target at $1.60. Macquarie has around 40% of net asset value attributed to wet gas assets and notes commercialisation through an infrastructure partner is yet to be confirmed. UBS has become more upbeat on Drillsearch following an update on financial numbers, upgrading its rating to Buy from Neutral, given the 19% drop in the share price this year compared with the broader sector's 5.2% rise. The price target is $1.55. Deutsche finds recent price weakness a compelling opportunity and retains a Buy rating. It has retained a $2 price target, a mid point between its Brent forward curve and discounted cash flow net asset value calculations.

Looking ahead, Drillsearch has indicated an audit of reserves is underway to appraise the reserve upside form the recent success at Bauer and the Pennington oil find. Brownlow wet gas reserves are also expected to be revised up. UBS also highlights the completion of the takeover of Acer Energy as that company's northern Cooper wet gas project and tight oil play will be incorporated into Drillsearch's portfolio. Catalysts for this broker are the completion of the Bauer-Lycium pipeline, which should increase Bauer production to 10,000 bopd, or even more if export trucking capacity is maintained, and the first shale well, drilled with partner QGC. This should start drilling mid 2013.

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