some other factors to consider

Hi Shrewd

thanks for taking the trouble to come up with some numbers to value this great prospect. Before too many get too excited about the power of compounding interest, I suggest we look at some other issues that give a more realistic picture.

Even though my comments following may cut your rough estimate to only 10% of the end point of compounding profits on heaps of wells, I strongly believe that NWE is a good buy. Five years ago I was in the top 20 shareholders of NWE...when the price was 30 cents. After questioning the then MD, Ken...about how likely the immediate Puffin finds could be replaced by new finds in their tenement, I was told by Ken that the lease was absolutely full of puddles just waiting to be exploited. A few months after this conversation, Ken left the company and the share price crashed to less than one cent. The situation can change very quickly in ways that we can't predict.

Without reworking your numbers - you may wish to, if you have the time and interest - it would be worth taking the fol into account:

1. The price estimates offered by the good minister and others surely didn't refer to the likely price LONG TERM of gas into Perth? Sure, for the next few years, gas at up to $10 or more, piped to Perth, is feasible. But let's go into more detail about who will be buying and the competition for those customers...And are we comparing apples with apples? It's likely that the prices mentioned are DELIVERED gas to market, not the WELL-HEAD prices that NWE will receive.
Alcoa accounts for (I recall,about) 70% of Perth's demand for gas. It has a contract with Buru to supply a large part of Alcoa's needs when gas is available - let's say in two or three years, which can be supplied from a relatively small extension of the pipeline to the Canning Basin. (The Canning will have heaps of gas for Perth and export markets in two or three years.)
So it's conceivable that NWE will have to compete hard with the Canning Basin producers in a few years for what markets are then left. And if NWE doesn't join AWE and its partners, and other potential Perth Basin suppliers, in a marketing JV, it will be competing against all of them for markets....where otherwise will AWE sell its (larger) share of gas from the Perth Basin?

In my opinion, the price of gas for the Perth market will decline significantly over the next five years. The price for shale gas has fallen in US from $13 to $2.50 per thousand cu ft over the last three years. US shale gas suppliers have stopped production from wells, slowing exploration in only gas-prone areas and are concentrating on producing gas with condensate....so the price of gas has fallen to the marginal cost of production. It's conceivable that Perth prices could fall to similar levels unless export markets (LNG)open up. If LNG plants are built in WA based on on-shore gas supply, the price to the plants will approximate what will be delivered to the Qld LNG plants - back up towards $8 CIF...but that's many years away.

So I suggest you use $8 for gas for the well-head price, (not piped to Perth price) for the next three years, then hope that NWE can sell all its production if it drills many wells and gets $6-8 net well-head price from four years out, then use a bit higher price than this for the long term.

2. Let's make some assumptions on the net cash flow from NWE's production. I realise that your assumptions of price for gas were net of opex...but I think I've demonstrated that they look too high. How about $1-2 for OPEX? And you note that you haven't added in capex, because you've been 'conservative' elsewehere, why not use a capex cost ...say $1-2.50??? (I'm not in the oil game, so you and others could make a better guess.)

The effect of these alternatives is that instead of using your assumption of $8 per thousand cu ft NET of pipeline transmission costs to market, net of Opex and net of Capex, the realistic net cash flow before tax is more likely to be $5 - or a reduction of nearly 40% on your net price. Big difference when compounded!!

3. What happened to income tax? After the initial high costs of exploration and development have been offset against taxable income, NWE will be paying tax at 30%. So let's assume that after five years NWE will be paying 30% and so the cash flow after tax falls from $5 to $3.50 per thousand cu ft....now less than half your cash flow.

4. I'd like to also ask about life of the well. You know far more than me on this subject, but my understanding is that using a depletion rate of only 8% and continuing for 20 years isn't realistic. I realise that there hasn't been 20 years of history anywhere in the world to test how long fracked wells will deliver...but for the sake of an alternative point of view, can you please assume a depletion rate of 15% and a 10 year life. (Seam Fiend...any comment?)

5. You've also used a 10% discount rate to bring future cash flows to a Net Present Value. Two refinements here will make a big difference to your answer
a. NWE will have high initial outflows of cash
because of the drilling and development - so
we won't get good cash flows until a few
years have passed ...and these will be
discounted to PV.
b. I believe most analysts would use a discount
of more than 10% pa for a mining or O&G project
to reflect that the risks and unknowns are far
greater than analysing an industrial or retail
business with far more certain parameters.
So if you use a 12% or 15% discount value, again, the impact on your NPV will be considerable.

Please have a crack at a rework using these assumptions. My guess is that your value will fall to only 10% of what you've used as an illustration of what "could be" (which itself is a very useful exercise.)

Despite my comments that indicate the NWE valuation is unrealistic, I have been buying up NWE and will continue to do so. IMO, it's still got a long way to go.

Good luck!