fox davies capital recomend sell qgc

Fox-Davies Capital Limited, a highly respected London based Research house has put out coverage on four companies with BUY recommendations for Sydney Gas, Arrow Energy, Fortune Oil and a Sell for Queensland Gas.

The recommendations are:
SGL BUY Target A$0.48
Arrow Energy BUY Target A$3.26
Fortune Oil BUY Target 9.10p
Queensland Gas SELL Target A$1.47


QUEENSLAND GAS COMPANY (QGC AU)

Background
Queensland Gas Company (QGC) was listed on the Australian stock exchange in August 2000. It is exploring and developing the CBM resources of the Surat basin in Southern Queensland. It has majority interests in over 7200 km square of permits, adjacent to gas and electricity infrastructure and markets. The company has also started construction of a power generation project, which will be supplied with QGC gas.

During 2006/2007, QGC was approached by both AGL (Australian gas light) and Santos as a potential takeover target.

In October 2006, Santos made a hostile takeover bid offering A$1.26 per share. In December, AGL made an offer break 27.5% stake, effectively blocking the Santos takeover. In February 2006, Santos improved its offer to buy all QGC shares at a price of A$1.30 per share in cash.

In February 2007, Trust Company of the West offered a combination of cash (75%) and preference shares (25%). The amount offered in cash was A$1.51 per share. The offer was rejected by two QGC.

In March 2007, QGC accepted an offer from AGL for A$1.60 per QGC share for a 27.5% interest in the company plus a QGC tender buy back of at least A$1.52 per share. Santos did not improve its offer and subsequently withdrew.

Key assets
QGC core assets are its CDM projects. The company is also developing power projects in conjunction with these assets.

Berwyndale South
The project comprises 24 development wells, a 40km of underground gas and water gathering, gas compression system and processing facilities, and a 14km high-pressure export pipeline connecting the field to the Roma-Brisbane gas pipeline. The project was commissioned nine months after the start of construction.

Commercial gas production started in May 2006, three months ahead of the contract date with CS energy. Production ramped up to the contracted rate of 4PJpa (3.6bcfpa) and by the end of may 2006 it was supplying C. S. energy with additional volumes of gas required due to shortfalls from other suppliers. The higher than expected production allowed for suppliers of 2PJpa to be delivered (1.8 bcfpa) to the Braemar Power Station in June 2006. The full contract volume of 4PJpa (3.6bcfpa) for Braemar was reached the following August 2006.

QGC is developing the adjacent Argyle field to supply its contract with Incitec Pivot to supply the Gibson Island fertiliser plant in Brisbane, with 7.4PJpa (6.7bcfpa) of gas. This contract will start in October 2007 and gas from Argyle will be processed by the Berwyndale South facilities.


Power generation projects
QGC is planning the construction of a 100MW- 170MW power station within the Berwyndale South project. The further Condamine power station will provide a 24 baseload and will consume 8PJpa to13PJpa (7.3-11.8bcfpa), depending upon its final design. QGC estimates that the station will be commissioned in 3Q09. The electricity will be sold directly into the National Electricity Market.

In June 2006, QGC and Incitec Pivot extended and MoU for an additional two years, for the development of a gas-fired power station located at Gibson Island, Brisbane. The power station will supply Incitec Pivot and other industries in the Australian Trade Coast precinct. The project is estimated to require 8PJpa, but gas pipeline constraints are delaying its development. An investigation into the pipeline constraint was announced in June 2006

Cash flow analysis
• We have made the following assumptions when valuing Queensland gas’ assets.
• Base gas price, A$3 .50/mcf.
• Upside gas price, A$3 .85/mcf
• Operating Costs of A$1.75/mcf.
• Capital expenditure for the Period 2007-2011 will total A$112mn.
• We have estimated that QGC will upgrade its 2P Reserves by 305PJ (277 bcf) during 2007. We also estimate 55% of QGC 3P reserves (1, 0171PJ or 974bcf) will convert to 2P following additional exploration and appraisal work. We estimate that these reserves could add A$400mn in value.
• We valued Queensland Gas’ asset base at A$1.47/share using a 10% discount rate.

Summary
• Queensland Gas has a strong portfolio of exploration and producing assets located in Australia.
• Whilst we feel that Queensland gas has an excellent asset base and good management, we feel its share price is inflated due to recent approaches to acquire the company. QGC remains an attractive M&A target, but the recent deal with AGL will probably put off potential suitors in the short term.
• We feel its share price is inflated due to M&A activity in the sector as well as a mini resources boom relating to Queensland companies during1H07.
• We are initiating coverage on Queensland gas with a SELL recommendation and a target price of A$1 .47/share.

SYDNEY GAS COMPANY. (SGL AU)

Background
Sydney gas listed in Australia in June 1996 and is developing CBM projects in New South Wales, targeting the Sydney gas market. In 2005, SGL sold 50% of its assets to Australian Gas Light (AGL) and entered into a joint venture agreement to develop its tenements. The company's core development is the Camden gas project, which is entering the second stage of expansion. It is also exploring in two tenements, ( PEL4, PEL267) in the upper Hunter Valley, where it has already drills two pilot production Wells.

Key assets.

Camden gas project
The project is located 50 km southwest of Sydney and is operated by AGL. It has been supplying AGL with gas since May 2001 and it is estimated that it will cost A$150 mn to fully develop the field. The contract with A G. L. has duration of 10 years with the option to extend for another four. SGL is contract to supply 14.5PJpa (13.2bcfpa) from 2008. The project is being developed in two stages.

Stage one has been completed and comprises 21 production wells and one gas processing plant. It is covered by two production licences. These licences were the first of their kind in New South Wales as the State has no other sources of indigenous gas supply. Production from stage one has remained constant at 2,250GJ per day (2mncfd) with the bulk of this production coming from the seven top performing wells. The stage one planned (Ray Beddoe Treatment Plant) was decommissioned in February, 2007 and the gas from the stage one wells is now directed to the field facility at Rosalind Park (RPTP).

The second stage of development is under way and aims to expand total production to 40mmcfd (14.5PJpa) or approximately 8% of the current gas consumption in New South Wales. Total producing wells to date are 68, with a further three completed but not tied in and four awaiting stimulation and completion. The RPTP, a second larger gas processing plant was commissioned in December 2004 and is located 500m from the Moomba to Sydney Gas pipeline. SGL has stated that compression will be added in line with increasing production. Indeed, this has been occurring and installed capacity is now available up to 26TJ/day (23.6mmcfd), which is approximately twice the current rate of 14T J/day (12.7mmcfd).

An extension to the original AG L contract was signed in September 2005 increasing the contracted volume to 14.5 PJpa (13.2mmcfd) from June 2008 for 10 years. This contract commits all of the gas produced by all phases of the Camden development, which could be substantially extended in area over time.

During 2Q 2007, seven vertical and four directional wells will be drilled. Also eight vertical directional wells will be fracture stimulated. The company will continue to construct in-field infrastructure as well and interpret seismic darter in an effort to locate potential drilling targets. There is potential that conventional gas reserves are located under the coal seams and the joint-venture is developing options for the production of this gas.

Hunter Gas Project and Merriwera Prospect

SGL is exploring this project to the north of Sydney. Core hole drilling started in January 2007 with the aim of determining the gas composition, gas content and coal seam thickness. This information is required to confirm the location of pilot production Wells.

The joint-venture has given technical approval to drilling six exploration core holes, one of which will be drilled by the end of June 2007. It is also acquiring 131 km of 2D seismic within the project area. The company does not expect either the Hunter project autumn Merriwa (located in block, PEL 4) to come on stream in the short term and anticipates that it will be several years before commercial production starts at these projects.

Cash flow Analysis
We've made the following assumptions when valuing Sydney gas assets.

- Base gas price, A$3.40/mcf.
- Upside gas prices for high value A$3.50/mcf.
- Operating costs of A$1.18/mcf.
- Capital expenditure for the period 2007 - 2010 will total A$64mn.
- We have estimated that the is approximately 92 PJ of exploration upside possible from SGL's current Australian assets. We estimate that these reserves could add A$32mn in value.
- However, further work will be required to move these reserves from the 3P to the 2P category.
- We value Sydney Gas' asset base at a A$0.48/share using a 10% discount rate

Summary
- Sydney gas has a strong portfolio of exploration and producing assets located close to the Sydney gas market in Australia.
- Following the deal with AG L, SGL has shown that its assets and business model are attractive. Whilst we do not see Sydney gas being approached in the short term, it remains likely that any exploration success may result in future, M&A activity.
- The recent, unexpected retirement of the managing director Philip Moore is a loss to the company, but hopefully this will lead to only minor disruption.
- We are initiating coverage on Sydney Gas with a BUY recommendation and a target price of A$0.48/share.