karoon history - making of a company

A stable of seasoned talent and strategic, careful expansion has seen exploration company Karoon Gas grow to become a significant player in the Australian oil and gas market. Where some large oil and gas players have jettisoned vast amounts of experience from their workforce through earlier down-sizing exercises, Karoon is utilising a vast knowledge base and an astute partnership with US giant ConocoPhillips to capitalise on exploration opportunities in Australia’s Browse Basin.

The company’s main focus area in the Browse Basin has shown considerable promise, with success reflected in a robust share price and growing market capitalisation. However, it is the recent announcement that Karoon had acquired acreage in the Santos Basin offshore Brazil which indicates the company is yet to realise its enormous potential.

Mark Smith, Karoon’s Executive Director and Exploration Manager, said, “The Karoon view of what we are is obviously a small Australian company, but highly leveraged to big LNG in Australia.”

Mark Smith characterises the Karoon approach of thorough assessment, calculated risk and utilisation of industry proven, experienced human resources. He has 27 years experience as a geologist, exploration and project manager in petroleum development around the world, the bulk of which was gained with BHP Petroleum (BHPP). Executive Chairman Bob Hosking has over 30 years of commercial experience in the administration of several companies, and is the founding director and shareholder of Nexus Energy. They are joined by a modestly sized team whose expertise with large energy companies is paying dividends for Karoon.

“We want to keep Karoon as lean as possible, but there’s a delicate balance there. You’ve got to have enough people with the technical expertise to accumulate the knowledge in Karoon, otherwise all you’re doing is educating all these consultants”, Smith said with a wry smile.

The ‘delicate balance’ appears to have been struck in Karoon’s measured expansion from relatively humble beginnings. “Initially we picked up acreage in the onshore Gippsland Basin, PEP162, with the view to exploring the CBM potential in coals in the Strzelecki group. From looking at all the seismic around from my regional geological background, there were more big, higher amplitude packages in that unit than I’d seen anywhere in southern Australia. So we picked up that acreage and raised about $4.7 m and floated on the stock exchange”, he said.

“When we drilled the first well, Megascolides-1, we got 15 m of coal but the coals were nothing more than half a metre thick and the gas contents were fairly low. So that downgraded the CBM potential, but we also drilled down to near Basement in order to understand the whole stratigraphy of that part of the onshore Gippsland Basin.”

“In the end we came back and did a sidetrack well in late 2006 and cored the 10 m reservoir section. Porosities were as predicted in the logs from the previous and current well, but unfortunately the permeabilities were all less than one mD, which meant that it wouldn’t flow with anything. Perhaps we were in a residual column or an oil column but it’s not something you could actually produce. We drilled a second well up dip from that and the sand wasn’t present. So that basically finished our exploration program in the Gippsland and we are no longer in PEP 162.”

The Karoon brains trust, conscious of the speculative nature of oil and gas exploration, was not discouraged, and shifted their focus to greener pastures. “During that total (Gippsland) program over three or four years we looked for other assets that might add value to the company, and because of my experience with BHP, I was very familiar with what was going on in the Browse Basin, having worked up in that area.”

“Liberty Petroleum held WA-314 and WA-315-P; they’d picked it up at gazettal. We did a deal with them where we took over the ownership of the permit and they backed out with a 1.5% over-riding royalty going to 2% after five years.”

Having secured the acreage, Karoon was still exposed to the possibility the exploration would not be successful. “I knew about the Buffon- Scott Reef high trend, and the frequency of the faulting and the structures, and it was very likely there were going to be a series of other big tilted fault blocks out there. So technically, in summary, that was the assessment, but still we were taking a risk because we didn’t know the leads were there. We bought the 2D data, acquired the work program 3D, and once we had that we basically de-risked it to a degree because we mapped up the structures, and we’ve now got hi-res 3D over them”, Smith said.

“By October 2006 we had just about all the seismic products in, and at that point we completed the farm-out. We had B.G. in there early, prior to the 3D surveys, and they wanted to do some aeromag first, and because at that point we were a fairly small company we let them have the option after the aeromag to go forward with the 3D. As it transpired they did the work and then sought to renegotiate the terms. Fortunately for us, with Bob’s commercial nous, we had raised the money in the market to pay for our share of the seismic and subsequent wells, so we were in a position to reject the renegotiation request, take over operatorship and acquire the seismic ourselves.”

“During the farmout process, once we had all the data then we had probably 10 of the biggest oil and gas companies on the planet through the door looking at it, because at that time the perception of the world oil and gas market had changed markedly as well. The previous model for big gas development in Australia was: ‘Who is next in this limited market to supply Korea or Japan’? You had to join the queue and a lot of the brokers had very entrenched views on that at the time. Others could see the crack in the door and they were more supportive of us because there was a shift in market analyst perceptions of what was going to happen in the LNG market, and they’re proven to be correct”, he said.

The market’s respect for relative newcomer Karoon is a sign of the company’s growing maturity. “The market risk changed and that was occurring at the same time as we were farming out with all our 3D.”

“It’s interesting how it all works in your relationships with the market. People can do all their sums on you and be very rational about what your potential is, but once you say, ‘Oh, we’ve got a credible partner in with us’ there’s that emotional side of the market that says, ‘Oh, that’s ok’, and you get a big kick from having them in there. The market is both technical and emotional, and you’ve got to address both sides”, Smith said.

“The reason why we like ConocoPhillips is that they’re a proven LNG developer and marketer already established in Darwin, it’s a simple joint venture and there is room for expansion at their Darwin site. In the event of exploration success Karoon would like to have the joint venture consider Darwin as a site for the LNG plant. Obviously we’d have to pay our share going into it, and this would include a pipeline over to Darwin: a distance of about 1000 km.”

Smith is understandably bullish about Karoon’s prospects in the Browse. The permits are situated in close proximity to Woodside’s Torosa development which has a proven resource of 21 Tcf and 300 MMbbl of condensate. Karoon’s assessment of recent seismic data indicates the acreage has potential prospective resources of over 20 Tcf of gas, with high ratios of condensate and LPG, potentially 33 bbl per MMcf of condensate and 68 bbl per MMcf of LPG based on Buffon gas samples. The condensate and LPG in particular have the potential for an enormously positive impact on cash flow.

“It’s potentially a company maker. Sometimes you have some segregation in your gas field and the condensate rates are different, but by and large until you get an extended production test you don’t know what the final number is going to be. But indicatively when you look around the area there is a fair bit of condensate and LPG and through the economics that Karoon has done on the prospects surrounding the Buffon well, you end up with about half of your value actually coming out of the liquids component.”

“Using Bayu Undan as an example, the liquids component extraction was ready first, so for about 18 months they produced 100,000 bopd, or thereabouts. That helps underpin your LNG development; you’re getting early cash, although a lot of the cash you’re spending occurs before that. You’ve also got exploration costs and appraisal costs, so you drop into a pretty big cash flow hole for a year or so before production”, he said.

Such expenditure, whilst shared within joint ventures, represents significant risk in an industry where nothing is certain. Karoon’s unsuccessful foray into the Gippsland Basin bears testament to that, but it’s a gamble worth taking according to Smith. “The overall strategy is to have the best quality technical assessment you can make, with the best people. My philosophy is to surround myself with smart people, and then you can take calculated risks on things that can really make a company grow. It’s a case of what you do is what you get. As a small company you could go and look for 1.5 MMbbl projects in the Cooper Basin for example. Although you could still make money, you make a discovery, production goes up, and then two years later it goes ‘pffft’, and there’s nothing left. You’ve got to go do it again and again. The share price goes up and then it plateaus with no big upside”, he said.

It is paradoxical that while Karoon is taking off, the wise heads in charge are keeping their feet firmly on the ground. A comprehensive spread of market nous increases the ‘calculated’ component of the company’s risks, whilst reducing the risk itself.

Smith and Hosking are flanked by experienced personnel such as Engineering Manager, Lino Barro, with 28 years experience in reservoir and development engineering with Delhi, BHPB and Kufpec. Geophysics Manager, Jorg Bein, spent 36 years as a geophysicist and manager with Exxon and BHPB and David Ormerod, New Ventures Manager spent 20 years with BHPB, Woodside and Tap. That such talent was available to Karoon is a result of an industry where the streamlining of human resources comes at the expense of knowledge and skill.

“Karoon’s really a product of the ‘dumb-sizing’ of all the majors. It’s ludicrous. It was all a numbers game with seemingly no consideration for the future or appreciation of the talent being disposed of. I was at BHP for 18 years and survived about six or seven redundancy rounds, then I got ‘liberated’ in the end”, said Smith.

It seems the majors’ loss is Karoon’s gain, particularly when analysing the remarkable success it’s had in its commercial and financial operations. Karoon’s resources include approximately $121 MM in cash, 132 MM fully paid shares issued and a market capitalisation of approximately $400 MM. A recent share placement raised a total of $51.06 MM. In addition to this placement, 1.875 MM of its shares were sold by Karoon directors to exercise a total of 2.25 MM incentive options. The capital raising gives it the flexibility to continue its exploration program in the Browse Basin.

With Bob Hosking’s commercial background, Karoon is very attuned to the fundraising activity so crucial to small oil and gas companies. Karoon’s revenue raising is part of a concerted push to target ‘sophisticated and professional’ investors, which provide stability in periods of economic uncertainty and market ‘jitters’. Talbot Group Holdings invested $26.4 MM into Karoon, subscribing for 12 MM shares at $2.20 a share as part of ‘Coal King’ Ken Talbot’s diversification of personal holdings. Smith believes Talbot fits Karoon’s investor profile. “We’re looking for more sophisticated longer term players”, he said.

Karoon’s long term vision took further shape recently with the acquisition of significant acreage in Brazil’s Santos Basin. The five blocks, 1037, 1101, 1102, 1165 and 1166, are considered to lie in a hydrocarbon prospective neighbourhood, with potential for multiple hundred MMbbl of oil and multiple Tcf of gas. Infrastructure exists nearby, with Karoon’s blocks situated between the Caravela field 100 km southwest and the Merluza field 100 km northeast.

The proximity of the permit to the Tupi field, just recently discovered by Brazil’s state owned oil company, Petrolio Brasilio (Petrobras), is most exciting, according to Smith. The find has caused a substantial re-rating of Brazil’s exploration potential, and is the second largest resource to be discovered anywhere in the world in the last 30 years. Well tests in November indicate that the Tupi field could contain up to 8 Bbbbl of oil, which would be a 62% increase on the nation’s currently defined reserves, and will put that discovery alone on par with Norway’s 8.5 Bbbbl of proved reserves.

“The timing’s very good. We’re not saying our play is directly analogous to Tupi but it certainly highlights how productive that basin is. We’ve five blocks at 100%. They’re not big, they’re about 170 km2 each, but they’re contiguous.”

Many in the oil and gas industry are surprised a company of Karoon’s size was able to secure acreage in such a hot area. Smith believes the expertise of Karoon’s personnel enabled them to compete successfully with the big boys. “We’ve already got legal representation helping us through the bidding process and ongoing legal work, so we’re setting up the right infrastructure legally and technically. We have South American consultants that have been advising us.”

“We spent a lot of time examining bidding histories. In the Santos Basin there’s a lot of small blocks, particularly in the shallow shelf area where we are. Analyse those and you get a feel for how many are competitively bid, by whom and how successfully. So its not just a matter of doing the geoscience, you’ve got to integrate it with the commercial and the legal sides as well. So again it’s that principal that we’ve got these ideas but let’s get hold of the people with the expertise to help us to secure the asset the best way”, he said.
While involvement in Santos Basin exploration is a sensational achievement for Karoon, Smith recognises they are still in a different league to the likes of PetroBras. “We are looking at 300-400 m water depth in our five blocks. Karoon, with its short history, didn’t qualify for the deep water acreage, because under Brazilian rules there’s particular operational requirements that bidding companies need to meet. Out where the Tupi field is it’s 1200-2000 m water depth, so that’s not a game we can play as an operator”, he said.

“At some point we’ll farm out and the timing of that will depend on the nature of discussions we’ll have with interested parties. We did the geoscience and de-risked it by acquiring 3D, and the further down the path we get, while we’re taking the risks, the better leverage we’ll get. It’s a fairly simple principal, but if somebody comes in with an amazing offer with broader implications, then we listen to that as well”, Smith said.

Going forward Karoon does not plan to rest on its laurels. “We’re looking for opportunities we can grow, and we don’t mind taking risks moving to countries that have a slightly higher political risk, like Brazil. There are other countries out there where the personal and political risks are too high and you leave them alone. Our feeling is that South America is a little bit easier to deal with culturally. If you’re looking at a country where the board’s not comfortable having people there, and you can’t walk in there to look at your asset, you don’t want to be there”, Smith said.

“The Santos Basin gives the portfolio balance. It’s got some very big upside, and it can happen a bit quicker, so if you look at potential news-flow or significant events in Karoon in total, we were basically populating the timeline with different events that overall balance it up.”

For now, Karoon’s Browse operations form the core of the business. Its northwest acreage has extended, too, with the November acquisition from Woodside of Bonaparte Basin permit AC/P8. 3D seismic in WA-398-P has commenced, completion of which is expected in the first quarter of 2008. The survey includes 1,400 km2 in WA-398-P with a further 500 km2 outside the permit.

The joint venture has also secured the SEDCO 703 rig, with drilling expected to begin in blocks WA-314-P, WA-315-P and WA-398-P later this year. “I see seven months of drilling on the range of prospects available. I never like one prospect/one deal, because it’s all hanging on one risk event. But when you’ve got three or four wells, when you play the probability game, you could have an 80% plus chance of one of them working.”

While the industry analysts scratch their heads at Karoon’s accomplishments, Mark Smith believes it’s that philosophy of playing the odds, measuring the risk and sound strategy, that has served Karoon so well in its formative stages. “Karoon has often been perceived as this one hit wonder, you know. Every company has its critics and they said, ‘Oh, they lucked out there in the Browse and lucked out when you farmed out.’ The question every time you get more acreage or do a deal is, ‘Why us now’? It’s kind of that winner’s curse consideration where you stand there with your acreage and ask, ‘I’ve got this, why hasn’t anyone else beaten me’? When you have the right people and processes these doubts are greatly diminished.’”

“We don’t have plans for massive expansion, it’s just strategic, careful expansion, which is how we’ve gone along the way.”