bell potter target .87

Initiating Coverage - Carnarvon Petroleum (CVN.AX - A$0.41) Target: A$0.87

Current net oil production of 4,000bopd to rise 50% in the next 6 months



Carnarvon Petroleum is a significant oil producer onshore Thailand, with excellent prospects to expand production from a growing reserve base. The operating environment is good, with low capital and operating costs, and a reasonable fiscal regime. Even with strong re-investment in further drilling, the company generates excess cash flow, particularly at current high oil prices around US$125 a barrel. We value the company at $0.87 a share and forecast the company’s PE ratios at 6 - 4x for the next three years. Bell Potter initiates research coverage on CVN with a Buy recommendation. CVN is generating very strong cash flow thanks to the low capex and opex environment onshore Thailand. At a cost of about US$1m per well, payback is less than a month. Asset quality improved dramatically 18 months ago, with the discovery of oil in fractured volcanic reservoirs, generating flow rates up to 4,000 barrels of oil per day (bopd) compared to 100-200 bopd from the sandstone reservoirs exploited in prior years. Cash flow is re-invested into drilling more wells, which is expected to significantly lift production in the next six months, to 15,000bopd gross (6,000bopd net to CVN). The identified contingent resource potential is in excess of 200m barrels gross, or 90m barrels net, compared to current 2P reserves of only 11.4m barrels net to CVN. The joint venture has two rigs under contract and is negotiating for a third rig. The continuous drilling program should see 20-30 wells drilled per annum, with a number of low risk prospects within the large license areas. CVN management is experienced, and focused on keeping overheads to a minimum. The operator of the joint venture is Pan Orient Energy, a Canadian company with good alignment of interests, as the Thai oil fields are both companies’ major asset. Our base valuation of CVN is dominated by four producing oil fields north of Bangkok, comprising $0.62 of value. This DCF valuation is based on oil prices staying firm over the next three years and then declining to US$96 by 2012. Due to the fiscal regime in Thailand, the valuation is not particularly leveraged to oil prices. A more relevant sensitivity is to increased reserves, whereby a 10m barrel increase in net reserves would be worth about $0.20 a share. CVN holds 40% of licenses L44/43 and L33/43, covering the entire Phetchabun basin, with four oil fields and one gas discovery made to date in L44/43. Exploration drilling has just commenced in L33/43, with a three well program underway. We initiate research coverage on CVN with a Buy recommendation. We are attracted to the established production base in a low cost environment, where surplus cash flow provides strong capability to expand production, and excellent growth potential in a focused area. Good, sensible management adds to the appeal of CVN.