euroz update

Price Target: $1.47/sh
Investment Case:
Over the past 6 months RFE has achieved significant improvements to spud to first sales cycle times. Additionally, non-operated activity, in both the Mississippi Lime and underlying Woodford Shale, has increased substantially. This brings forward cash flow and maintain well capex at the low end of guidance, but also accelerate sdevelopment capital spend in the short term. The proposed A$47.7m capital raising complements the Company’s low cost, US$100m facility, enabling RFE to effectively leverage its strong debt-cash funding position and sound capital management to deliver excellent shareholder returns. The A$0.43/sh issue price is compelling given the layered upside via: Full field development; evolution of the Woodford Shale potential; and on-going optimisation and deliverability improvement through incorporation of industry technical advances. Buy.
Key Points:
• RFE is seeking to raise ~A$47.7m @ $0.43/sh through a placement of 111 million shares, via a two tranche placement.
• The need for additional working capital is borne largely out of the accelerated pace of development as a consequence of the significant operational efficiencies (in terms of spud-to-first-sales cycle times) achieved by RFE’s operations team over the past 6mnths.
• The funds will provide additional funding flexibility to complement the Company’s low cost (3.25%) US$100m RBL finance facility.
• The Company will also make a small acquisition of acreage (~2,000 net) in Noble County to give RFE a controlling interest in a number of additional sections adjacent to some of the Company’s best reported results to date.
• Cash of approximately US$57m post placement, available facilities of US$20m and debt of US$25m.
• Our valuation remains at $1.47/sh, accounting for dilution, EZL est. of hedging and incorporating the new acreage.
• Production (circa 2,200boepd gross) is twice the exit rate at the first re- determination on Dec 31, 2012.
Analysis:
RFE is seeking to raise ~A$47.7m @ $0.43/sh via a placement of 111 million shares to be quoted on the ASX.
Placement is via two tranches:
• Tranche 1 of 58m shares for A$24.9m under the Company’s 15% placement capacity;
• Tranche 2 of 53m shares for A$22.8m subject to shareholder approval

USE OF FUNDS
Funds will be applied to progress RFE’s oil prone Mississippian assets.
1. Fund accelerated development of the Mississippi assets as a function of:
a. Reduced spud-to-first sales times (nearing 45days per well on av.) realising improved efficiencies of 14 wells per rig per year driving an annual gross development rate of 56wells/yr
b. Increasing non-op Mississippi Lime and Woodford Shale development, particularly by Devon Energy (DVN)
2. Fund a small acquisition of Mississippian acreage complementary to RFE’s existing operated interests in Noble County.
a. This 2,000 net acre acquisition provides additional acreage effectively resulting in RFE gaining a controlling interest around the Lake McMurtry area, where to date RFE has had some of its best results.
b. Continue incremental lease acquisition via forced pooling and private landholder negotiation.
3. Fund working capital to supplement its RBL facility, particularly whilst the Company undertakes redetermination of its reserves in order to increase the availability of its US$100m facility.
EUROZ VALUATION
Our valuation is now $1.47/sh, after incorporating the new net wells attributable to the acquisition, our estimate of the required hedging and the dilution (and associated cash) due to the capital raising. We had previously forecast RFE to require US$80m in debt funding in order to realise positive operating cashflow. As a consequence of the proceeds from this issue, we have lowered our expected debt requirement to US$55m (US$25m currently drawn).
IMPACT TO PRODUCTION
We estimate that at the current pace of development in the Mississippi Lime, RFE will exit CY’13 at circa 2,800boepd net (post-royalties) vs ~670boepd (post-royalty) as at Dec 31, 2012.
Highlighting that we assess total gross production of circa 35kbboe in the first 12mnths from our type Mississippi Lime well, we see risk to the upside as a function of:
1. Exceeding the 40 gross wells we forecast RFE will participate in this CY;
2. Further improvements to that already witnessed from completions optimisation;
3. Introduction of new intellectual property via Jointventure with industry leaders, such as Devon Energy; and
4. The expanding, non-op Mississippi Lime and Woodford Shale wells and Wattenberg programmes.
Continued acceleration into CY’14, with a further 56 gross wells likely, has the Company exiting the year at over 5,000boepd (net after royalties) on our forecast.

Significant value has clearly been added through the drill-bit in the 5 months to May 31, with the PV10 of the Company’s 1P reserves increasing to US$144m vs its EV of $190m.
That is, very little value is being ascribed to the Company’s increasing 2P and 3P reserves position which are arguably being derisked by the current development spread across all its acreage, designed to HBP. Lee Keeling and Assoc. assess the value of RFE’s 3P and 1C Resource at US$600m (vs EV of ~$190m).
The relative underperformance of RFE to its peers is evidenced when putting the 1P PV10 into context with its peers:

Notably SEA’s current 1P PV10 is US$160m (EV circa of $330m);
• AUT with 1P PV10 of US$1Bn (EV of $1.9Bn).
The Company is completing behind drilling and this, combined with improvements to completions design and reservoir management, is seeing sizeable increases in production rate, month-on-month. The current gross production rate of ~2,200boepd is double the Dec’12 exit.
With the perceived funding overhang now cleared, RFE should trade up towards its peers with market recognising the operational performance and funded growth profile.
NON-OP ACTIVITY INCREASING
RFE recently reported being notified of non-op participation in at least 12 wells with DVN this CY. In addition, it expects to continue to participate in development activity with operators such as Petroquest (which achieved ~600boepd 30-day IP for Lynn- 1H: RFE ~12.5% non-op interest), Calyx and Range.
We see significant improvement to RFE’s operated results as function of participation in non-op activity through cross pollination of industry learning.
As an example, the recent DVN Mar Q’ly conference call, highlighted that the Company has recently consistently delivered IPs of 600-1,100bbls of oil (plus NGL rich gas) from its recent Mississippi programme, focused in acreage coincident with RFE.
RFE – where pooled with DVN – has the opportunity to review DVN’s operational techniques (for it is in DVN’s interests ie, where RFE operate on their behalf) and we expect some of these key learnings to be applied immediately to the current programme.
We watch the results from June (Jekyll and Hyde – 1H et al) with interest on this basis.
IMPACT TO FUNDING
Total liquidity of circa +US$130m vs est capex of ~US$90m in FY’14 on this basis, provides a substantial funding buffer.
The Company’s cash position increases to ~US$57m.
The current development programme, should realise circa US$47m in EBITDA in FY’14 on our commodity price assumptions (WTI oil - US$95/bbl and gas US$3.06/mcf). The current run-rate into FY’15, would result in EBITDA generation of US$118m (on WTI av. of US$97.5/bbl).

Current debt is ~US$25m, with a further US$20 undrawn of a total facility of US$100m. We forecast RFE will increase availability to US$80m by CY’13 end and that this will be partially drawn to US$55m by end FY’14 on the current assumed development pace.
Availability should increase with development and corresponding reserve growth.
The hedging – we believe will be fixed at around 600bopd – provides certainty of ~US$20m in revenue. Whilst this will likely become a minor proportion of total production and revenue in time, this is a sensible move by the Company, so as to protect its balance sheet in the event of commodity price weakness, particularly in this early phase of development ramp up.
IMPACT TO MISSISSIPPI LIME WELL ECONOMICS
We are realising a significant improvement to our original Mississippi Lime type well NPV as a consequence of the lower well costs and improving initial production rates being realised by greater operational efficiency in the recent development programme ie the last 6mnts. This is being enhanced by good reservoir management and the currently high prevailing oil price.
Our Mississippi Lime type well assumes a gross EUR of 234kbboe (78% oil) over 20yrs of production, though we only model the first 11yrs of production for valuation purposes.
At our original assumptions of US$100/bbl oil price and US$4.37/mcf rich gas price received, generated an after capex, pre-tax NPV (after royalties) of US$3.2m/well.
This results in a pre-tax IRR of 36% and operating netback of US$46.42/boe, NPAT of US$20.49/boe.

Recycle Rate - A key metric that we assess to a valid measure of the economic potential of a resource play is the ‘Recycle Rate’ or ‘Profitability Ratio’. We express it as the Pre- tax Recycle Ratio or ‘PTRR’. On our assessment, this is the measure of the ability and thus capacity of a single well to fund further development. This essentially captures the ‘multiplier effect’ ie, after funding the first well, the capex is recovered over a period (av. 18mnths in the case of our RFE Mississippi Lime type well), and the cash after capex is sufficient to fund x new wells. Which in turn (and now fully funded) can themselves fund new wells and so on. This is a powerful concept for what are otherwise developments requiring 100’s to 1000’s of wells.
Our analysis suggests that post initial funding injection,a typical RFE well can fund an additional 2.0 new wells @US$3.5m/well over the type well’s 20yrs of production. More importantly, it can fund 1.4 wells after the first 5yrs; and 0.85 new wells after 2years.
Upside to Economics - The leverage potential is highlighted that by reducing well capex to US$3m (in line with current results) our NPV increases to US$3.7m/well and Recycle Ration improves to 2.4 times:

We see significant additional upside through improvement to productivity. We note that DVN has recently consistently achieved 30-day IPs of 600-1,100bopd of just oil (Devon Energy, Q1 2013 Earnings Call). Retaining our current decline curve parameter but incorporating (what is an effective) a +300% uplift to our oil IP, our well economics improve to an IRR of 155% on US$17 mafter capex NPV; There is also a dramatic increase to the Recycle Ratio to 6.5 times.

Economic Breakeven - We assess our breakeven oil price to be US$55/bbl (vs WTI of
+US$100/bbl currently) with a fixed gas price of US$3/mcf:
1) Full Field Development
Our Mississippian development only considers development of the Lime over RFE’s ~77,000net acres. At 3 wells per 640 acre pooling unit to HBP acreage under Oklahoma State regulations, we model a 330 net (550 gross) wells drilled over the next 10yrs. We note that independent reserve engineers and industry talk to full field development comprising as many as the 5+ wells per pooling unit or +625 wells net to RFE. We do not contemplate development of the Woodford Shale in our Mississippian NPV.
2) Pace of development
We currently assume 3 rigs currently increasing to 4 in CY’14 drilling at a rate of 56 gross wells/yr to FY’23 in the Mississippian.
Upside to our valuation will be realised as production and associated operating cash flow generation supports additional drilling resources to effectively bring forward NPV.
3) Operational efficiency
Improving spud to first sales cycle times is having a dual net positive effect on valuation via lower well costs (a key sensitivity in resource oil and gas play development) and development efficiency on a well count per rig per year.
a) Cost Reduction – we understand RFE is consistently achieving b) Increased Pace of Development - Additionally, with reduced spud-to-first sales cycle times it follows that this improved drilling efficiency will enable RFE to complete more wells on an annual basis. This is accretive to NPV due to the associated cash flow being brought forward.
4) Increasing Well EUR
Reservoir management has delivered some promising early results for RFE’s Mississippian wells, with negligible rates of decline observed in the first 3 months (see Jardine and Flinders wells).
5) Reservoir Management
Early production improvements following modified completion design and load water recovery, can allude to enhanced reservoir recovery over well life. This improves field recovery factors; this is significant when considering industry determines that the likely recovery factors pertaining to tight reservoirs are as low as 1% and likely no more that 5% in the Lime (vs conventional reservoirs which are typically 30-40%).
Therefore, an improvement in EUR per well can have significant impact to field economics when considering the in-situ volumes.
6) Well Spacing
Clearly field recovery factors will be improve on tighter development spacing.
7) Additional Plays
The Woodford Shale - as the underlying source rock for the Mississippi Lime play – is an emerging development in its own right. RFE have recently spudded a Woodford well with Devon (operator) with encouraging results. Devon, has drilled a number of Woodford tests, and has achieved several results north of 500boepd (+80% oil) as a 30-day IP. The play looks highly prospective noting well capex should be very similar to the Mississippi lime development.
8) Higher Commodity Prices
We assume that Henry Hub gas prices remain relatively flat over the life of the assets. Similarly, we maintain a flat oil price forecast at US$100/bbl from FY’15, and assume US$97.50/bbl in FY’14.
Due to the dynamic nature of the US onshore E&P industry and pipeline network as well as good strategic commercial negotiation, we have already witnessed operators seeking to access the higher ‘Louisiana Light Sweet’ benchmark price (circa US$10/ bbl premium to spot WTI) via new rail takeaway capacity accessing existing Gulf Coast and emerging east coast and potentially canadian refining capacity.
Considerable upside to projected cash flows will be realised should this continue and/or oil and gas prices escalate.
9) Lower A$ Currency
A falling Australian Dollar will enhance valuation.
RISKS
Commodity Price - The key risks to our valuation lie with predominantly commodity price outlooks. We maintain a long-term oil price forecast of US$100/bbl and a Henry Hub gas price of US$3/mcf with a 1% per annum contango. Whilst the evolution of the onshore mid-continent resource oil and gas development has seen a significant increase to US production (up to 10% of total US daily output) we do not foresee long term sustained price destruction as a consequence. This is borne out of our view that the human, drilling, service and infrastructure capital required to maintain this rate of growth cannot ultimately outpace or even keep pace with the inherent high rates of natural decline witnessed in these reservoirs.
Refining bottlenecks may occur (as has been witnessed already at Cushing) from time to time to create short term price weakness. However, we highlight prompt reaction by industry to construct infrastructure, increase rail borne crude export and reconfiguration of east coast refining capacity to receive light sweet crude (in preference to the heavier Middle Eastern grades) to meet this oversupply; this is unique feature of the US market (http://www.bloomberg.com/news/2013-07-01/ brent-wti-oil-spread-shrinks-to-5-for-first-time-in-2-1-2-years.html).
The need for the US to limit significant price escalation to avoid deleterious impacts to economic recovery, should see prices contained long term, as per our forecast.
Furthermore, RFE is currently negotiating with its financiers to hedge a portion of its crude production. This will provide reasonable security in the event of commodity price weakness.
Operational execution - As a function of Company proficiency, variation in asset quality (as a function of the usual petrophysical variations expected within reservoirs) and/or access to services may also impact forecasts in terms of production and thus cashflow.
Though we stress, that the nature of RFE’s current development programme – designed to hold its acreage by production – has resulted in penetrations across the Company’s full 75knet Mississippian acreage position. As a consequence, drilling to date, combined with extensive historical vertical and non-op horizontal drilling has demonstrated the relative homogeneity of the reservoir as well as the operational competence of the Company.
Market Risk - General market risk.
INVESTMENT CASE
RFE continues to demonstrate a systematic approach in developing a high yielding, scalable oil dominated production asset that offers substantial upside potential via on-going completions optimisation, technological advances (realised via JV activity) and maturation of the underlying Woodford Shale. Recent evidence of the Company’s operational acumen, highlights the leverage potential of the Mississippi Lime asset as well as the emerging potential of the Woodford Shale. The additional funding, combined with the accelerated cashflows realised from an increasing pace of development will further enhance Management’s capacity to implement its growth strategy via operational and corporate execution. With the perceived funding overhang now cleared, RFE should trade up towards its peers.