my view, from exile

Hello all,

So, any news? ;)

My timing seems to have been impeccably bad. I head off on holidays, and a 'deal' is announced the next trading day.

Sorry, I wasn't intending to say anything on HC for the next month, but given the importance of these events, I think it is only reasonable that I put in my two cents worth.

RISK/REWARD:

Okay, some people are angry about the price (fair enough too), and some will think this is only the beginning. So, let's think about this buy/sell/hold decision from a purely risk/reward perspective. IF this Scheme of Arrangement, as announced, is the end of the ESG story, the buying at the current time has little downside risk - the share price is supported by the equivalent Santos scrip price, so the downside is limited. IF, however, this is just the beginning of a multi-party process, then buying now offers excellent upside, in a short space of time, with little downside.

That is why I bought more ESG, at 86 and 89.5, subsequent to the bid. It is an excellent risk/reward. And, as you all know, I have been forecasting a contested auction right from the start.

IF MY TIMING WAS POOR, THEN ESG'S WAS WORSE!

Okay, so ESG have deferred doing a reserves upgrade for some time, despite having done more testing of the Bohena and Namoi seams, despite having done a heap of coreholes extending the size of the field, and despite considerable progress on the market side of the reserves equation (not to mention the recdent massive changes to the gas-fired power market due to the carbon tax). And after an 18 month wait, just before this long-awaited upgrade, ESG agree to a Scheme of Arrangement at a low price and modest metric. How low will this metric be considered AFTER the reserves upgrade?

So, don't get angry. Get suspicious! This is not the price at which ESG is selling themselves. No way.

ARE ESG AND SANTOS WORKING TOGETHER?

This 'deal' reeks of cooperation between ESG and Santos. Santos, who have all the data, will know that there is no way ESG holders will agree to such a price. Back in July 2009, soon after the GFC, Santos bought into an $800m company at a price of $1.00 per share. For that, they got 220PJ of 2P, plus a contingent resource upside. Since then, the 2P reserves have Quadrupled (even before the coming upgrade). So, ESG sell themselves for less than the HGO transaction, when they have 4 times the proven and probable reserves?? No WAY. it isn't even plausible!

Look at it from Santos' perspective. Even if such a deal was agreed, wouldn't it be so much easier to sell to their own shareholders and analysts AFTER the upgrade? Wait a few weeks, and then the market can see what a great deal this is for Santos? And yet they didn't. And nor did ESG wait until the uplift from the reserves upgrade. That should make everyone suspicious about what is still to come... Santos and ESG know that after the reserves upgrade, the deal has to be changed. A lot.

UNCONSTRAINING THE MARKET CONSTRAINT: 2C TO 2P

We have known for some time that ESG already had the technical data to support a very large reserves upgrade - they had a large 2C resource, just constrained by the lack of a market. They just needed a market to move that large 2C across to 2P. So the potential upside in ESG's reserves growth came not from more pilot data (although that will help also), but from proving a market. That is where the upside lay.

What better way of proving a large LNG market than ESG agreeing to a Scheme of Arrangement with Santos? Far more compelling than a mere MOU, such a deal with Santos give the certifiers every reason to accept that there is a 'reasonable likelihood of the gas find a market' - GLNG - a large market, a 3rd train, at wholesale to LNG prices also. No more market constraint!

That being the case, consider just how big the ESG reserves upgrade is going to be ... that 2C resource is now unconstrained - there IS a market - so it can be upgraded to 2P!

Now, Santos of course have all the data. They know that ESG is going to do a very large reserves upgrade. And they also know that this large upgrade will make their Scheme of Arrangement hopelessly inadequate. Remembering that a reserves upgrade for ESG is also a reserves upgrade for Santos too - handy, if Santos need to convince both their shareholders and their GLNG partners that they need to pay more. Santos, too, need to find a way to get ESG share price from A to B in order to seal the transaction. And, the ultimate money comes from the Asian buyers - they need to see the reserves to sign up for the equity/offtake deals.

Agreed metric + reserves upgrade = increase in agreed price

Large Upgrade = Large Increase in Agreed Price

So, doesn't it seem as if this is all quite neat and tidy between ESG and Santos? This enables Santos to justify playing the higher price that ESG demands. All nice and cooperative...

Most of you will have stopped reading by now. Fair call. But before you start calling for the ESG's board's head, ask yourself whether all it not as it seems. What happens after the reserves upgrade. Where are Origin? Where are BG? These guys haven't shown their hands yet. But they will.

This story is FAR from over. Whatever you do, don't be one of those poor souls who sells after the first 'bid'. do not let ESG supposed agreement fool you.

Yaq (having his own 'multi-party' in the Mediterranean) :)

Sorry, but I have not been able to read your posts, nor will I be able to read any replies to this post. I will be back on deck mid August.