Over the last few posts I have been building an argument regarding what the BRK reserve position in the SWISH acreage is on a true WI level .
Based on that I will try to outline what I think BRK will be doing over the next 12-24 months in terms of the SWISH AOI. Though there will be numbers and $ valuations involved, they will almost certainly be wrong but IMO ball park accurate in terms of magnitude. It is the process and concepts behind the argument which I am confident will be fairly close to the mark.
I assume most acknowledge by now that BRK are a unique Aussie E&P company which require a different approach in trying to understand how to appreciate and value what they are doing right now, and what they will be doing in the future. The best way to understand and value the company is to look at it's asset base, namely the PUD reserves held on it's operated SWISH acreage, rather than just it's production that the company generates from the reserves on the same land position. As mentioned previously, to be able to prove up PUD reserves , a horizontal fracked well needs to be drilled and placed on production on a DSU, to get that acreage covered by the DSU, and all the contained reserves Held By Production.
By the end of 2022, all 3 BRK operated DSU's , barring unforeseen circumstances will have a Sycamore formation producing well which will facilitate the reserves held within both the Sycamore and Woodford formations to be HBP, which will allow those reserves to be booked by BRK. The funding of the Rangers and Flames wells will be through the cash already raised, the $15 million from in the money option conversions and production cashflow. When all 3 wells are online , BRK will also benefit from a significant production revenue from ~2800 BOEPD, but which will be subject to a significant decline rate. I have shown in previous posts why I believe BRK hold ~27 million BOE of reserves net to their average WI across the 3 DSU's as per the 90% BRK guided in the initial November 2020 resource report. The actual Jewell WI is 84%, and we as yet don't know what the final % will be for the Rangers and Flames until after those DSU's are pooled. So all calculations will be based on a 90% WI level for now.
Note, I will also exclude the reserve held within the new 320 acre Rangers extension DSU, but the net result of that is an increase in reserves of 13% across the SWISH portfolio, which in simple terms will mean the BRK reserve position will also be 13% higher. Also note the division between the Sycamore / Woodford reserves is approximately 50/50.
I will use a undiscounted NPV value of US$15 a barrel per BOE, being roughly 30% of the US$55 per BOE price BRK are currently receiving as shown in previous posts.
The argument:
Once the 27 MMBOE reserves attributable to the BRK WI are HBP, BRK do not have any more drilling requirements as those reserves are held for as long as the wells are in production, which is typically 25-35 years. This allows BRK to determine how they wish to proceed with the monetisation of those assets without any drilling funding pressure. The company has guided that full development of the SWISH will require 7 Sycamore wells, and 14 Woodford wells. BRK have stated any monetisation will proceed on the basis of what will give the best return to shareholders at the time.
In previous posts, based on the knowledge that BRK do not drill wells for production as such, that each well costs ~AUD $ 10 million to drill which would require an ~AUD$180 million investment IMO we can excluded the option of BRK being involved in drilling ALL the 18 development wells outside the initial well in each DSU. However, as the high rate of return and rapid payback currently exists on wells drilled into the Sycamore formation, it appears the company may be keen to keep their interest in the Sycamore zone , develop those reserves , and sell the PUD reserves in the Woodford zone.
How can we be confident BRK will be successful in selling the Woodford reserves without too much difficulty?
Typically, a US private equity sale of PUD reserves to a major involves selling the reserves at a material discount to the NPV, up to 30%. The major attraction for the buyer is when they purchase those reserves at say the 30% discount , they actually book those reserves at the NPV value, which when those reserves and resultant value is added to their reserve based lending account has two immediate positive outcomes. Firstly , it improves their loan LVR and secondly, it creates an immediate book value "profit " due to the 30% margin.
In that context, IMO, sometime in 2023 we will be looking at a situation where BRK will sell the ~ 13-14 MMBOE PUD reserves in the Woodford zone, almost certainly to a larger producer in the area with the most obvious candidate, Continental resources. They are the Woodford producing specialist in the region. At a undiscounted value of US$15 a BOE, that would make the Woodford PUD reserves worth ~ US$180 million dollars. However, depending on the NPV discount, the purchaser will pay between US$ 125-US$145 million, thereby booking a " profit " on the transaction of US$35-55 million dollars.... the " incentive".
If BRK collect US$ 135, we still have to take into account the Black Mesa 25% back in , which kicks in after BRK recoup all their costs associated with the SWISH acreage. If we assume BRK were still " owed" US$15 million for all the SWISH leasing, legal, GG&A , Jewell, Rangers and Flames drilling costs and taking cashflow into from the wells into consideration , that leaves US$ 120 million in the pot for Black Mesa to receive their 25% cut ( US$30 million).
Royalties are paid on production, so there is no subtraction of 20% on the sale proceeds, and are considered in the NPV value of the reserves There are company taxes to pay but BRK hold considerable tax losses carried over from the RFE days and should be able ( hopefully ) to offset any tax payable. The above workout is the reason why I had to convert the 11.6 MMBOE " economic" reserve into the ~27 MMBOE WI reserve, otherwise it would have been impossible to do the exercise.
So BRK in the above scenario should be able to bank US$105 million, with Black Mesa banking US$30 million.
With the BM shareholding being 50% BRK, and 50% BM executive team, you would expect most of that US$ 30 million being distributed to shareholders. This is how the Black Mesa executive team get rewarded for all their outstanding work in generating, developing and operating the assets they bring to the BRK table. A very clever incentivisation process that ensures only the highest quality assets come into the BRK fold.
In regards to any distribution from Black mesa, BRK actually get the first US$ 1.2 million stemming from the original total US$ 3 million seed investment by BRK and other investors ( Funding equity) . As per the WI back in on assets, BRK recoup their seed investment before the BM executives receive their share of any distribution . The original funding investors ( excluding BRK) were bought out during the GFC which resulted in BRK gaining its 50%. This means BRK on any distribution from BM , get the first US$1.2 million plus 50% of any distribution after that. So if Black Mesa had US$28.8 million to distribute and decided to keep US$3.8 million , BRK would receive US$ 1.2 million plus US$ 12.5 million or US$13.7 million, in addition to the US$ 105 million it banked in the sale for a total of ~US$119 million.
What will BRK do with that cash pile?
If BRK were as expected, to keep it's interest in the 3 Sycamore producing wells, and associated PUD's it would have to fund 3-4 wells to develop the remaining ~7 MMBOE PUD reserves ( assuming each original well had 2 MMBOE PDP reserves). This drilling program would cost ~US$30-40 million and that would give BRK, Sycamore production from 6-7 wells with a WI of 42% for Jewell, and 80-90% in the rest. What the BRK production profile at the mid of 2024 would look like under this scenario would obviously depend on the pace of drilling and well results. With a Jewell type result for the initial DSU wells, and a baseline production rate for the other 3-4 ,even with the modelled steep declines,a 6-7 well Sycamore portfolio should be producing ~ 6000-7000 + BOEPD net to BRK with the company holding ~US$80-90 million in the bank , before taking any free cashflow into account.
In regards to the remaining SWISH operated DSU reserves, (remembering they are net to BRK at the 90%WI would be after production from the Jewell and its 42% interest in that well) BRK would have ~ 4.2 MMBOE PDP reserves and 7 MMBOE PUD reserves .
Such a cash pile and significant cashflow will allow the company to return a significant portion of the cash to shareholders as a capital return, say US$ 60 million leaving US$20-30 million + cashflow to fund future operations.
What will those future operations be?
That will be acquiring further prime undeveloped acreage along the oil and rich gas trend along the Anadarko basin, or other similar basins to repeat the exercise. The main difference being where initially BRK were capital constrained, thereby missing out on acquiring the 8 + operated SWISH DSU's they had lined up for a net 8000 acre position... as per the Oct 31 2018 quarterly report below
This time BRK will have more than enough capital to peruse a much larger acreage position. Had BRK managed to achieve the above 8-9 DSU , 8000 operated acres as originally planned, we would be talking about 80 + million BOE under the bonnet. That is the size of the prize we had to let go. It will not be easy to pick up that acreage, but remember when it comes to pooling, you only need ~30 % of the acreage in each potential DSU to be in a good position to apply for the DSU, and win operations which then gives you the right to pool and attain the 80-90% WI .
If there is to be a share consolidation, the time to do it would be after any such significant sale of the PUD reserve.
The 5 billion SOI could consolidate to 500 million shares , the company would have a significant cash backing , significant free cashflow and just as importantly, a reputation in the Oklahoma oil patch that would have other companies approaching them with opportunities.
Sure this sounds hypothetical, but as the team alluded to in the Spark interview, they know where they are headed in the next 12 -24 months, and it is not just about drilling a few wells... or as @TheProfessional so aptly puts it, something about spiders.
What can go wrong?
Well, a share price collapse to get the oppies out of the money will put a break on the Flames well. A technical problem with the Rangers causing a cost blow out won't be good. Conflict with China , a major share market crash or oil/ gas price collapse and anti hydrocarbon US legislation all would be deleterious . The only thing that is certain is that nothing is certain.
Hopefully the above makes some sense, has highlighted some of real value of the BRK asset base and is the reasoning behind why personally I am so very optimistic about the future direction and prospects of BRK.
cheers
Dan
BRK Price at posting:
2.3¢ Sentiment: Buy Disclosure: Held
(20min delay)