[click graphic to enlarge]Europe’s dependence on Russia for it’s natural supplies has in recent weeks been highlighted in light ongoing dispute between Russia and Ukraine over gas pricing. In anticipation of European utilities and gas providers turning to additional sources of natural gas supply, Sterling Resources seem ideally positioned to deliver on this prospect. Pierce writes “The company has net best estimate contingent P50 resources of 94 bcf in the Doina development offshore Romania and net best estimate P50 resources of 263 bcf in the Breagh Field in the UK North Sea.” Sterling’s assets, while in need of further development, should in Pierce’s opinion, command a premium in the market place. Furthermore, there is significant exploration potential in Sterling’s asset base and thus opportunities to expand its resource base.
Sterling and its partners are currently in the process on appraising the Breagh fields. Pierce writes “Testing has commenced on the recently drilled 1200 foot horizontal section into the West Breagh well and results are expected in ~2 weeks. The test results of the appraisal well on West Breagh will help the partnership determine potential production parameters. We understand the partnership is looking for a rate in excess of 30 mmcf/d if the total sand interval is tested. With the test results Sterling and its partners will be in a position to monetize either a portion or all of Breagh.”
In December 2008, Sterling announced that it had farmed out 50% of its 65% offshore Romanian interest to Melrose Resources plc in exchange for an initial payment of US $12-million which will be made to Sterling on closing the deal (Pierce expects this to happen in Q1/09) and a further US $12-million will be paid at the time of the Doina area development project sanction or one year from the date of closing, whichever is earlier. Melrose will also carry Sterling for a proportion of their future development costs. The amount of the cost carry will be between US $58-million and US $72.7-million, depending on the gas price achieved for the development project, ensuring Sterling is carried for development activity into 2011. Sterling will retain a 32.5% working interest in the Pelican and Midia Blocks. Pierce considers this a “clearly positive” transaction as it “implies its remaining interest in its Romanian offshore assets is worth at least C$0.71/sh.”
Pierce opines that Sterling is trading at 24% of the company’s break-up value using current transaction metrics (see figure below).
[click graphic to enlarge]He believes that much of the discount is unwarranted because:
1. Non Distressed Sales of Gas Assets Still Relatively Robust
The recent transaction by which Bow Valley got rid of its Peik Field to Centrica implied a “transaction metric of US$2.17/boe. This distressed sale was at the bottom end of the range for undeveloped assets and clearly reflected the difficult position Bow Valley found itself in.” Given the large size of Sterling’s Breagh and Doina prospects, higher working interest positions and operatorship and as mentioned earlier and the need for European gas providers to procure resources outside Russia means that” Sterling could realize selling its assets would be much higher than we have used in our calculations above (See figure above).
2. In addition to the US $12-million that is due from Melrose Resources plc, Sterling has an agreement under which it may call for a further US $8-million of additional funding in the form of a "top up facility" with Jersey based Gemini Oil and Gas Fund II, L.P., as a supplement to the existing loan agreement with Sterling's UK subsidiary. Furthermore, the company has deferred drilling on its promising Airdh and Midia SE exploration wells, is looking at farming out a portion of its UK offshore assets, including Breagh, and has put up its UK onshore and French assets up for sale.
Catalysts Over The Next 12 Months
- Results from the testing of West Breagh horizontal well are expected within the next week to 10 days. Pierce writes “The partners are hoping for a test of 30 mmcf/d+ which if achieved would significantly reduce the capital requirements to develop the field.”
- The announcement of a sale or farm-out of a portion of Breagh, similar to what was done with Sterling’s Romanian assets and the arrangement with Melrose Resources plc. Pierce expects news to this effect before the end of Q1/09.
- Testing of flow rates at the Cladhan prospect and an additional appraisal well or sidetrack, which is expected to occur toward the middle of 2009.
- Sale of its onshore UK and onshore French assets. The sale should further bolster Sterling’s balance sheet and reduce some of the company’s capital commitment in the future.
- Exploration well on the Midia SE offshore prospect. Price writes “A successful well (fully carried by partners) is due to be drilled prior to year-end and would be worth C$0.23/sh unrisked.”
Valuation
[click graphic to enlarge]Assuming US$50/b oil and US$7.00 mmbtu, Pierce comes up with a core NAV of C$1.86/sh based on C$0.20/sh in cash and C$1.71/sh in undeveloped assets which are made up of primarily Breagh, Cladhan, and Doina. Pierce pegs a C$2.30/sh target price on Sterling Resources.
Disclosure: I own Sterling Resources.
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