Australian oil and gas company Red Emperor Resources (LON:RMP) has just kicked off trading on London’s Alternative Investment Market – offering investors interesting new leverage into the exploration assets behind one of the market’s most heavily traded stocks. Red Emperor is a pure play exploration business that holds 20 percent stakes in licenses in the former Soviet state of Georgia and the Puntland region of Somalia. For those investors that have tracked and traded AIM and ASX listed Range Resources (LON:RRL) , the flotation of Red Emperor means there are now two ways of buying into the same exploration projects – though the companies themselves have wildly different valuations. With drilling in Georgia about to get under way and a well targeted to drill in Puntland in the third quarter of this year, there will be no shortage of news from Red Emperor in the coming weeks.
In London at the time of the flotation, Red Emperor’s managing director Greg Bandy and executive consultant Tony King, are in no doubt about the high risk, high reward potential of the forthcoming drilling. With an ASX listing that values the company at around A$50 million together with US$14 million cash in the bank, the company’s comparable valuation to Range is at a significant discount. While Range’s market cap of around A$410 million includes production interests in Texas, US and Trinidad, there is a significant disparity between their respective valuations based on what could come from Georgia and Puntland. Apparently, Red Emperor’s London quotation is partly an effort to rectify that inconsistency by appealing to an investor base that already understands these projects well.
In the Republic of Georgia, Red Emperor has a 20 percent working interest in onshore blocks VIa and VIb, covering around 6,500 sq km. Its partners include Range, with a 40 percent stake, and Strait Oil and Gas Ltd, also with 40 percent. Twelve months ago Range completed a 410km 2D seismic programme with independent consultants RPS Energy identifying 68 potential structures containing an estimated 2.045 billion barrels of oil-in-place. In Puntland, Red Emperor holds a 20 percent working interest in two licences covering nearly 40,000 sq km of the highly prospective Dharoor and Nugaal valleys. Its partners are Range, with 20 percent and Africa Oil Corp (TSX-V:AOI), the operator, with 60 percent. The licences have been independently assessed to potentially contain over 19.9 billion barrels of oil-in-place. Africa Oil recently signed a letter of intent with a drilling subcontractor and is aiming to drill the first well in Dharoor later this year.
Greg, Red Emperor had been trading on the ASX for some years without much success before you took control in the summer of 2010. What was going on at that time?
Greg Bandy: Red Emperor originally listed on the ASX in August 2007 under a different management team and raised about A$3.5 million. They were involved in a gold and copper project in Western Australia and they had a crack at trying to acquire a Siberian potash play and a forestry play. But they had just about run out of cash. Meanwhile Pete Landau at Range Resources introduced us to Africa Oil, which is the operator in Puntland and which was looking for a farm-in partner for 10% or 20%. So Tony flew to Singapore and met them and thrashed out a deal on what we thought were pretty attractive terms. That was when we approached Red Emperor and said: ‘Look, can we use your company to put this asset in – you hand it over and we’ll take it in a new direction?’ All that crystallised in August last year. What we inherited from the original company was Jillewarra, which is a 25% free carried interest in the gold and copper project in Western Australia but we’re not ascribing any value to it and we are not spending any money on it.
With the Puntland deal agreed and Red Emperor with a new focus, you farmed in to Range Resources’ holding in the Georgia licence earlier this year. What was behind that deal?
Greg Bandy: With Georgia that was us specifically approaching Pete Landau in December last year after their seismic had been interpreted and it all looked really, really prospective and really exciting. The market thought so as well because Range got a really good kick out of it. They were committed to carrying Strait Oil and Gas through to the completion of two wells so Range had a big commitment there and we knew that if we offered a farm-in opportunity to Pete that he would probably look to reduce his exposure. He didn’t want to reduce it too much so we took 10% off him and 10% off Strait.
Tony King: We are paying 40% to earn 20%, so we are relieving some of their burden; it was a sensible deal for them. I guess also, leading up to that, we had this company with Puntland as the only asset and we thought we needed to broaden that just a little bit. I mean this is a very high risk, high reward portfolio of two different assets but we thought two was better than one so we did want to get some further exposure. With Georgia being drilled in July we think that is going to time-in perfectly with our corporate ambitions for the company as well.
Clearly there are always going to be comparisons with Range Resources but at the moment it look like you are focused on the ‘sex and violence’ of high risk exploration drilling. Is that right?
Greg Bandy: That’s a very good description. Everyone talks about the underpinning of Range’s production assets but they are underpinning Range to the tune of maybe a third or, on a really good day, a half of their market cap. There is still nearly A$300 million of Range value out there on these two assets. We have got about A$30 million worth of value from our current market cap in here so it is too valuable to go and do anything else with it until we get some proper leverage. That is the reason why we are in London because the UK market is where Range have really got their market awareness and their recognition from.
We think that spending just over A$5 million to have a look at Georgia with these guys is a pretty good punt, given that we have got A$14 million cash in the bank. Spending A$5 million on Georgia is not going to blow us up but at the same time a discovery in Georgia is really going to put many multiples on our share price. So we have got downside protection because we have got plenty of cash in the bank but we have also got far more leverage than Range on a success case because we have got less shares on issue, we have a smaller market cap and we have got a lower base to bounce from.
The comparable valuations between Red Emperor and Range Resources are interesting. What is your assessment of that?
Greg Bandy: If you read the research note by GMP, who cover Africa Oil, they value a 20% interest in Puntland at A$350 million, which is a A$2.33 valuation on our Aussie shares, or £1.50 in UK terms. Old Park Lane Capital’s valuation is a bit less and probably the most conservative but their valuation of a 20% interest in Puntland is still five times our current market cap, as is what they value a 20% interest in Georgia.
Range is capped at around A$450 million and it’s up to the market to work out what their four assets are worth – Texas, Trinidad, Puntland and Georgia. How do you chop up that A$450 million for those four assets? It is probably fair to say that a bit under half of that is Trinidad and Texas. They’ve just paid A$70 million for Trinidad and Texas is not worth A$100 million because it is not cash flow positive at the moment, it certainly will be but it is not just yet. If you say that A$170 million of Range’s A$450 million market cap is in those two assets that means that A$280 million is attributable to the other two and they are the two that we have got.
Tony King: Range has got a 40% stake in Georgia so you can say probably the market is giving them a value for what we have got of A$200 million plus. I think you can comfortably get to those numbers.
Drilling is scheduled to begin in Georgia in the coming weeks. Tell me about that?
Greg Bandy: Well, what’s getting us excited is immediate news flow, spudding in two weeks, a really large target, a target of somewhere between 100 million and 180 million barrels in place. It is a really exciting starting point for a small junior like us. It will be a forty-five day drill programme and there will be news flow over the course of that. They are expecting to see some gas early on and, whether it is commercial or not, they are expecting to see a pay zone of oil about two thirds of the way down. Then at target depth of 3,500 metres, that is where they are most optimistic about seeing some commercial oil.
What are the details of the drilling programme and who else is operating in Georgia?
Greg Bandy: It is a US$14 million, two well programme of which our costs are capped at US$5.6 million. So we are paying no more than US$5.6 million to have a look at two really big targets in Georgia. The seismic interpreters, RPS Energy, have identified two ready-to-go targets and helium surveys across those target areas have confirmed that the drill targets are rich with helium, which is a hydrocarbon indicator. The oil and gas technical guys are really excited.
Tony King: There are a few other operators in Georgia but the key guys in there are CanArgo Energy, which is a Canadian group, Anadarko (NYSE:APC), Jkx Oil & Gas (LON:JKX) and Frontier has got a big position over in the eastern side.
In terms of regulations and local relationships, is Georgia an easy place to be drilling for oil?
Greg Bandy: Our operator and joint venture partner, Strait, are the ones with the relationships with the Ministry, the Government and with the locals there and the relationship is incredible. Alan Hitchins from Strait is there all the time. Everything is in place, the approvals are in place and there have been no real delays or hold-ups, it has been as smooth as you could hope for.
Tony King: Strait has invested heavily in Georgia, in infrastructure and the people and I think the Government really appreciates that. A lot of foreign companies will come in, run around a bit, use a few people and then disappear, whereas these guys have been there for six years now and they have got an infrastructure and they employ a lot of people.
Turning to Puntland in Somalia, there is obviously significant upside here if you can get drilling under way. Red Emperor has got involved at quite a late point in the process towards drilling. How is the progress going?
Greg Bandy: Africa Oil have signed a letter of intent with a rig company and they are looking to formalise that into a rig contract soon. They are still expecting to spud a well in the third quarter of this year. Never before has a rig contract or a letter of intent for a rig been signed, so this is as close as anyone has ever got. We are guided by our joint venture partners and operators and they are telling us all the right things. When you have got billion-barrel oil targets you have only got to get a sniff down there for it to be really meaningful for a A$50 million company. You are right, we have really come in at the pointy end, we haven’t spent A$80 million getting here like the other two have, we haven’t spent five years telling people it is going to happen. We have been a bit opportunistic but that is what I think gives us our real upside value.
Obviously oil and gas companies work together on licences all the time but the high risk exploration similarities between Red Emperor and Range Resources are stark. Will that continue in the future?
Tony King: Greg and I are corporate guys, we see opportunities in the market place and we move on them. We have got a very strong investment support base in Australia and they will back us in these things. So we saw this as a great high leverage play and we are all happy to write cheques for these wells. The fact that both of the assets are also in the Range portfolio is pure coincidence. If we had seen something else in some other company that we could get the same shot at then we would have done it, and we will do it in the future if there is an opportunity.
Are you looking to further diversify your portfolio – perhaps with production assets?
Greg Bandy: At a market cap of A$50 million and an enterprise value of A$35 million, no, because there is too much leverage in the upside to go and muddy the waters by putting anything else in. If we were capped at A$200 million now and had the same sort of recognition in the market as Range had then we would probably go and look to underpin that with some production or diversify somewhere else. While Range have gone out and diversified and added other assets to their portfolio, in turn they have lost a little bit of the leverage upside to the Puntland and Georgia assets. In a success case I think there is far more upside in us than there is in Range but you would probably invest in the two companies for different reasons now. If you were looking for pure exposure to Georgia and its drilling programme then you would have a crack at the A$50 million company not the A$450 million company, and probably the same with Puntland. But if you are looking for a little bit of upside with production then you would probably buy Range. But you would have to get your head around the fact that the production is worth a large proportion of that A$450 million market cap. So I think a fair bit of the upside is already factored into Range with these exploration plays. It is not with us and that is what we are hoping to take advantage of.
You mentioned you have got good relationships with institutional investors in Australia. Have you been meeting institutions in London?
Greg Bandy: Yes, we have met some new institutions and funds and private client brokers. We want to set up an office over here, we want to take it seriously over here and service the market over here and hopefully raise some capital down the track when required.
What sort of reaction did you get from those institutions? My sense is that the City is bullish on pure play exploration at the moment – is that something that you found?
Greg Bandy: I think they are and, as I said, for our market cap there is too much upside not to be. To spend A$5 million in Georgia when you have got A$14 million in the bank and you are only capped at A$50 million… it is not going to blow us up if we don’t succeed in Georgia but it is really going to be a company maker if it is there. Then you look at Puntland and the implications if that comes in. There is too much upside not to have a dip at it, and that is the feedback we are getting.
Tony King: Personally we are more focused on the private client investors and retail investors because this isn’t an institutional product at the moment in Australia and we would hesitate to think it is here. But certain institutions are saying: ‘Yes, we want to have a look at this because either we did well out of Range or we missed out on Range and we don’t want to miss out’.
The volume of share trading in Range Resources is has been very high. Why do you think that is and are you looking for the same kind of shift in ownership from investors in Australia to those in the UK?
Tony King: Certainly Old Park Lane (the broker to Range Resources) has made a contribution to that but I think the Range management are very good at dealing with retail people and groups that reach out to retail investors. They always put the time and effort into catching up with those types of people and they will respond to emails and queries from shareholders. I think they have got a very good rapport with private investors and that’s probably one of the big secrets to their success, whereas a lot of other companies might shy away from that. We will be happy to have whoever wants to own us for the right reasons. We don’t want to set any wild expectations for people, we are just going to quote what we are told from the operators and from the technical people that we talk to. We are in it together and hopefully we will have some success. We are very excited.
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