Description

Executive Summary:

Strike Energy (“STX AU”) is an onshore Western Australian gas exploration company, transitioning to a producing asset. It is located in the Perth Basin in Australia They also have long-term ambitions to integrate downstream to become a urea fertilizer manufacturer with their cheap / clear natural gas feedstock (they have plans to produce a 1.4Mtpa urea facility –with zero scope 1 and scope 2 carbon emissions by 2030 using sequestration). Total demand for urea in Australia is currently 2.5Mtpa and it is all imported, for the purpose of current valuation we completely discount this project given the capital cost (north of A$1.5bn) and timing. This write-up is more focused around the value of their upstream resource and assets.

In terms of the upstream value – Strike Energy effectively is four “real” assets and then some exploration assets (rights):

1) Their 19.9% stake in WGO AU (recently purchased by Hancock—we view as cash)

2) Their 50% operating stake in the West Erregulla (a project whose JV partner Warrego was just acquired by Hanock solely for that asset);

3) A 55% stake in an ultra-low cost gas field called Walyering which is coming into production this quarter and generating given offtake agreements ~A$50mn in FCF a year for seven year reserve life;

4) A recently found and currently being drilled resource: South Erregulla, right next to West Erregulla, which has already found double the 2P and 2C reserves of West Erregulla and maybe the most prized asset. They have additional land for prospecting in the area as well – which we believe (as per the below) – given the location and interest in the area is worth something but for this current analysis we don’t incorporate it.

All told whether on a SOTP basis or on a conservative DCF basis for just the three “real” already found --- we get 60%+ upside. IN addition we get optionality on the promising South Erregulla find, further growth in West Erregulla, and further upside in their prospecting area for free.  All of this is occurring with a ton of M&A in and around where they are operating from some of the largest commodity players in Australia.

Given the cash on the balance sheet, a completely de-risked project starting last quarter for further cash flow (Walyering—brownfield, infrastructure in place) and their JV stake which was just taken out – we see limited downside. We also note—on the key West Erregulla asset – they are the operator and thus majority partner.. ahead of Hancock which just bought out the minority. We doubt that is Hancock’s long term goal to be a minority just on this one field.  

West Australia Gas – Market has changed – Strike is primly positioned as the largest player—more gas is needed:

The AEMO (Australian Energy Market Operator) recent report – “2022 Western Australia Gas Statement of Opportunities – December 2022” – says the WA market is facing a tight supply demand balance between 2023 – 2029 and needs more supply. The regulator itself put out a call to arms. The reason is industry is so important to western Australia and because of that they need energy – and hopefully cheap and clean energy. A look at the current energy mix for this industrial area in Australia shows you also they are reliant on coal. When you factor in growth in the lithium refining / industry, in continued gold growth --- plus how recent gas declines have been far more than anticipated—the call to arms is understandable. Santos – the largest supplier of gas recently announced plans to close a gas plant in WA amidst supply concerns. Just in January 2023 – multiple generators have had to switch to diesel in WA because they couldn’t source gas.

WA is still 42% reliant on coal.

For years there has been underinvestment from cheap energy globally – not they are running out of gas supplies right when they need more for industry.

Strike Energy has positioned itself as the biggest owner of reserves in the WA Perth Basin. All of this is in prime locations, near existing infrastructure. They are strategically very well placed. 

WGO buyout – if one takes out the minority partner, what about the 50-50 operating partner with a field potentially 5x the size right next door?

Hancock offer for Warrego:

Corporate activity around Perth basin gas shows its strategic importance.  Multiple large investors, energy consumes / industrial companies in Australia have engaged. STX is the largest owner in the basin with 413 PJ of 2P reserves and 613 PJ of 2C contingent reserves for a total of 1025PJ. For the majority of the 2C contingent reserves, they are drilling in the coming weeks / month at the South Erregulla field to upgrade them to 2P reserves. One can also assume that since there were 4 different bidding parties for Warrego’s stake in the field, there is a good chance for conversion of the contingent resources, or overall growth of the resource and reserves given the level of due diligence that was done when the asset was effectively put in play.

With Warrego, STX Energy, Beach Energy, Hancock (JV’s with Posco in Australia) and Mineral Resources all bid for the company or purchased stock with an intention to bid (Mineral resources bought above the final deal price in fact). These are real global players – multibillion dollar industrial consumers of gas bidding for assets in the Basin.

WGO AU only material asset is its 50% non-operating interest in West Erregulla; 2P reserve 221PJ. Strike Energy is the joint venture operating partner… giving them effective control. This is key. Hancock bought out WGO when they are a minority in this project to Strike.

Going after WGO instead of STX (the operator and majority owner) may have been because of the position of financial strength that STX is in (more below).  Perhaps other parties and Hancock went after the minority partner WGO as they knew STX wouldn’t or didn’t need to sell. Also, Strike may have been worried that a party was looking at them also for the West Erregulla land and so went after Warrego with a bid as a defense.  Regardless of the reason – there are a lot of large, in the know, smart parties involved in this Perth Basin area.

If one were to take just the implied value of the Warrego offer on its reserves and resource (2p and 2c)– one would get 60% upside for Strike Energy. This doesn’t take into account their control position for the Warrego asset, how 10-15% of those reserves have been invested in and are producing – and the upside across multiple different exploratory assets / land in the portfolio. It is interesting that valuing just the 2P reserves and cash from the WGO stake – does get you the current share price.

Hence the 2P upgrade we expect to occur in the coming weeks / months from both West and South Erregulla could act as a catalyst.

Another way to look at the implied value is the graph below. Taking activity in the area – Strike – the largest player --- is significantly undervalued versus peers:

Balance sheet is now strong – No dilution necessary – off-takes in place:

While some exploration assets could trade at a discount because of 1) Execution risk and 2) worries of dilution – Strike Energy is now secure. They had arranged financing the past year leading into the WGO offer and combined with that stake sale have ~A$120/130mn cash on the balance sheet and their first producing asset is set to start generating cash imminently with capex already being spent. With effectively no debt or liabilities and there $A1200mn market cap, 10% is in cash alone. Just ~45mn in capex is needed to develop West Erregulla. They also have the bonus of owning 100% of the highly prospective South Erregulla right next door. 

Source: Bell Potter Research

They also have offtake agreements in place—tied to both Walyering and other assets not named– most likely West Erregulla. These offtakes again are with reputable parties like Wesfamers (“WES AU”) a A$55bn company that traffics in many consumables (medial products / fertilizers) that need natural gas.

Two big next steps:

Over the coming weeks months, we will get an update on the West Erregulla and South Erregulla resource. Conversion of South Erregulla resources to 2P reserves would be a huge catalyst as per above.  Additional growth in West Erregulla could also further increase the value of that stake as it moves into development.

West Erregulla is waiting for their permit to proceed with building. Given the strategic importance of the asset outlined, its location amongst infrastructure in WA already starved for natural gas – we would expect this in the coming months.

Catalyst

M&A

Resource growth