LON:PHAR | IMS - May 2010

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17th May '10 by emptyend

21 comments 5916 reads

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Emptyend

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21 comments

emptyend

17th May '10

Does this imply that 100% of the well costs fall on SOCO? AND, if so, then presumably more of the upside potential is up for grabs?

It seems that a) they are indeed paying 100% and b) that will give them PTTEP's share* in the event of success..... though there is also a huge back-in penalty that PTTEP could pay if they change their mind after the event and want to come back into the acreage (7x well costs....cf 5x well costs paid by CIECO when they backed into a successful DNX well in the North Sea).

Looks like a potential windfall gain to me, given that their confidence in the well remains extremely high! I surmise that budgetary pressures may be being applied to PTTEP by stakeholders there - and I know that they have been forced to highlight previous drilling cost writeoffs in the financial statements, so perhaps it is down to shareholder/government pressure rather than any considered technical difference in their opinion.

*ps....of the whole appraisal area - plus their share of cost recovery on the previous well (which is quite large, as you'll recall!). Net net this greatly increases the upside potential, though of course also doubles (ish) the cash cost of a failure.

arkleseizure

17th May '10

Is that seven times the full cost of the well, or seven times what their share of that cost would gave been?. After the last hugely expensive and long drawn out attempt on the structure, perhaps one can understand the the attitude of PTTEP's (presumably) non-oily government overlords. Mr Market doesn't seem overwhelmed by the IMS.

emptyend

17th May '10

7x share, I think.

As to the market, the only analyst comment I've seen so far focuses on the "disappointing production" in Q1 (despite the fact that the downtime at CNV had been flagged previously!). Perhaps they don't realise that SOCO is primarily an exporation company and that current production is hardly here or there when a quintupling of reserves might be derisked in the next 6 months!

ps....continued oil price weakness today of course has a significant bearing - but volumes are extremely low and, IMO, anyone selling here needs to be prepared to see a very sharp snapback when the analysts actually re-run the numbers this week.

Isaac

17th May '10

It seems that a) they are indeed paying 100% and b) that will give them PTTEP's share* in the event of success..... though there is also a huge back-in penalty that PTTEP could pay if they change their mind after the event and want to come back into the acreage

Are you saying if this well fails then Soco are liable for all costs but if it succeeds then PTTEP get back their upside so therefore no gain to Soco ?

If so then how does that increase the upside for Soco? Sounds they are taking all the risk for no extra gain for the extra risk!

The management SHOULD clarify what is in it for them rather then just saying they will take all the risk!!!

Isaac

17th May '10

OK - I have re-read your post....

I think what you are saying is if the well is succesful PTTEP will have to pay Soco 7 times the well cost as a penalty in order to get their share of the upside else on a failure Soco will bear all costs.

Do you know whether this also applies to future wells so in effect if PTTEP does not excercise its right to get back into the acreage after this well any future wells Soco own their acreage plus PTTEP ?

emptyend

17th May '10

Are you saying if this well fails then Soco are liable for all costs but if it succeeds then PTTEP get back their upside so therefore no gain to Soco ?

No. Read what I've written!

emptyend

17th May '10

Do you know whether this also applies to future wells so in effect if PTTEP does not excercise its right to get back into the acreage after this well any future wells Soco own their acreage plus PTTEP ?

OK - now you've (partly!) re-read it.....

.....If the well succeeds then SOCO would be entitled to PTTEP's share of the whole fan - unless they pay 7 times their share of the well costs to back in. Obviously if it flows at 15,000bopd one must assume they will back in. Backins are clearly quite complicated (especially as there are sunk costs on TGD-1X etc) so it would be a good question to ask at the AGM to try to quantify the potential upside.

I'd guess that the calculation is something like: SIA think the well is 90% likely to succeed and that the back in terms mean that one should sole-risk the well if one thinks it has more than a 25% CoS.....so on a risked basis it is literally a no-brainer (even if it is unlikely that they won't back-in in the event of a commercial success).

loglorry

17th May '10

I guess the important thing here is that the potential upside is less than 7x the cost of the well. If not then it is a no brainer for PTTEP as they can always buy into any success more cheaply than the resulting upside. I realise though that there are a whole spectrum of possible drill results so I guess we'll only know in hindsight who benefits the most.

2/3 of the CB being put back is not a bad result but I'd prefer to have seen more so that the only way into the large potential upside of the drilling program for institutions is via the stock rather than via the CB. Nevertheless, this does significantly reduce the issue size and presumably those who did not put back the CB are not willing sellers, at least nto around par value.

Stocks down a bit probably a good entry point.

Log

Isaac

17th May '10

OK - So will Soco have to pay for the share of PTTEP TGD-1X drill costs as well or is this just for the TGD-2X and providing they don't excercise their option all future wells?

Sounds like a VERY Good deal to me....I love it when the management team really backs themselves like this.....

thebuffoon

17th May '10

Without knowing the exact contractual relationship we had with PTTEP, it is not possible to know what our options were.

Taking 100% of the risk without getting 100% of the reward is not uncommon, but only when one gets something significant for doing so. We will be getting something it seems; a multiple of well costs. However, if we get a fantastic result (I know, I should be a headline writer for The Sun..) that will be chickenfeed.

I guess a simple summary would be that the boards' view is that this is not too much of a risk, and we'll get more than the cost of the well from PTTEP while only giving them the share they had in the first place.

Buffy

6502

17th May '10

I'm not happy to read of the sole risking.

Clearly if the odds of a successful outcome are anything like as good as suggested, then Soco are delighted to have a 90% chance of taking 6x well costs off PTTEP for a 10% chance of losing 1x well costs.

But the corollary is that PTTEP surely can't believe the chances of a successful outcome remotely approach 90%. EE's explanation of avoiding the embarrasment of pouring more money down dry holes helps with why they might be prepared to pay over the odds to insure against failure, but not this far over the odds. PTTEP surely can't believe the odds of sufficient success to warrant backing back in approach 50%.

So for me, what the arrangement reveals about PTTEP's lack of enthusiasm rather outweighs the increased upside.

davjo

17th May '10

IIRC, PTTEP wrote off TGD-1X costs within months of it being p&a’d. That seemed exceedingly odd at the time since those costs were assumed recoverable against TGT. However, I’m thinking perhaps that’s not the case and the appraisal area is ringfenced? Consequently, it looks to me like PTTEP must have pretty well decided back then not to proceed, way before re-interpretation of the 3D (and before the appraisal area was approved?). Of course, 1X was way over budget, something like $50m on a net basis to them I think, so that in itself may have triggered the axe?!

doverbeach

17th May '10

@Isaac: So will Soco have to pay for the share of PTTEP TGD-1X drill costs as well or is this just for the TGD-2X and providing they don't excercise their option all future wells?

The partners will have already paid for the TGD-1X drill costs and they were (as I am sure you remember) extremely large. There is no way that they can have been wrapped up in this deal.

re future wells. Who knows what the precise terms of the agreement are, but the simple way to structure it would be a straight-forward option: Soco will pay all the drill costs and take over PTTEP's share of the block unless PTTEP choose, once the well result is known, to pay Soco 7x what they would have originally paid. If PTTEP do not exercise this option, then they no longer have a share in the block. If they do, then they retain their current share and will pay the associated costs for appraisal / development going forwards. [nb this is common sense not any knowledge of these sorts of contracts.]

@rapier So for me, what the arrangement reveals about PTTEP's lack of enthusiasm rather outweighs the increased upside.

Well fairly obviously PTTEP can't believe the 90% CoS. But as ee has pointed out, even a 25% CoS makes this deal a good one for Soco. In the end you have to decide how much you trust the management of the company you are invested in - Soco have put huge amounts of effort into deciding what to do in TGD. PTTEP have the same share of the block as Soco, but for them it is a small project in a long list of others - here is a list of their international projects and their list of Thai projects is a similar size. So for PTTEP it simply isn't something which will have got a corresponding amount of senior management time.

emptyend

17th May '10

IIRC, PTTEP wrote off TGD-1X costs within months of it being p&a’d. That seemed exceedingly odd at the time since those costs were assumed recoverable against TGT. However, I’m thinking perhaps that’s not the case and the appraisal area is ringfenced? Consequently, it looks to me like PTTEP must have pretty well decided back then not to proceed, way before re-interpretation of the 3D (and before the appraisal area was approved?). Of course, 1X was way over budget, something like $50m on a net basis to them I think, so that in itself may have triggered the axe?!

I'm pretty certain as well that PTTEP took a charge in their accounts. However, I am explicitly given to understand that the costs of TGD-1X are indeed part of the cost recovery pool - so it might just be that Thai accounting rules demand an immediate write-off of uncommercial wells rather than a capitalisation of spending. It isn't too difficult to conceive that they aren't quite as optimistic as SOCO is - and they may well have come under shareholder pressure too. However, I also understand that some of the people who took them into the VN acreage have since retired - so the "new guard" could easily pull the rug on something that is "not their project" in order to protect what they want to do elsewhere.

The partners will have already paid for the TGD-1X drill costs and they were (as I am sure you remember) extremely large. There is no way that they can have been wrapped up in this deal.

TGD-1X costs are sunk - but they are also recoverable out of production in the event of a commercial find. SOCO would be entitled to PTTEP's share of theis recovery of back costs, unless PTTEP back in again!

Rapier's point is a good one - IF one takes the view that all decision-making is entirely logical. However, we've just had proof that not all decision-making is entirely logical - because two-thirds of the convertible has been put back to the company at par, despite it trading around 100.5 or so. In this case I think there is also some evidence that the PTTEP choosing not to participate isn't wholly logical - though it is difficult to ascertain why that may be. You may recall that CIECO decided not to participate in the first Rinnes well last year - following which Dana successfully drilled it sole risk and CIECO are now paying 5X their cost to back in. I don't think one can deduce much about the likelihood of success from a partner deciding to not to pay up until/unless success is proven.

davjo

17th May '10

I am explicitly given to understand that the costs of TGD-1X are indeed part of the cost recovery pool

Yes, I’ve since had it confirmed that the appraisal area is not ring-fenced (as per my earlier supposition), thus, these costs can be expensed against TGT, i.e. TGD success or otherwise is irrelevant to cost recovery. I’m sure ee and others will know that but I mention in case others do not.

Also worth noting PTTEP’s comment from their Q3 2008 briefing :-

http://www.pttep.com/imgUpload/E-MDA%20-3Q08_final%20Reviewed.pdf
In Vietnam 16-1 Project where the appraisal well TGD-1X, TGD-1X-ST
was drilled in Te Giac Den (TGD prospect, PTTEP reported, on 10 July 2008, a
discovery of oil and gas and that the company would engage in a further detailed study of
the well in order to determine its potential for commercial development. However, the
most recent technical study shows that the flow rate of oil and gas in TGD-1X, TGD-1XST well is not substantially sufficient for commercialization. PTTEP, therefore, has
proceeded to write-off this well in the accounting period of the third quarter of 2008 with
the total cost for PTTEP of 2,735 Million Baht.

At the time, that was about $82m. Effectively then, with 2X budgeted at $50m(?), Soco will be drilling at nil cost to them and will receive future compensation of $32m should TGD fail, or a bonus of $350m if it succeeds. PTTEP must be stark raving bonkers!

peterg

17th May '10

Hi DJ,

It does seem remarkable, though extremely welcome, that the TGD appraisal area and the TGT development area are to be considered as one in terms of cost recovery. My assumption, as yours, had been that it wouldn't be the case, partly because, as you say, if it is then not drilling TGD-2X would lose money whatever the outcome!

I haven't seen either your question to the company, or its answer, but Is it possible that while costs can be recovered across the whole of the development area in 16.1 that only becomes the case once/if TGD has been proved commercial, and the TGD appraisal area been upgraded to a development license? That would seem plausible, and a little less bizarre in terms of outcome.

Peter

davjo

17th May '10

Hi Peter

My original understanding, dating back to the early 90’s, was that all explo expenditure within the boundaries of Block 16-1 can be expensed against any production in the block, irrespective of whether a development area has been designated, provided that the explo licence remains in force for the remainder of the block, less any relinquished areas.

As to the proposal about the appraisal area being a new standalone entity, I suggested this as a possible reason why PTTEP wrote off TGD costs when they did, in other words, if there was no prospect of recovering costs without TGD success, their action made more sense.

My question to the company was simply, is the appraisal area ring-fenced for cost recovery? As you know, this is common parlance referring to recoverable costs being restricted within the area. The answer is, it is not ring-fenced.

Agree, PTTEP’s action does seem rather bizarre but I wonder whether their Montara blowout disaster in the Timor Sea last August had any bearing. PTTEP are 100% owner/operator. They took nigh on 3 months to kill the well, during which time anything from 300 to 2000 bopd spilled into the sea. It seems they took a $155m write down as a result in Q3. Haven’t looked at subsequent quarters. Appears an Official Public Inquiry is currently taking place in Australia amidst plenty of adverse publicity. Not the best backdrop to be associated with drilling TGD at this time. One can imagine protest groups taking a look at TGD-1X for example and alleging PTTEP have a record of drilling wells offshore Vietnam with underrated BOPs and screwing up like amateurs in the process etc. etc. With global interest also focused on the GoM, it seems to me that PTTEP don’t want to risk anything going wrong right now and that is the main reason why they’re not participating. All the more reason to celebrate (with fingers crossed) :-)

passinthru

18th May '10

Hi Davjo

In February 2009, Coogee Resources Limited was acquired by a subsidiary of PTT Exploration and Production Public Company Limited (PTTEP) and renamed PTTEP Australasia Limited. Really unfortunate timing considering the blowout that took place a few months later.

The official Inquiry you referred to (montarainquiry.gov.au) has endless submissions as exhibits and over 2300 pages of transcript (yes, I have read them all). PTTEP comes out badly. Halliburton did the cementing and the cement ended up in the wrong place. Drilling contractor did not have the BOP installed on the well that blewout. And blame all around. Sounds familiar does it not! Australian QC ripped apart the defence by PTTEP that they were acting under the sound principle of 'good oilfield practice' in their operation. I think PTTEP will be very bruised by this exercise - it must have consumed them for most of last year and up to the inquiry last month.

As a passing note...if BP are going to have to go undertake the vigorous examination line in GOM that PTTEP has had to endure in Australia then I think some of the comments in defence of BP (and that BP are using in their defence) might quietly fall apart in the next couple of years. Having said that, BP will still be drilling in deep water, using Transocean as contractors with Halliburton pumping the cement :-)

Shuko

18th May '10

If PTTEP have been nervous about costs and risks for some time it may be another reason why SOCO have been making sure they had plenty of cash in the bank. Thus there is no question of them being capable of taking on sole risk without it affecting other operations.

Shuko

marben100

18th May '10

Just a random thought... but I wonder whether PTTEP's decisions might be influenced by the current political instability in Thailand (forcing them to be ultra-cautious about short-term spending), given that they are Thailand's NOC?

Cheers,

Mark

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IMS - May 2010

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Emptyend

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