- Tui has proven AWE's jewel in the crown
- Tui's reserves have been downgraded by 50%
- AWE now has a lot riding on shale


By Greg Peel

One might be forgiven for assuming the Australian energy sector has provided substantial shareholder returns over the past five years, what with the price of crude, the CSM explosion, major project developments in WA and now even a shift into shale. The unfortunate reality is, however, at least if one uses the ASX energy sector index as a benchmark, that we're currently back where we were in 2007.

Project delays, weather problems, dry exploration wells, a depressed global gas price, global competition, high risk ventures, and now a repeat story of surging costs have all conspired to make Australian energy a frustrating rather than rewarding investment. (Oh, and the GFC.)

Lack of exploration success has been a recent thorn in the side of AWE Ltd ((AWE)), formerly Australian Worldwide Exploration. AWE's business is built upon cornerstone conventional assets which have provided the funding for the company's wider search, and it must frustrate the company no end that having established the highly successfully Tui operation, no further strikes have been made in the New Zealand region. For Tui has proven a jewel in the crown for AWE ? on Citi's calculation the project has provided an internal rate of return of 141% and paid itself back in less than 12 months. Tui's reserves have been constantly upgraded over its life, suggesting a well life beyond 2030, and it produces quality oil ? the best of AWE's production suite.

But alas, AWE has now remodelled its assets and decided that rate of decline of Tui production will be faster than earlier assumed, resulting in a reserve downgrade in the order of 50%. The subsequent loss in AWE net production across all its assets would only be about 5-6%, but it's the good stuff. JP Morgan thus calculates a loss in valuation for AWE of 21cps. AWE may be able to recover some more through infill drilling, and notes some potentially prospective results in surrounding locales, but with such lack of success in New Zealand of late it would be bold to be optimistic.

Tui's is the last of the cornerstone asset reserves to be downgraded by AWE this year, with the knife already been taken to the Ottway operations of Casino, Henry and Netherby, as well as Cliff Head. The company's mature legacy assets are quite simply on the wane.

The company did welcome a new CEO on board this year however, and as tradition dictates a new CEO of any company always downgrades everything asap. That way devaluation can be blamed on outgoing management and any upside provided by overly conservative de-rating can be taken on board as one's own success. With Tui the latest victim, Macquarie suggests "the deck-clearing is now complete". Other brokers agree, noting downside should be limited from here, allowing for the adjustment on the Tui news.

It would want to be limited. AWE shares were trading near $4.50 in 2008 and near $1.00 last month. One dry well after another has taken its toll on market confidence. This has led analysts to suggest AWE has been trading in a deep discount to a fairer valuation, and six out of seven FNArena database brokers covering the stock retain a Buy or equivalent rating (BA-Merrill Lynch-Neutral). The Tui news would have been a kick in the teeth for AWE investors nonetheless, given the stock had rallied around 40% in just the past month.

The main reason for that rally comes down to one word ? shale. Over the period, BHP Billiton ((BHP)) has acquired tier one shale assets in the US, the Aurora Oil & Gas ((AUT)) share price has rocketed due to its assets at nearby Eagle Ford, and Beach Energy ((BPT)) has seen a very positive reaction from better than expected results for its Cooper Basin shale testing.

Analysts have been surprised how well the market received the Beach news, given few of them believe Cooper shale could ever become a reality given much greater costs of production here than in the US. The same could be said of AWE's shale assets, although at least they lie in the Perth Basin and not 1000kms from the nearest tree.

As with Beach, successful commercialisation of AWE's shale could mean serious share price upside. As with Beach, that prospect is still a long way off and dubious at best. In the meantime, AWE's jewel in the crown is more likely to run dry closer to 2022 than 2032 so the company needs to find some more conventional winners in the meantime. At least Sugarloaf, of which AWE owns 10%, has seen a rapid increase in production.

The market may have been more focused of late on the trials and tribulations of Australia's gas majors, like Woodside ((WPL)), but it is clear the mid-level players are also having a rough time of it. Horizon Oil ((HZN)) is another to have disappointed with its quarterly production report this week.

And all the while the global gas price, and the US spot natural gas price in particular, remain stubbornly low. But Big Oil interest in shale continues unabated at this stage, with legacy players eyeing off non-conventional sources to take them into a future ruled by carbon pricing and dwindling commercial crude reserves. It's a long term game, for both Big Oil and AWE.

The consensus target price for AWE has fallen to $1.86 from $1.99.