JKX Oil and Gas - Trend Change?

http://www.jkx.co.uk/



JKX Oil and Gas (LSE:JKX) is a well balanced oil and gas exploration and production company with interests scattered in countries close to the Black Sea in Eastern Europe. In early 2011 the share price topped out at around 375p/share, and has suffered badly following this, hitting a low of 73p/share recently. The price currently stands at 80p/share which is a level not seen since Q2 2004. JKX has an  market capitalisation of £137m with 171m shares in issue.


I have been watching JKX for a few weeks now, looking to see when it may reach a minor low and had looked to be forming a major low in the form of a double bottom. This now looks confirmed and the subsequent rise both yesterday and today means that it is likely there are some good gains to be made through investing in JKX at the current time. The fact that JKX is currently at lows not seen for almost a decade does not tell the whole story - the fundamentals of the company are surprisingly good for its current share price position.

The institutional structure of JKX is straight-forward. CEO Dr Paul David owns almost £3m worth of shares so certainly has an interest in a rising share price. Multiple other directors also have holdings with some smaller buys recently by directors. One of these was worth £5k in August at 87p/share. Through directors and institutional holders combined, there are approximately only 50m shares available for private investors on the market, however this figure is always fluctuating.

Courtesy of NASA Goddard Photo and Video

JKX operates in three core countries (Ukraine, Russia and Hungary) and two further countries (Slovakia and Bulgaria). Initially its easy to identify these countries are close together geographically speaking hence their focus is quite narrowed. Whilst this could be perceived as a disadvantage, the diversity of having five asset locations reduces this risk. For example, potential political problems in Russia can be negated by the other countries. The only disadvantage of operating in these sorts of countries is that you often get a series of difficult to write, read and pronounce operating licenses. JKX is no exception. These countries also offer potential commodity price upside that is not seen in more mature markets such as the USA. Gas prices in Russia are likely to over double prior to 2020. A risk to this may be US shale gas prices that have been brought about by a rise in fracture stimulation techniques to exploit previously unviable resources.

JKX holds a number of exploration licenses across the countries. In Ukraine JKX holds the Zaplavskoye license is held within the Nova-Nikolaevskoye complex. It is an onshore license comprising 137km2 of land where JKX has a 100% interest. In Russia they have a 100% interest in the Koshekhablskoye Callovian license, in Hungary 25% and 50% interests in the Veszto and Turkeve licenses, in Slovakia 25% interests in three licenses and an 18% free carried interest in the Provadia license in Bulgaria. Clearly, in terms of exploration Russia, Hungary and Ukraine are the three main operating locations, thus the benefit of having the others means that there is good diversification in terms of both geographical location and risk profile.

In addition, JKX have also been awarded the Giorgievskoye exploration license in Russia in recent months. This license has been estimated to have up to 170bcf at a Pmean level, which is a decent asset albeit not groundbreaking. Both 2D infill and selected 3D seismic is planned for this zone before the drilling of two exploration/appraisal wells.

In terms of production, JKX has 100% interests in two Ukrainian licenses; Poltava and Elizavetovskoye, has a 100% interest in the Russian Koshekhablskoye Oxfordian license and has 50% interests in two Hungarian licenses entitled Hernad and Gorbehaza. In terms of size, this amounts to 5643km2 with most of this heavily biased towards Hungary where the Hernad license contains over 5000km2 of land. The benefit of JKXs operations is that they have a first mover advantage in the region particularly in Russia and the Ukraine where they also have a presence due to their extensive operations in the area. At the Koshekhablskoye field, whilst a delayed ramp-up in production was experienced, this should simply be set back and benefit the share price in the near future. Furthermore, an expansion project should increase refining plant capacity here by at least 15% allowing for greater production rates. At the end of June 2012, the groups total reserves stood at a combined level of 89.3mmboe which is what makes JKX seem particularly cheap.

courtesy of macle

Since the start of 2012 JKX has released a number of operational and corporate updates. The first significant RNS was issued in March with the signing of a Russian gas contract with an established supplier. Whilst this is almost a formality, it represents a key milestone through which JKX can continue to monetise its Russian assets. This gas production eventually began in May. Soon after this the first exploration well success of the year was bagged. The Z-04 well in the Zaplavskoye license had flowed at 20.8mmscfd and 1040bpd of condensate which greatly improved the economic viability of the discovery.

In late March the FY 2011 results were released with some mixed figures included. Revenues reached record levels of $236m, up by $40m on 2010. However, production was down on 2010 by around 1000boepd to 9400boepd and operating profit was down 14% to $82.1m. CEO Dr Paul Davies commented;

"With the completion of the Koshekhablskoye gas field facility in Russia, we have achieved a milestone which is transformational for JKX. Southern Russia is one of the fastest growing gas markets and, similarly to Ukraine, we have positioned ourselves early. We have signed a sales contract agreement and are currently awaiting our permit to operate. We will start delivering gas to our buyer shortly and expect to build to plant capacity by mid-year."

"Ukraine continued to be the engine of the Group in 2011, providing the bulk of our record turnover of $237 million. Its strong cash flow allowed us to absorb a significant $62 million increase in production taxes in the period. We have experienced a period of very intensive capital investment, notably in Russia. The Board will therefore not recommend a final dividend for 2011."


In April production at the Ukrainian M-53 well in the Elizavetovskoye licence commenced with 3.8mmscfd and 1.1bcpd produced. Rather than being a full production well, this acted as a test well to provide production data prior to investing heavily in the field as to ascertain the likely economics. However, the sidetrack of a well entitled Well 27 led to the delaying of a production ramp-up at the Koshekhablskoye field which had negative implications on the share price. To help with ramping up production a multi-stage fracture stimulation contract was agreed upon in August to aid operations at the Well R103 in Ukraine.

Courtesy of Professor of Death
In their half yearly report issued in August, JKX drew upon a number of issues and milestones that had arisen during the period. Notably the start-up and initiation of gas sales from the Russian Kosekhablskoye field will increase future revenues. Furthermore, the production from the Elizavetovskoye license in Ukraine will help generate future revenues. These extra revenues will contribute to finally paying off the short term credit facility that was previously provided by Credit Suisse. This should act as a catalyst to improve investor confidence in the share which has been lacking for multiple months. Over the period, production was significantly down by 21%, however the majority of this negative effect was offset by higher realised gas prices which were up over 36% over the period. This also bodes well for the next financial report as production is set to increase again. Thus this combined with sustained higher gas prices should benefit JKX. In addition, Ukrainian production taxes were lowered over the period which should translate into improved operating margins in coming quarters. This should add to the current cash level of $20.3m.

In August the work at Well 27 was completed; "JKX Oil & Gas plc ("JKX") is pleased to announce that gas production from well-27 has commenced in its Koshekhablskoye Field, Adygea, Russia. The well is now flowing to the gas processing facility and production testing is under way. Reservoir response will be closely monitored before ramping up towards its production plateau."

However it was the RNS released today that caught most investors attention. Whilst both gas and oil production was still down on the 2011 levels, they were slightly better than during Q2, and with higher commodity prices and improved production, it highlighted that JKX will do well in terms of revenue in coming months. 'Good progress' was being made increasing the gas production in Russia with levels exceeding 50% of the plants capacity. Clearly this means that without much capital expenditure, production can continued to be increased through utilising this spare capacity.

"We are encouraged by the progress made on the three producing wells at our Russian gas plant and we remain on course to reach plant capacity of 40 MMcfd in the first half of 2013. Preparations for the Rudenkovskoye multi-frac project in Ukraine next spring are on-schedule with results of the initial injectivity test expected next month. We are achieving strong oil, gas and LPG realisations in Ukraine and are beginning to see an improving revenue stream from our Russian development. We anticipate average daily production in the fourth quarter to reach 10,000 boepd."

courtesy of todbaker
It was the anticipated average production rate that acted as the share price catalyst with the company forecasting a rise to an average of 10000boepd. If this is achieved it should lead to a significantly improved share price. Moreover, it will reinstall confidence back into investors. This was seen today with the share price emerging from vastly oversold levels, at one point being up over 11%, but eventually settling to finish up circa 6.70%.

In political news Ukraine is threatening to withdraw as a gas partner for Russia as it is felt they are paying disproportionately high gas prices. Russia has offered a settlement whereby Ukraine joins the 'Customs Union' which will see the price it pays more than halved. The catch is that Russia gains control over the Ukraine's pipelines. Interestingly though, this plays into JKXs hands in either circumstance. If Russia ceases trading with Ukraine, gas prices are likely to rise as gas represents the majority energy source domestically. Alternatively, if a deal is struck it may seen increased demand due to the lower price thus allowing more Ukrainian businesses to expand output as more projects become viable. The inherent problem here is that political issues may end up getting in the way of expediting work not solely in the Ukrainian situation. Ukraine are not the first to ask for a price cut either with Serbia, Belarus and Armenia.

Its worth taking a look at broker targets for JKX. Oriel securities have a net asset value assigned of 275p, almost 400% to the upside and just on the value of assets. Barclays Capital, N+1 Singer, HSBC, RBC Capital Markets, Goldman Sachs and UBS have targets set at 175p, 169p, 140p, 200p, 269p and 100p respectively. Each of these targets represents the extent to which JKX is undervalued by the market. As noted earlier, the double bottom chart formation could see significant medium-term gains.

The bringing online of various Russian drilling projects, extension of the plant facilities and continued solid progress in other core operating locations should see JKX build upon its current production rates and reverse the decrease seen during 2012. With average production down to ~7500 in 2012 so far, JKXs target of 10000boepd would see it at a more advanced stage than two years ago (2011: ~9500boepd), but for a fraction of the price.

25/01/2013 - JKX has fallen through its previous bottom as a result of the placing of Convertible Loans - this is no longer a good technical trade

9 comments:

  1. looking promising, good article again

    A.J

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  2. Another great report Elite. Really helpful. Keep em coming!

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  3. just bouht some at 79p.

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  4. FIrst tranche at 79p today. CAn definitely see upside from here

    thanks for the tip

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  5. So why's it gone down to 68p now?

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    Replies
    1. JKX failed to break and hold 80p which appeared crucial. In addition it broke through the established bottom probably in combination with a lack of news.
      Fundamentals have not changed, but neither has sentiment ultimately. I might do a follow up article after the next set of news

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  6. Thanks for the research, in light of recent developments like the Bond issue, will you be doing a follow up piece? Seems the market takes any news as bad news with JKX - very frustrating!

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