South Africa backdrop still supportive for shale gas
Challenger Energy Ltd (ASX:CEL) is making progress towards the award of exploration permits with the submission of the updated environmental management programme (EMPr) in late February. If the legislative framework is in place by this northern hemisphere summer, CEL could potentially be awarded a licence and commence its work programme in Q315, with corehole drilling starting 12-18 months later. Meanwhile, the power crisis in South Africa is getting worse, highlighting the need for new energy sources including gas. CEL remains in farm-out discussions. A licence award and farm-out could lead to a near-term re-rating, with longer-term upside based on drilling success.
Another step towards licence awards
In late February, Challenger submitted its updated environmental management programme (EMPr) after extensive stakeholder consultation. As per the regulator’s request, CEL’s work programme now excludes hydraulic fracturing, allowing it to proceed with initial exploration before technical regulations are finalised. CEL plans to reprocess seismic data, build a geological model and drill up to three coreholes. The regulator has until end June 2015 to approve the EMPr; and if the MPRDA bill is approved by then, exploration licences could potentially be granted soon after. Shell (LONDON:RDSa)’s well-publicised ‘pull-back’ from South Africa could be a tactical move to put pressure on the government to accelerate the legislative and licensing process.
S Africa power crisis worsens; rising need for gas
Regular ‘load shedding’ by Eskom is hurting South Africa’s economy to the tune of 0.5-1.8% of GDP per month, depending on the blackouts’ severity. The country does not have easy or cheap options to solve its near-term power crisis, as gas imports from neighbouring Mozambique would require an expensive new pipeline and LNG (TO:EEL) imports would be technically difficult. If shale exploration is successful, indigenous gas supply could help meet the country’s dire need for more power. Current commodity price fluctuations have little impact on newbuild power economics, which continue to favour gas over coal or diesel in the long term.
Valuation: Appraisal and farm-outs to create value
CEL’s valuation of A$13/acre (down from A$25/acre in Dec 14) equates to pre-feasibility acreage pricing in Australian farm-outs; however CEL is arguably more advanced given the original well success. This leaves significant upside potential given partial de-risking from one well and CEL’s strategic value as the only Karoo shale pure-play. The key near-term catalysts are a licence award and farm-out. A follow-on farm-out would likely attract much higher valuations (A$250-1,000/acre).
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