with Michael Scott, Managing Director, Cooper Energy
2009 may have been a difficult year for some of the junior exploration and production companies given the instability in commodity prices and capital markets. Yet, it was a positive year for Cooper Energy as it posted its highest ever record of recoverable oil and cash-on-hand. What were the main factors of Cooper Energy’s success in 2009 compared to its industry peers?
The industry is subject to very long lead times in terms of securing a block, shooting seismic, and drilling exploration wells and it’s not unusual to experience several up and down financial cycles within that time. Cooper Energy had a number of exploration wells stacked up last year in the Cooper Basin that were on the schedule prior to any financial downturn in the markets. Basically, we stuck to our plan and went out and drilled the wells regardless of the external conditions. The lead time to get our wells to drilling time greatly over-ruled any short term financial crisis considerations. That is what our success was based on: we went out and drilled wells as per our strategy and grew by the drill bit.
The financial crisis didn’t seem to impact the industry much here at all. Western Australia (WA) tends to be a little behind the curve anyway, so by the time the financial crisis wave passed under us we were still sitting in a healthy place. Although we are a small company, we had $95 million in cash so the crisis did not impact us very much. If we were in a position that required us to go out to the market and raise capital, we probably would have struggled since the capital markets dried up to a certain extent. Because we were well cashed-up, we just kept on the same train and did not change our modus operandi very much. Commodity prices obviously dropped from about $145 per barrel to a little over $45 at one point, but that was a very low spike. You have to remember that back in the 1980s oil prices were about $9 per barrel so in our opinion we are still in a relatively high oil price environment.
So our success is simply due to being cashed-up, sticking to our strategy, drilling the wells we had planned to drill and emerging from the financial crisis in a strong position.
Cooper Energy is a very international company with acreage in the Cooper Basin, Indonesia, and Tunisia. What was the strategy behind being based in WA and spread out around the world?
Our vision is to have about 50 million barrels of reserves on our books. Very early on in our history we realized that we were probably not going to achieve that in the Cooper Basin alone so we had to look internationally to meet our growth aspirations. In 2004 we initiated a strategy to secure acreage in Indonesia and Tunisia. Indonesia and Tunisia are very attractive countries because they are prospective for hydrocarbons, the fiscal terms versus the risk is acceptable, the political risk in both countries is reasonable, the oil and gas infrastructure is good and they are relatively safe countries. In Indonesia we operate onshore with one block in South Madura – Java – and three small oil fields in South Sumatra. In Tunisia we have two offshore exploration blocks – one operated and one non-operated.
These international assets compliment our nine oilfields and six exploration blocks in Australia.
Does the mooted Australian resources super-profits tax (RSPT) increase the investment attractiveness of Indonesia and Tunisia relative to Australia?
Tunisia and Indonesia have never changed their fiscal terms. Once you sign a contract in those countries, it is stable. We invested in Australia six to eight years ago and the Government is now proposing to change the terms of our engagement. I think if they want to change the terms, they should change them going forward, not retroactively. But the Government obviously has decided to change the terms retroactively which I think is a bit unfair because we made investment decisions based on the fiscal system that was prevailing at the time we made our investment.
In summary, yes the RSPT changes the attractiveness of investing in Australia and we will need to hedge ourselves against this proposed tax change by increasing our presence overseas. Cooper Energy will make sure that the Company is positioned to weather any value risk by changing the mix of opportunities in our portfolio.
Your Tunisian acreage being offshore is a bit of an outlier amongst your onshore blocks in the Cooper Basin and Indonesia. What were the challenges that came with working offshore and adopting a new offshore focus?
This is an interesting question because I am always of the opinion that a company has no soul. A company only exists by the people that are in it. For example, most of the people who work here have previous experience with Chevron, Texaco, Talisman, ExxonMobil, and the like. Cooper Energy itself has no experience; the people in Cooper Energy, however, have all the experience. In my previous job I came from Woodside where I was responsible for developing some very big offshore oil and gas fields. Cooper Energy has never developed a 13 well offshore platform with gas recycling. But I was at one point a person responsible for doing that. So for people to say that Cooper Energy is changing a focus, well, maybe Cooper Energy as a company has never done it before. But the people within the Company have experience so it really was not a problem for us to make that step and it was something that we were very comfortable with. People talk about companies as if they have souls. A company is just a registered vehicle with an address. It is actually the people inside the company who have the experience.
Cooper Energy’s Vision is to become a leading mid-sized oil and gas company. However, all of its production is currently oil in the Cooper Basin in South Australia. Where is the gas part in the equation?
To date we have only discovered oil fields but, like the previous question, we would be happy to develop gas fields if we discover them. Oil fields are usually easier to develop but gas fields need substantial downstream infrastructure. We started in the Cooper Basin and were lucky to make a few discoveries there so we became mainly oil producers with no gas. Should we make a discovery with oil and associated gas, then we will try to export the gas. And should we make a gas discovery then we will become a gas company.
For example, the well we are about to drill in Indonesia is a gas prospect. If we make a discovery, then we will develop it and be an oil and gas company. The portfolio really evolves from the drill bit and it just so happens that we made our initial discoveries in oil. The next one might be gas or might be gas and oil.
As we grow the portfolio will flesh out.
How are drilling targets and commercialization timetables sizing up for Cooper Energy in 2010?
We have a massive program in front of us. Looking at the second half of 2010, we have about 12 wells to drill, including a few important international ones. We have an onshore well in Tunisia and an onshore well in Indonesia that are currently progressing. In the Cooper Basin we have four development wells and five exploration targets that are waiting on rigs. The Cooper Basin wells will hopefully continue to underpin our fundamental value and the international wells will hopefully move us up to the next phase of our growth.
Is the Cooper Basin very crowded with activity?
Almost every block in the Cooper Basin has been awarded. I think people are stretching the frontier a bit more and starting to go to more places where they would not have gone previously. You are also seeing shale and other unconventional gas exploration as companies look for value. In our portfolio we probably have three to four years of prospects left and then we will have to replace those exploration blocks with new acreage. We are active overseas precisely for that reason.
It is a similar comparison to a barrel of apples. If you have a barrel of apples and take one out every day, by the end of the year you will have no apples left. So you have to go to a tree and fill the barrel up again so you can continue to grow. If I just sit with my one barrel you will eventually wither away.
How far along the way until Cooper Energy becomes the major equity holder and operator of its activities?
At this time, our focus is very much on the front-end of the hydrocarbon value chain. We believe that new ventures and exploration can add the biggest value to our company. We are also quite happy to undertake development activities. Once it gets to the production end – turning the valves and managing the day-to-day operations – we would prefer to let others do that. In the Cooper Basin, Beach Energy and Stuart Petroleum operate all of our permits and production. We like to operate exploration because that is where our strengths lie, in the subsurface. We are not averse to doing developments. But if we work with a good operator who likes to develop and produce, then that is fine with us.
The good thing about being an operator, though, is that you are in charge of your own destiny. That is important because you can drive the pace. We tend to be fairly nimble. We make quick decisions and drill wells while a lot of other companies are a bit slower in their decision processes. We like to drive the show so it keeps things moving quickly. I think it is important that we are an operator in the exploration and development phase and then if someone else wants to lead production then that is suitable for us.
Does Cooper Energy stand to directly benefit from the exploration rebate that is tied into the new proposed tax scheme?
Not really. You have to remember that you get a 30% corporate tax deduction on failed exploration anyway; so 40% on the dollar does not really make much of a difference to the value of the company. If you think about project financing: you spend $1 million on exploration and get $100 million back on production. That is how the industry works; exploration risk gets compensated by production profits. So when the Government says that we will get 40% back in exploration risk there is simply no way the Government is going to send companies a cheque back for all the failed exploration – it’s just not going to happen.
Another thing to think about is that we have drilled 30 wells in the Cooper Basin and we have nine oil fields. When we get up to production the Commonwealth government is going to take 40% of our production but will not give us a credit for the 21 dry wells that were previously drilled. The Government is cashing in on the exploration success forgetting that to get that success we had to drill 30 wells. I think we deserve some money back for that. What the Government is doing is a little bit unfair. We do not make super-profits either. We make $40 million in revenue and $12 million in EBITA. We are not a big profits company. But the super tax will remove more money from our bank accounts and will hinder our growth aspirations.
I really do not think that the big companies make super profits either. If you look at the net present value of an LNG project it is typically quite low at around 6-8% rate of return. When looking forward from Day 0, LNG projects are not overly attractive. After capital has been sunk, the risk has been taken, and the projects start to make reasonable profits, the government comes around and says that it will take all your money. If the Government said that on Day 1 they were going to put a super profits tax in place then maybe many of the investment decisions would not have gone through – and perhaps they will not in the future. It’s a very ill-considered tax.
As you mentioned you have worked for large oil companies such as ExxonMobil and Woodside. How do you apply the managerial thinking from a big oil company to a small, but growing company such as Cooper Energy?
I think the oil industry is driven by its technicals. The fundamentals of the business are always the same. You have to have good geologists who know their geology. You have to have good engineers who know their engineering. You have to have good administrative assistants who can run the office. We believe we have some of the best people in the industry here and that helps us grow. As long as you have the fundamentals right, the business should look after itself to a certain degree.
The view that I always take is that the Managing Director is like the captain of a ship. If you have a big tanker sailing along, the captain is nudging it to keep it going. All of the other people on the ship are doing the jobs that they are supposed to do. As long as they are doing their jobs, the ship will keep sailing right. But if the captain has to come off the break and start doing things then you have the potential for an incident. So long as the people in the office are the best technical people I can get, then the business should be pretty safe.
Compared to other exploration and production companies Cooper Energy places a very strong emphasis on its human resources. How would you sum up the corporate culture and the morale amongst the crew of the ship?
We try to have some fun along the way. My philosophy is that everyone here is in charge of their own destiny to some degree. You get a project, you run with it, you deliver it. Because we are small it is very transparent if you are not delivering it. It is like playing football. You get the ball, now run with it. If you cannot run or if you drop the ball, we will all see you. I think the culture here is that everyone is authorized to run with the ball and is responsible for their jobs. We try to have a bit of fun along the way, but at the end of the day, I want to see very good technical work and I want to see you running hard; and you will be rewarded for that if it is a success.
Looking down the road, in five to ten years, how far along the way will Cooper be towards its goal of being one of the leading oil and gas companies in Australia?
At the time that we did our analysis we said that 50 million barrels is loosely equivalent to about $500 million in market capitalization. If you map a graph of time versus market capitalization on a log scale and plot where we are, we are more or less on track with our Vision. We need to accelerate our growth in the next year or so if we are to be really successful.
We increase our value by simply adding reserves to our portfolio. To achieve this we are all out looking for new projects and prospects to drill. I’m confident in our future – we just need to keep applying the technical fundamentals and have a bit of exploration luck along the way.
Are there any final comments or messages that you would like to convey to our readers about Cooper Energy?
Cooper has very strong technical staff and a clear idea of what drives the business in terms of adding value. We are not necessarily conservative, but we are fairly prudent in our choice of opportunities. As a result, it may sometimes look like we are sitting idle, but what we are actually doing is rejecting the unattractive options. If you have the choice between a company that takes a lot of marginal, unattractive projects and one that goes a bit slower but is more cautious in its undertakings, I know that I would want the one that goes slower and is positioned to grow.
I believe that Cooper Energy has a great future; we have cash, we have production, we have an excellent exploration portfolio and we have people who are hungry to add attractive new projects to our portfolio – watch this space.
Investors should visit our website (www.cooperenergy.com.au) for up to date information on the Company.