I always find it surprising that private investors are prepared to take big risks on the drilling of oil and gas wells, yet they won’t touch certain shares due to geopolitical risks. I would argue that in most cases, and unless the countries where these companies operate turn into a war zone or see a fundamental change in political regime, there is far less risk involved than there is in an exploration well where statistically it is far more likely to fail. I’ve watched the recent decline in the JKX Oil and Gas (JKX) share price, and whilst that will be partly down to the lower gas prices which we have seen in recent times, I think that a fair amount of that is also down to the fact that its producing oil and gas fields are located in the Ukraine and southern Russia.
When you consider the fact that it is producing close to 12,000boepd and has virtually no debt, not to mention substantial amounts of reserves and resources, then the current market cap of just £46 million, at a share price of around 27p, seems crazy and suggest that far too much weight is being placed upon the potential risks. The company does have a bit of a chequered history, aside from the fact that it operates in countries that some investors are wary of, including a fallout with its largest shareholder, Eclairs Group (currently with 27.54% of the shares in issue) a few years back which resulted in accusations of an attempt to gain control of the majority of the voting rights, and was settled via a court case. There are also outstanding legal cases in the Ukraine, partly relating to claims of underpayment of rental fees on licences, and dating back to 2010, but one of those cases was recently settled in favour of JKX, and the remaining seven should be settled by the middle of next year. The company has already made provisions in its accounts relating to the 2010 and 2015 rental fees disputes - $13.8 million in current liabilities as this is expected to be resolved by the end of 2019; and $33.5 million for the 2015 dispute, with a hearing taking place prior to the end of June accounting period – and has the ability to settle should it lose these cases. That is the main risk here as far as I can see – even though it has won the first case doesn’t mean it will be successful with the others, although the odds look favourable – as although it does have the resources to meet it, it would still be a big blow for the company.
The biggest problem has been that most of its production is made up of gas, and the prices realised have been weak – especially in the Ukraine, where prices for Q3 2019 were 21% lower than in the previous quarter, despite being fairly stable in Russia (down just 2%). The last set of financials, the interims up until the end of June, showed that the company made a net profit of $2.2 million, and although it is now producing substantially more, the weaker prices will have had an impact – just how much is hard to gauge as prices are volatile and cyclical, and that is reflected in the amount that the company holds in inventories. At the end of September it had $11.5 million of inventories, along with $9.5 million, and all of its continuing capital investment into its various fields was still coming from cash flow generated from its operations. Sometimes you get companies where current production looks strong but there are questions about the longevity of that, but that certainly isn’t the case here as its 2P reserves across all of its assets stand at 93.9mmboe, along with 381.7mmboe in the 3P contingent resources category.
Ultimately, where the share price goes from here will largely come down to gas prices, and we may continue to see weakness in those for some time to come. We are now entering the time of year where demand always increases, but currently there is a large amount of gas in storage which will need to be drawn. Other factors also come into play, including the demand from Asia, and China in particular, plus the increased in the supply of LNG from the US, which has reduced the reliance on gas being piped from Russia to the rest of Europe. All of this is creating a lot of uncertainty about gas prices going forwards, but that is out of the hands of JKX and all that it can do is continue to perform well operationally. I would also argue that many of these negative gas pricing factors are already factored into the share price anyway as they are known to the market. Of course, JKX isn’t totally reliant on gas prices as it does also produce oil – although the Brent price has also weakened in recent months – but the business does mainly revolve around the gas. So, taking into account the risks arising from the court cases along with possible weak future gas prices, and weighing that up against growing production; the size of reserves and resources; lack of debt; and cash generation funding current expansion and work, I would view this as a buy at current levels. But I wouldn’t necessarily commit all of my funds just now as we may well see further share price weakness. But I do view it as a good time to take an initial position as long as you are intending to hold longer term as an actual investment, as it does have the potential to quickly generate substantial amounts of free cash flow should gas prices improve.
Filed under: JKX, Peter Shea, Neil Woodford, RM2, Panorama, Amur Minerals, Sheriff of AIM
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