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Eagle Bay Resources

Juniors Urged To Embrace Forward Selling Methods

Junior oil and gas companies should look at the mining industry to embrace forward selling methods to help fund their production projects following "historic" developments in the Australian share market after it discounted share prices of companies involved in the Cliff Head and Jingemia oil discoveries in January.

The advice was given by Tony Rechner, the Chairman of Perth oil, gas and mineral explorer Eagle Bay Resources. Rechner has employed the technique, widely used in the mineral exploration industry, to help develop several gold mines, including the Mt Percy mine in WA's goldfields, the Galtee More mine and the Chalice gold mine.

Rechner explained that the process usually involved an independent feasibility study of the estimated reserve size, which was then forwarded to a merchant bank which funded the project against forward sales of the commodity.

He said this kind of arrangement could be used to help pay for the development of projects, citing the recent Cliff Head discovery. "They have made a discovery … and the market has said, well that's good boys, but you are now going to trade at a lower price than before that discovery because we are terrified about how you are going to raise the money to do this development", he said.

"It is becoming inappropriate for small companies to engage in oil and gas exploration in the current market because the market says the development costs are so great, you are so small, you are never going to be able to do it, and even after the discovery we are going to trade you at a lower premium than you were at before the discovery."

He said forward selling had become a feasible way for mining companies to operate, and could be applied to junior oil and gas exploration companies. Rechner said the recent discounting of share prices for companies that had made a discovery was a new development in Australian share market activity.

"The industry has said we will fund you through the exploration stage but we will then discount your shares if you have a discovery", he said.

"And in a down market like we've got at the moment, it becomes a self-fulfilling philosophy. It is an extremely important point of Australian exploration history that these six companies that have been involved in the Perth Basin are trading at a discount. And if you don't recognise that, or pretend that it's in some way just the market coming off, then you will be bound to repeat the lessons of history."

He said junior companies could get an independent feasibility study carried out, present it to a bank which would provide "project finance" with the security for the lending agent being the project itself. "Now that's not available if you've got a major as a partner because they don't want to do that, they have their own internal funding arrangements and you can't finance 5% because … its not the same security as having the security of the project which is what we do with gold", Rechner said.
"We say, here is the gold mine, you've got the ounces in the ground, if it all goes wrong at least you can shut the mine down, you've got the ounces and when the price gets better you can start up again." He said the main handicap facing junior companies was the small equity splits in joint ventures, but this could be overcome if the whole joint venture agreed to take part in a forward selling deal, a concept easily enshrined in the joint venture operating agreement.

"And there is a longer time lag and less facility to sell your oil forward because in gold you can do the feasibility in a few months, and a merchant bank will lend you the money in two weeks, and you can sell all the gold forward instantly. Well that's still possible in oil, you can sell oil forward but it's on longer term deliveries and you have to have the whole project, not 10%, as security".

Eagle Bay Resources has used this technique to help acquire a diversified portfolio of mining interests since being floated as a mining company in 1987. Rechner has a strategy of setting up exploration companies and selling them off once they reach the production stage. He has done it three times during his career so far, and is hoping to repeat his earlier success with Eagle Bay.

The signs are looking good for Eagle Bay in the minerals sector. The company recently farmed into a copper and gold prospect, at Myall Creek in South Australia, with Minotaur Resources. Rechner said the prospect, which is scheduled to be drilled during the first quarter of this year, could provide potential rewards equivalent to drilling an offshore oilfield, but at a fraction of the price, about $100,000.

Eagle Bay also owns outright the Uley graphite mine, 32 km from Port Lincoln which Rechner said contains a ‘world class resource’ of high grade flake graphite, a major component in the manufacture of the new emerging fuel cell technology. Rechner said the mine has an expected operational life of more than 100 years. The mine also comes complete with a $14 MM processing plant, with an annual production capacity of 14,000 t, funded by previous joint venture partners, Pittston Mineral Ventures.

But it's been a harder slog in the oil and gas industry after Rechner decided to get back to his roots in an attempt to diversify the company's operations. Rechner has been involved in several oil discoveries during his 30 years as a geologist, including positions as operations manager for West Australian Petroleum (WAPET) and Chevron Oil in North Africa.

Eagle Bay's first foray into the oil patch occurred about four years ago when it picked up a number of blocks (100% EBR and diluting) in the offshore Gippsland Basin near the Patricia Baleen (East Patricia VIC/P47) and Sole fields (VIC/P41). It drilled an exploration well, Northright-1 in VIC/P41 in April 2001, but it was a duster.

Eagle Bay has carried out 2D and 3D seismic surveys and additional geological and geophysical reviews in both permits. It has offered a farmin deal to Bass Strait Oil Company (BSOC) for VIC/P47, which includes BSOC paying for the cost of interpreting seismic data and drilling a prospect. This will be either North Kipper or East Patricia, depending on the seismic results, to earn a 75% interest in the permit. BSOC can also increase its equity in VIC/P41 from 20% to 75% if it funds the total cost of drilling a well or records 250 km of 3D seismic.

So far, Eagle Bay has had $7 MM worth of seismic acquired over its permits, all funded by other companies. They are obliged to provide the seismic data acquired over the permit areas to Eagle Bay under the Petroleum Submerged Lands Act.

But getting funding to drill the next well in VIC/P47 is proving difficult, a problem Rechner said most junior companies were facing in the current economic climate. He said the drilling of Northright-1 in 2001 had cost Eagle Bay about $5 MM. "We were able to raise that money and drill 100% by ourselves", Rechner said. "So there is no question that it has been historically possible to raise that sort of money, but it is not possible today."

Rechner said diversification provided coverage in a range of commodity sectors and rejected concerns that his company was spread too thinly and lacked the expertise needed to manage diverse technical operations. "I think it is important now to run a diversified group", he said. "If you just run an oil and gas group, and the share market is clearly not supporting even those small companies that make discoveries, and the majors aren't farming in and drilling the wells any more, where do you go?"

"If you are not diversified you don't go anywhere, and for that reason I think it is important that you should have other assets such as gold, and in our case graphite, to give you an area to go to. We are talking about survival and I don't think you can entrust your survival to the majors or the oil industry at the moment."

Rechner believes that once an explorationist, always an explorationist. "We've had three exploration companies, all of which made major discoveries and all of which were taken over. We sold the first one to Alan Bond, that was Windsor Resources, we sold Rob de Crespigny his first company, Brunswick, when he left Hungerfords and Resolute Resources bought Geography Resources for the Chalice Gold Mine. "I can't go into production, I'm an exploration geologist", he said.

Eagle Bay had a 22.5% interest in an offshore Timor Sea block, permit AC/P32, but recently sold it. It has a 25% interest in two offshore Carnarvon Basin exploration permits, EP423 and TP21, near the coast between Barrow Island and Karratha. In September, 2002, Eagle Bay acquired a 25% interest in the Browse Basin permit WA331P which contains several cornea lookalikes.

Rechner has also had an eagle eye on international opportunities, with the company negotiating to acquire some acreage in offshore West Africa.