Renergen — On track for liquid production by mid-2021

Over the last few months Renergen has made several announcements that give us increased confidence the company will be able to switch to LNG and helium production in around July 2021. The company has also acquired the remaining 10% of the Virginia Gas Project that it did not own (in a significantly value-accretive deal). Meanwhile a horizontal well is currently being drilled in an untested sandstone reservoir and is showing encouraging results both for flow rate and helium concentration that could add additional volumes to existing reserves and resources during 2020.

Renergen is currently drilling and logging a horizontal well targeting a prospective shallow Permian Karoo sandstone that sits within the Virginia Gas Project production area. The sandstone was originally identified in the 2016 well, 2057, which encountered gas at 290m. The helium concentration in 2057 was found to be almost 11%, compared to c 3% on average in the rest of the field. Renergen estimates that the sandstone is up to 100m thick in sections and covers an area of up to 90km2.

The current well is designed to assess the scale of the helium and methane reserves in the sandstone. These reserves are not included in Renergen’s existing reserve estimates (current reserves are primarily based on deeper underlying fault zones below the sandstone). The planned horizontal section of 1.5km through the sandstone would maximise exposure to the faults and fractures where flow is expected to be highest, with the well path targeting three major fracture zones. The well is targeting gas bearing structures within two primary target zones, the upper Vryheid Formation sandstones and Dwyka Group diamictite.

Renergen was expecting to complete drilling of the horizontal section in January, having completed the vertical and toe sections of the well in late 2019. Very encouragingly, the company reported strong gas flows almost immediately once the well entered the sandstone; in fact, gas shows in the drilling mud were reported while still in the shallower Karoo formation. After drilling only 50m of the horizontal section, the company reported a choked flow rate of 850mcfd, which is substantially ahead of pre-drill expectations.

In addition to the strong flow rates, Renergen has also reported that gas from this section contained 12% helium and more than 75% methane. The helium concentration is similar to that previously reported from the 2057 well in the same area of the structure, and well above the helium concentrations Renergen assumes in its current reserves and resources (average 2.33% for 2P reserves).

While we expected drilling of the horizontal section to be completed in January, the most recent announcements from the company are that further drilling has been delayed. We understand the delay is to replace the rig blowout preventer (BOP) with a larger facility suited to the potential flow rates being seen while drilling. We understand the replacement BOP will be in place around late January/early February after which drilling can recommence. However, given the large flow rates seen at the toe of the well it is not yet clear if Renergen will be able to complete the horizontal well as planned, or if an alternative well plan will be deployed. While awaiting the replacement BOP, Renergen has been running electric logs since 17 January 2020 and these will be used to evaluate the forward programme for the well.

In addition to the horizontal well, Renergen has confirmed that the first of its planned inclined wells in the Phase 1 development and appraisal programme will spud in early February. We expect results from the inclined wells to be available around six weeks from spudding. Renergen expects to accelerate drilling of the inclined wells in due course using multiple rigs. At present there are a large number of suitable rigs readily available in the South African market.

The results of the horizontal well and the inclined wells will be incorporated into an updated reserves and resource report. Initially the plan was to have this complete by end March 2020; however, we now understand this is likely to slip to around April/May given the delays with the horizontal well and the potential complexities from the unusually high flow rates.

Following the closing of a US$40m loan in late August 2019 with US government agency Overseas Private Investment Corporation (OPIC), Renergen triggered the final milestone in late October 2019 to start construction of its Virginia Gas Project by appointing Western Shell Cryogenic Equipment Co (WSCE) as the equipment supplier for its first LNG and liquid helium plant. EPCM Bonisana (Pty) (EPCM) will separately install the pipeline and manage the interface between the two installations.

The plant is expected to be installed by April 2021 (ahead of first gas to the plant in July 2021) and will have capacity to produce up to 2,700GJ of liquid natural gas and 350kg of liquid helium per day.

We assume capital costs for the first helium and LNG liquefiers of US$3.6m (ZAR52.5m) and US$14.4m (ZAR210m), respectively, along with ZAR27m for power facilities.

Interestingly, Renergen is being very open regarding the milestones to reach first LNG production, and has announced its construction schedule and committed to the market an update as each milestone is reached (Exhibit 3).

This unusually open approach gives us confidence both as to how realistic the schedule is, and that we can track progress accurately towards first LNG production in mid 2021.

Renergen’s Virginia operation will be South Africa’s first commercial LNG facility as well as being sub-Saharan African’s first supplier of liquefied helium gas. As discussed in our previous notes, the majority of LNG production is expected to go into the South African domestic trucking market, in part replacing compressed natural gas (CNG) that Renergen is already supplying to a limited but growing number of domestic truck operators (see below). In the longer term there is the possibility of a substantially larger domestic LNG industry if the Total-operated Brulpadda field discovered in early 2019 is ultimately developed, although this will be some years off.

Ahead of LNG production in 2021, Renergen continues to grow out its commercial agreements with domestic truck operators for CNG. In September 2019, the company announced the commissioning of its second CNG filling station in Johannesburg, which will supply CNG to a fleet of approximately 15 trucks to be operated by Black Knight Logistics. Initially, these trucks will run on a combination of CNG and diesel, and once Renergen’s LNG facility is commissioned, they will be modified to take LNG, which will increase the refuelling range of the trucks. We understand the conversion from CNG to LNG is relatively simple/low cost.

We expect the new Black Knight trucks to consume in the region of 4GJ/day of CNG, ie adding a potential 60GJ/day to Renergen’s current CNG production. This would effectively triple the company’s revenues in the next 12 months (ahead of LNG production from 2021).

Renergen announced in late December that it was acquiring the 10% Black Economic Empowerment (BEE) stake that it did not own in the Virginia Gas Project (owned by BEE partner, Cheryl Sjoberg) for ZAR23m (A$2.33m), net of loans. Given we previously valued Renergen’s 90% stake (on a risked basis) at US$159m (c A$230m) this was clearly a highly value-accretive deal to Renergen. We understand the deal was particularly attractive for Renergen as the company had previously funded the BEE partner with loans that would have made the sale to a third party less attractive.

Renergen has indicated it will not need to secure BEE investors for the 10% stake based on the ‘once empowered, always empowered’ principle adopted in South Africa. However, the company is open to considering any fair, market-related offers from BEE investors for the 10% stake, and has emphasised its continuing commitment to transforming and growing South Africa’s economy.

To fund the acquisition of the additional 10% in the Virginia Gas Project, Renergen has raised in January 2020 an additional A$5.75m in equity (at A$1.2/share). This will also give the company additional funds to appraise the horizontal well and accelerate the inclined well programme as required. Encouragingly, we understand the raise was taken up by a number of institutions, in contrast with the ASX admission raise, which was split between a cornerstone investor and Australian retail investors.

Renergen also announced in November 2019 that its largest shareholder, Tamryn Investment Holdings Proprietary (Tamryn), had entered into an agreement with a private Chinese group, Notable Pioneer, where Notable Pioneer may acquire up to 20m shares from Tamryn, ie c 17% of the share capital. This would increase Notable Pioneer’s stake in Renergen to 24.81% (prior to the January placement). The option to acquire the stake expires on 5 February. We note that the South African Companies Act requires a mandatory offer to be made once a shareholder breaches 35%.

Reflecting the increase in Renergen’s stake in the Virginia Gas Project to 100% (which was highly value accretive) and the January 2020 placement (which is slightly dilutive at A$1.20 or ZAR11.8), plus some adjustments for ZAR/US$/A$ exchange rate movements, our valuation moves from ZAR20.5/share to ZAR23.9/share. However, this is still based only on the existing 2P natural gas/ helium reserves prior to testing of the Vryheid Formation horizontal well currently being drilled. All our numbers are likely to change once updated reserves and resources are available in Q220.

We continue to risk our model for development uncertainty by applying a 90% development/ commercial CoS for stage one and 70% for stage two and recovery of remaining 2P reserves. As the company achieves more of its construction milestones for stage one, we will expect to unwind the 90% CoS for the first phase of development.

Geological risk is accounted for in our DCF calculations based on the assumption that only 60% of wells drilled will be commercial (and connected to pipe). This is based on the historical success that the company has had intercepting natural gas- and helium-bearing faults in the underlying Witwatersrand Supergroup with its legacy vertical wells. If the company is successful in proving that the Vryheid Formation sandstone is able to accumulate natural gas and helium within the sandstone reservoir (and that this can be exploited with horizontal wells), then this should result in a substantial increase in the repeatability of wells and improved drillex economics.

In keeping with our previous research, we do not ascribe any additional value for Renergen’s substantial contingent resources.

Our base valuation is based on the 2P reported levels of helium (2.33%) and the final US Bureau of Land Management (BLM) auction price in August 2018 ($280/mcf). However, with a potentially tightening helium market (refer to our February 2019 helium macro report for more details) and the possibility of significantly higher accumulated helium in the Vryheid Formation sandstones, there could be substantial upside to our valuation based on ultimate helium volumes and prices. The sensitivity table below (Exhibit 6) shows the impact of these uncertainties on our base case (2P) valuation.

Our valuation is also sensitive to the current and future LNG situation, both globally and domestically in South Africa. Currently Renergen is likely to enjoy an LNG price that is linked to domestic diesel prices with an assumed 30% discount. However, as described in our 2019 outlook note we assume that this will switch to an Asian LNG-indexed model at some point (we assume 2025) as domestic markets become more exposed to LNG imports. Both Asian LNG prices and South African diesel prices are similar to when we published our 2019 outlook (South Africa diesel is currently ZAR14.62/litre vs ZAR14.46/litre in July 2019, and the Japan LNG import price is US$10.05/mmbtu vs US$10.13/mmbtu in July 2019), hence we maintain the LNG price assumptions outlined in our 2019 outlook, as shown in Exhibit 7.

Our base case core NAV assumes a 30% discount to diesel up to 2025, and an Asian LNG-indexed price of US$12.8/mcf thereafter (inflation adjusted). As we show in Exhibit 8, our valuation will move as these variables change.

The 2019 ASX listing proceeds and January 2020 placing (c A$16m or ZAR162m) and the US$40m OPIC funding (ZAR521m) should cover almost all capital costs required for Renergen to complete Phase 1 of its Virginia LNG/helium development (Exhibit 9). We estimate at the point of first LNG production – around July/August 2021 – the company will have a negative cash balance of c ZAR5m (A$0.5m). This forecast may change once Renergen clarifies the work programme to complete the sandstone appraisal programme.

However, thereafter Renergen can be expected to be cash flow positive and the net debt position from mid-2021 should improve dramatically as we show in Exhibit 10.

The cash flow outlook will be very different if Renergen presses on with Phase 2 development at Virginia as shown in Exhibit 11. This forecast is based on current 2P reserves and will change once the updated reserves are available in around May 2020.