Fox-Davies Capital Limited a highly respected London based...

Fox-Davies Capital Limited a highly respected London based research house has put out coverage on four companies with BUY recommendations for Sydney Gas, Arrow Energy, Fortune Oil and a Sell for Queensland Gas.
The recommendations are:
SGL SP A$.38 BUY Target A$0.48
Arrow Energy SP A$2.75 BUY Target A$3.26
Fortune Oil SP 6.17p BUY Target 9.10p
Queensland Gas SP A$2.75 SELL Target A$1.47


SYDNEY GAS COMPANY. (SGL AU)

Background
Sydney gas listed in Australia in June 1996 and is developing CBM projects in New South Wales, targeting the Sydney gas market. In 2005, SGL sold 50% of its assets to Australian Gas Light (AGL) and entered into a joint venture agreement to develop its tenements. The company's core development is the Camden gas project, which is entering the second stage of expansion. It is also exploring in two tenements,
( PEL4, PEL267) in the upper Hunter Valley, where it has already drills two pilot production Wells.

Key Assets.

Camden gas project
The project is located 50 km southwest of Sydney and is operated by AGL. It has been supplying AGL with gas since May 2001 and it is estimated that it will cost A$150 mn to fully develop the field. The contract with A G. L. has duration of 10 years with the option to extend for another four. SGL is contract to supply 14.5PJpa (13.2bcfpa) from 2008. The project is being developed in two stages.

Stage one has been completed and comprises 21 production wells and one gas processing plant. It is covered by two production licences. These licences were the first of their kind in New South Wales as the State has no other sources of indigenous gas supply. Production from stage one has remained constant at 2,250GJ per day (2mncfd) with the bulk of this production coming from the seven top performing wells. The stage one planned (Ray Beddoe Treatment Plant) was decommissioned in February, 2007 and the gas from the stage one wells is now directed to the field facility at Rosalind Park (RPTP).

The second stage of development is under way and aims to expand total production to 40mmcfd (14.5PJpa) or approximately 8% of the current gas consumption in New South Wales. Total producing wells to date are 68, with a further three completed but not tied in and four awaiting stimulation and completion. The RPTP, a second larger gas processing plant was commissioned in December 2004 and is located 500m from the Moomba to Sydney Gas pipeline. SGL has stated that compression will be added in line with increasing production. Indeed, this has been occurring and installed capacity is now available up to 26TJ/day (23.6mmcfd), which is approximately twice the current rate of 14T J/day (12.7mmcfd).

An extension to the original AG L contract was signed in September 2005 increasing the contracted volume to 14.5 PJpa (13.2mmcfd) from June 2008 for 10 years. This contract commits all of the gas produced by all phases of the Camden development, which could be substantially extended in area over time.

During 2Q 2007, seven vertical and four directional wells will be drilled. Also eight vertical directional wells will be fracture stimulated. The company will continue to construct in-field infrastructure as well and interpret seismic darter in an effort to locate potential drilling targets. There is potential that conventional gas reserves are located under the coal seams and the joint-venture is developing options for the production of this gas.

Hunter Gas Project and Merriwera Prospect
SGL is exploring this project to the north of Sydney. Core hole drilling started in January 2007 with the aim of determining the gas composition, gas content and coal seam thickness. This information is required to confirm the location of pilot production Wells.

The joint-venture has given technical approval to drilling six exploration core holes, one of which will be drilled by the end of June 2007. It is also acquiring 131 km of 2D seismic within the project area. The company does not expect either the Hunter project autumn Merriwa (located in block, PEL 4) to come on stream in the short term and anticipates that it will be several years before commercial production starts at these projects.

Cash flow Analysis
We've made the following assumptions when valuing Sydney gas assets.

- Base gas price, A$3.40/mcf.
- Upside gas prices for high value A$3.50/mcf.
- Operating costs of A$1.18/mcf.
- Capital expenditure for the period 2007 - 2010 will total A$64mn.
- We have estimated that the is approximately 92 PJ of exploration upside possible from SGL's current Australian assets. We estimate that these reserves could add A$32mn in value.
- However, further work will be required to move these reserves from the 3P to the 2P category.
- We value Sydney Gas' asset base at a A$0.48/share using a 10% discount rate

Summary
- Sydney gas has a strong portfolio of exploration and producing assets located close to the Sydney gas market in Australia.
- Following the deal with AG L, SGL has shown that its assets and business model are attractive. Whilst we do not see Sydney gas being approached in the short term, it remains likely that any exploration success may result in future, M&A activity.
- The recent, unexpected retirement of the managing director Philip Moore is a loss to the company, but hopefully this will lead to only minor disruption.
- We are initiating coverage on Sydney Gas with a BUY recommendation and a target price of A$0.48/share.

Angers
Still hearing persistent rumours of a T/O for SGL