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Date : 03/08/2021

Warrego Energy Limited



Market Cap : $291.63 Million


52 Week Range : $0.155 - $0.285

Share Price : $0.265

Emerging natural gas player that is close to first earnings following significant progress. We recommend a "Buy".

Company Analysis

Warrego Energy Limited (ASX: WGO) engages in the exploration and development of gas properties. The company holds interest in the EP469 basin covering an area of 224 square kilometres and interests in the STP-EPA-0127 basin, which comprises an area of 8,700 square kilometres located in Perth Basin, Western Australia. WGO also holds two projects in the South of Spain.

June last year, the natural gas price reached lows not seen since 1995 at an average of $2 per million British thermal units (MMBtu). However, since then, natural gas rebounded back to its mean above $5 per MMBtu. With the cleanest fossil fuel available at the lowest price, we are projecting the share of gas in the future energy mix to increase over time. In the case of the rapid development of a net-zero emission scenario, the natural gas price could continue to slip by more than 20%. But we believe this will only happen progressively. We think that natural gas will have an essential role in building a clean energy future. However, to some extent, we also expect a reduced and varied role for natural gas due to the emergence of alternatives and renewables with the regionalisation of industries. Gas seems trapped between oil and gas companies’ decarbonisation strategy of focusing on low-carbon fuels and the broader momentum to replace fossil energy with renewables for power generation. We can expect industrial needs to become the dominant driver of gas demand. Although gas demand, either as a competitive feedstock or for process heat, is expected to remain strong in the medium term. We believe that gas will play an important role in the global decarbonisation process and eventually pair or compete with cleaner fuels. However, it is worth noting that the gas demand might experience a tightening of the domestic market due to the emergence of regulations in favour of green energy.

Warrego, a company with stellar upside potential

If you want to play on the natural gas field, Warrego (ASX: WGO) is on the sweet spot for massive growth potential. Firstly, it is an onshore gas exploration company which means – generally better margins. Usually, onshore gas extraction is relatively cheaper in terms of development and exploitation than offshore. Warrego’s projects are also well-located, its main interests are in the Perth Basin with its transformational assets nearby infrastructure and markets, a great advantage. The company is also well-funded and is led by an experienced management team.

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That said, we are convinced Warrego has an excellent platform for generating long term revenue to underpin growth. Warrego is currently having interests in four projects, two in Australia and two in Spain. The most exciting project is in the Perth Basin where Warrego owns a 50% interest in the West Erregulla EP-469 gas project which has been recently certified 2C of 513 billion of standard cubic feet of gas (Bscf) which suggests a massive revenue opportunity ahead. So, what does it mean exactly? It means that we can soon expect Warrego to generate income from its 2C reserve. 2C denotes the best estimate of contingent resources defined by the internationally recognised Petroleum Resources Management System. If we consider that the recently discovered 2C reserve is coming just from a single well, we can imagine the huge potential that the company has at its disposal to increase its reserves and resources via its current drilling campaign.

These are our top reasons why you should consider Warrego as your next play in the gas sector:

  • Warrego will be on time to deliver its gas production to profit from the rebound in gas price driven by the demand from industrial needs and as a low-cost alternative to the advent of clean energy.
  • Warrego exhibits a prolific onshore gas province with excellent prospective nearby key infrastructure and pipelines.
  • Onshore gas exploration and exploitation is a low-cost solution compared to offshore. Hence, this advantage will translate to a higher profit margin.
  • Warrego has a brilliant and talented management team and we have seen successful major explorations at West Erregulla, Waitsia and Beharra Springs Deep. The firm has also appointed Perth Basin expert, RISC Advisory to undertake independent resource evaluation and certification which provide certainty to gas buyers. Thus, Warrego recently signed a 10-year plus large-scale gas sales agreement with tier 1 customer, Alcoa which has underpinned the West Erregulla development.

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Warrego exhibits a clear development pathway with production expected for the second half of 2022

Warrego has progressed well during the first half of the year. As of the end of June, the firm has a cash position of more than $13.7 million. During the period, WGO has spent more than $10 million-plus for the exploration of West Erregulla. We believe Warrego is sufficiently funded to meet its requirements for further development of its WE-4 well and the recent ongoing work at WE-5 well. The bulk of this expenditure was related to the drilling of the WE-4 appraisal well, which spudded earlier this year in January. What we like about Warrego is that the firm has significantly improved over time, we can note that the drilling time and cost of WE-4 has substantially been better over the WE-2 and WE-3 wells. The WE-4 appraisal was a success, and we are kind of excited to see positive flow test results from the well. Last month, after a 46-hour flow period, Warrego’s WE-4 achieved a sustained gas flow rate of 35 million standard cubic feet per day through a 76/64’’ choke at circa 1,770 psig FTHP. The WE-4 well has been cased and completed as a future producer and the Ensign 970 drilling rig has been moved to the nearby, WE-5 location. Last week on Thursday, June 29, Warrego announced the commencement of its testing operations at WE-5 and confirmed that the well was perforated over a 6 metres interval from 4,641 to 4,647 metres at a total vertical depth subsea (TVDSS). Raw data are currently being evaluated.

At this pace, we forecast West Erregulla Phase 1 final investment decision to be completed by the second half of this year with gas production and sales to begin in the second half of 2022. Warrego’s discipline and solid execution of its plan give us strong confidence in the company. The recent success at WE-4 opens the door to more funding opportunities. In fact, Warrego is currently in advanced discussions with several domestic and international banks for up to a $75 million limited recourse project syndicated debt financing facility to further develop its West Erregulla Phase 1 project.

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Source: Warrego

So far, Warrego is on time for the production and sales as phase 1 of the project is progressing swiftly at West Erregulla. The firm has set priorities to accelerate its development plan to upsize to 80 terajoules per day delivery capacity to honour its agreement with Alcoa. The West Erregulla project development will utilise almost 70% of the processing capacity of the gas plant. To support such volume, Warrego has decided to enter into a balancing agreement with its partner, Strike Energy (ASX: STX), which own the other 50% of the project’s interest, whereby the firm will effectively purchase gas from STX to enable WGO to ramp up more than its 50% share of the field capacity to meet its sales commitments. The gas purchase with Strike has been agreed at a lower price than the Alcoa sales agreement allowing Warrego to even capture a small profit out of it.

For the rest of the Australian exploration, Warrego is undertaking native title negotiations at its North Perth Basin EPA-0127 projects which it owns 100% interest. According to an analysis of the terrain, the project’s area has been identified with fault-bounded traps that could be favourable for hydrocarbon capture. For now, Warrego is still seeking to obtain the exploration permit for this large onshore block.

As for the Spanish assets, Warrego is in discussion with various entities interested in acquiring all or part of its holdings in the Tesorillo and El Romeral projects. In the meantime, Warrego is expected to further develop the Tesorillo project and continue to be in contact with local government agencies to progress drilling approvals and permitting. The Tesorillo is a conventional sandstone gas reservoir of 94 thousand acres in Southern Spain which is estimated to contain 830 billion cubic feet gross unrisked prospective resources on the best estimate basis. The other Spanish project, El Romeral has some big potential as well that could turn up. Hence, El Romeral is an integrated gas production and power station operating on 76 thousand acres. The project comprises three producing wells with thirteen prospects and multiple low-cost development opportunities with the potential to substantially increase gas production for electricity generation. Electricity prices have been reported to be exceptionally high and have been for some time. Warrego has established a technical committee to evaluate immediate opportunities to enhance production and to put together a long-term view of development prospects with the objective to ramp up production at a time of high electricity prices.

Investment Thesis

Warrego to navigate the West Australian gas market tightening

We consider that Warrego provides an excellent early-stage investment opportunity into the emerging onshore Perth Basin deep gas play. Overall, we see in WGO strong resource upside, particularly from its promising West Erregulla project which recently saw significant progress. Warrego has even entered into a gas sales contract agreement with the giant Alcoa to underwrite future field development. The gas processing agreement with the Australian Gas Infrastructure Group is also a positive catalyst that enables WGO’s midstream development. All in all, we are strongly confident and are looking forward to the first production and sales expected for the second half of 2022.

The first phase of the West Erregulla project is planned to deliver a capacity of 80 terajoules per day. This has been confirmed by multiple Gas Supply Agreements which underpin the final investment decision. For the second phase of the project, WGO plans to increase its nominal capacity to 100 terajoules per day to respond to the anticipated gas market tightening that is projected to take place onward 2025.

This upcoming market event is an opportunity for Warrego to win some sales agreements with gas buyers that are planning to secure supply ahead of 2025.

Relative valuation: Warrego 47% cheaper than Strike Energy

When we look at Warrego (ASX: WGO), we can see that WGO is substantially undervalued compared to Strike Energy (ASX: STX) despite both companies owning 50% share in the same principal asset of West Erregulla. The market values Warrego at a discount of approximately 47% to Strike Energy in market capitalisation terms. This confirms that WGO has significant room for upside potential.

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The 1-year share price performance of WGO and STX

Ample liquidity to support further explorations and to achieve the first sales by the second half of 2022

Warrego exhibited strong operating discipline throughout the last few years, we can see that the company is doing relatively well in managing its cash burn despite not having produced any revenue since FY17. From FY17 to FY20, WGO has improved its working capital by an impressive CAGR of 71.4%. According to our analysis, we are projecting the working capital to keep on this positive trajectory, however with a more conservative CAGR of 25.2% throughout the next 3-year period. On top of that, WGO is also well-received by the community of investors which led to increased funding since FY19. Recently, Warrego successfully conducted a $50 million two-tranche placement with firm commitments received at 22 cents per share. The company will utilise the proceeds to continue to fund phase 1 of the West Erregulla project including the purchase of long-lead items for the 87 terajoules per day gas processing plant and long lead items for the upstream gathering system. The proceeds will also contribute to the re-entry, drilling, testing, and completion of the WE-3 appraisal well. Overall, Warrego appears to be well-funded, and we think that further capital raising may not be necessary at least until the end of FY23 at the current cash burn rate.

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Technical Analysis

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WGO price action has been impressive since the COVID-19 global market sell-off. Warrego share price rebounded by more than 252% from its COVID low at 7.5 cents to 26.5 cents per share at the current market price. WGO is now priced at the same level as the pre-COVID high sitting slightly under the key resistance at 27.5 cents. The “27.5 cents” is a long-term key level that defines the top of the long-term ascending triangle pattern. Theoretically, the ascending triangle is a bullish pattern, hence WGO is supported by the long-term upward trend line while being trapped under the resistance at 27.5 cents. The reduced volatility and the accumulation of buyers at the tip of the triangle suggest a forthcoming breakout rally which can send WGO’s share price back to 2019’s high above 40 cents per share. However, the RSI indicator is suggesting a diverging signal. A correction might be due, and we might see WGO moving back to its price equilibrium at 22 cents per share. The “22 cents” level is a confluence area between the price equilibrium and the recently issued share price from the latest placement. This price range also coincides with the upward trend line. In our view, we expect WGO to remain stuck between the 22 – 26.5 cents range until after the release of the earnings report on the 31st of August.

Volume and momentum

Volume increases since the last 200-day with the 20-day volume average up by 125%. The price action remains bullish in the near term, evolving in a range between 22 cents and 27.5 cents per share.

Trade consideration

  • Market participants might be interested to enter at key support levels: 25 cents and 22 cents.
  • Primary target price above 40 cents per share
  • It is recommended exiting the trade below 19.5 cents per share

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Warrego provides an excellent early-stage investment opportunity into the emerging onshore gas play in our opinion. Overall, we see in WGO strong resource upside, especially from its promising West Erregulla project which recently saw significant progress. The recent gas sales contract agreement with the giant Alcoa to underwrite future field development is a clue that WGO is on the verge to finally achieve its first earnings. Furthermore, the gas processing agreement with the Australian Gas Infrastructure Group is also a positive catalyst that enables WGO’s midstream development. All in all, we are strongly confident and are looking forward to the first production and sales which is expected for early FY23. In terms of valuation, WGO is at a discount of circa 47% to Strike Energy which by the way owns the other 50% of the West Erregulla project when we compare the market capitalization of both companies. Considering the significant room for upside potential, WGO is a “Buy” from us to long-term investors.


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