Key Petroleum Limited (ASX: KEY) is emerging as one of Western Australia’s brightest oil and gas explorers.

The company has a well-established position in the Perth Basin, having focused on a new phase of activity centred on the L7 (R1) Mt Horner acquisition, and the adjacent Wye Knot-1 drilling program in EP 437.

The Perth Basin has become a hot spot for oil and gas explorers on the back of corporate activity, exploration success and recognition of the promising supply demand dynamics that should support strong pricing in the coming years.

Highlighting why there is interest in this region is Strike Energy (ASX: STX), which received an overnight five-fold share price increase after announcing a significant gas discovery in the Kingia sandstone as part of the West Erregulla-2 drilling campaign.

This resulted in Strike’s market capitalisation soaring from less than $100 million at the start of fiscal 2020 to more than $400 million as its shares increased from approximately 6 cents to hit a high of 31.5 cents.

Shares in Key Petroleum increased more than threefold when Strike Energy released its news, due to the fact that it has substantial acreage and established resources in close proximity to Strike’s discovery.

While Key’s price has come off following a drop in the oil price, it could provide a buying opportunity for investors who like targeting under the radar stocks.

Key’s assets

Importantly, the group’s Bookara Shelf Project which incorporates the L7 (R1) Mt Horner acquisition, and the adjacent Wye Knot-1 drilling program in EP 437, comprises Key’s Perth Basin holdings and is located near infrastructure including pipelines and refineries in the Perth Basin.

Beharra Deep, West Erregulla and Waitsia gas discoveries lie on trend to the south from the Bookara Shelf Project.

Prospective resources for EP 437 and L7 now include the deeper Kingia/High Cliff Reservoirs, representing a material impact for the Bookara Shelf Project.

The case for Key Petroleum

While STX is one of only a handful of companies with acreage exposed to the Kingia/High Cliff play, Key Petroleum is the only one with on trend High Cliff and Kingia plays that remain undrilled.

However, the most useful means of arriving at a fair valuation for Key Petroleum at this stage is to weigh up the size of its resource against Norwest Energy (ASX: NWE).

One of the most important factors in terms of assessing Key’s investment metrics is its heavily discounted enterprise value relative to the likes of Strike and the smaller Norwest, which the has less to offer in the way of defined resources, yet trades at a significant premium to Key.

For example, Norwest has a mid-range estimated prospective gas resource of 92 billion cubic feet (BCF) at its EP 426 and EP 368 wells (net to Norwest – 20% stake).

This includes the Lockyer Deep-1 well which is a Kingia/High Cliff gas target with a 459Bcf mid case prospective gas resource (100%).

The $4 billion iron ore producer and mining services company Mineral Resources Ltd (ASX: MIN) is a substantial shareholder in Norwest with a stake of nearly 20%, and it has secured land access to drill the Lockyer Deep-1 well within EP368.

NWE has a 20% stake in this well and will contribute 20% of the cost.

Based solely on its gas resource, which exceeds that of Norwest by 60%, Key should be valued in the vicinity of $35 million.

However, Key’s enterprise value currently stands at approximately $4 million, making it a potential 10 bagger as it progresses to production and/or delivers a significant discovery in an area that is establishing itself as one of the most highly prospective regions in Australia.

Aside from its asset value, what makes Key all the more attractive is its ability to generate income from the company’s services business while investing in its exploration pursuits, leaving the group less reliant on raising capital.

Cash flow generation could be strengthened further in the near term if management chooses to monetise the oil resource that is on offer at L7, as this can relatively cheaply be trucked to the Kwinana oil refinery.

Demand for both oil and gas is likely to strengthen in the coming years, which should highlight the Perth Basin’s geographic advantages. With an important stake in a highly prospective onshore play in this region, Key is in a strong position to realise its value and emerge as a significant player.

By Jonathan Jackson

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