By Steven Ralston, CFA
Last week, Dejour Energy (NYSE MKT:DEJ) announced the closing of a C$3.5 MM debt facility due December 2014, the proceeds of which are being received in two parts. A part of the first portion, which totals C$2.5 million, was received last week and has been utilized to retire the entire non-revolving Tranche B of the bank credit facility (C$1.45 million), which was due on June 30th, and part of revolving Tranche A (C$200,000), both as required by the covenant of the bank credit facility. The balance of the first part and the second part (C$1.0 million) will be received in July. The revolving $3.7 MM bank credit facility (Tranche A), which is collateralized by the assets of the company, continues to be available to Dejour.
The C$3.5 million debt facility, which is being provided by Invico Performance Yield Fund Limited Partnership, carries incremental costs, but also provides benefits. On the cost-side, 1) it carries a 14% annual interest rate, which is higher than the rate on Tranche A (Prime +1%) and Tranche B (Prime +3½%) of bank credit facility; 2) it requires a 3.5% cash fee (or C$122,500) payable to Colonial Advisory, which acted as agent for the transaction; and 3) it entails the issuance of 7,291,667 two-year warrants exercisable at C$0.24 per share, which will result in more shares of Dejour being issued if and when Dejour common rallies above the exercise price. On the other hand, the benefits include 1) the fulfillment of Dejour’s obligation to retire Tranche B of the bank credit facility by June 30th, 2) a new relationship with a Canadian institutional lender, 3) a more comfortable relationship with the company’s existing Canadian bank in terms of satisfying the terms of the covenant of the bank credit facility, the receipt of $1.75 million if and when the warrants are exercised and 4) the improvement of the company’s working capital position to better support the completion of and the initiation of NGL production from the initial four wells at the Kokopelli project in Colorado.
Management still hopes to initiate production from Kokopelli in June, but time is short. Halliburton has been contracted to complete all four wells, but will be on site after the completion of the gas sales line tie in, which has not yet been announced by the company. Once on site and set up, Halliburton should be able to complete each hole in a time frame of 3-to-7 days. Dejour will earn a fee of $0.20 per MCF from the four-well project as well as a working interest of 10% to 14% (the specific percentage will be determined by the actual cash invested in the drilling program, which can be calculated only after the wells have been completed) up until the drilling fund earns $8.125 million. Management estimates the project’s gross production will be 1,580 BOEPD, of which 150-to-200 BOEPD (10%-14%) would be net to Dejour during the first production phase. Thereafter, even though Dejour retains ownership of a 93% working interest of the project (Brownstone owing the remaining 7%), the drilling fund will earn between 54% and 58% of the cash flow after costs by virtue of the previously announced production sharing agreement, leaving Dejour with an earned 39% to 35%, respectively. Given the progress to-date, we expect production from all four wells to come online in August.
Management has re-evaluated the potential of the Mancos play and re-prioritized the company’s capital expenditure program to focus on development of this deep, liquids-rich shale at Kokopelli. A project to test the formation is now in the planning stage for a production test well tentatively scheduled for the fourth quarter of 2013. In August, 2012, WPX Energy (WPX:NYSE) drilled an exceedingly successful discovery well here in the Piceance Basin. Targeting the Niobrara/Mancos shale at a 10,200-foot vertical depth and a 4,600-foot horizontal leg, the test well produced over 1 BCF of natural gas in roughly the first 100 days of operation. WPX Energy estimates the well’s EUR in the range of 7-to-10 BCF and the resource potential in the range of 20-to-30 TCF on its 180,000 acres. Also, Encana has been drilling the Niobrara/Mancos shale formation in the area. Of the seven wells on which Encana disclosed production, the output of three rival WPX’s test well. The WPX Energy well is situated directly between Dejour’s Roan Creek and Kokopelli properties. Dejour’s management believes that the Mancos formation offers superior economics to the Williams Fork (an estimated 57% IRR for Niobrara/Mancos gas versus 13% for Williams Fork gas). A venture with a partner is being sought to help finance the estimated $7 million developmental costs for a Mancos test well at Kokopelli.
Our rating on Dejour’s stock remains Neutral. Despite the progress at Kokopelli and the gas shows detected during the drilling process, Dejour has been hampered by a lack of sufficient working capital to independently develop production from its oil & gas leases. The company has relied on capital from a drilling fund (at a significant cost of future production) to finance the drilling of three additional wells and the completion of all four wells at Kokopelli. In addition, Dejour utilized a bank credit facility as an operating loan and a 14% debt facility from an institutional lender. Also, we are concerned that at least one production well must be completed by mid-2014 to retain the oil & gas lease of the northern portion of Kokopelli. We look forward to analyzing the production profile of the four Williams Fork wells at Kokopelli. The resultant cash flow may be the catalyst for providing operating capital needed to pursue additional drilling in Kokopelli North and further prove the company’s Colorado gas & NGL assets, especially the potential of the deep Niobrara/Mancos play that is not yet included in the Dejour’s estimated reserves.
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