This article first appeared in The Edge Malaysia Weekly, on January 18 - 24, 2016

UPSTREAM oil and gas player Sumatec Resources Bhd is in talks to secure a US$120 million (RM526.7 million) loan for the construction of a 70km-long gas pipeline in the Rakushechnoye oil and gas field in Kazakhstan for the supply of gas to KazMunayGas (KMG), the national gas company of Kazakhstan.

The pipeline will connect the group’s gas condensate field in Rakushechnoye to the Kendirli tie-in point, which in turn connects to the Central Asia-Center (CAC) gas pipeline that supplies gas to Russia. The CAC is one of two major gas pipelines in Kazakhstan, the other being the Eastern pipeline that supplies to China.

The gas pipeline project sounds important as it will facilitate the supply of fuel to Russia. But at the same time, with oil prices continuously falling, the large capital outlay raises eyebrows.

Sumatec managing director James Chan tells The Edge that the group is currently in discussion with a local bank to finalise the terms and conditions of the loan agreement, and expects to reach a deal with the lender by the end of the first quarter of the financial year ending Dec 31, 2016 (1QFY2016). He believes the group will be able to kick off the project by the middle of this year.

The financing will come in handy for Sumatec’s operations, given its low cash position of RM251,000 and short-term debt of RM22.64 million as at Sept 30, 2015, translating into a net gearing of 0.03 times. Furthermore, its rights issue and private placement exercises have yet to be completed.

Chan, who was recently reappointed managing director of Sumatec following the resignation of Christopher Layton Dalton from his position as CEO, had previously held the managing director position at the group from August 2003 to February 2013, before being redesignated as non-executive director.

Oil is currently hovering at US$30 per barrel. With the low price having an adverse impact on the global oil and gas industry, Chan says Sumatec will focus on the construction of the pipeline as well as the drilling of new wells for gas deposits along the pipeline. He estimates that the group’s earnings will increase in 2018, once the pipeline construction is completed.

“Currently, our off-taker for gas is the KMG. Unlike oil, you need to have a ready buyer for gas when you sign a long-term contract, as it goes directly to power plants. Every gas producer already has a buyer. There are two main pipelines in Kazakhstan that connect to China and Russia, and our plan is to build and do a small link-up of our pipeline to the existing one.

“Our oil and gas operations have the advantage of being onshore and in close proximity [to the CAC pipeline]. If it is farther away, then the construction will become more expensive,” Chan explains.

Sumatec, in which tycoon Tan Sri Halim Saad owns a majority 24.3% stake, also plans to drill 65 new wells over the next five years, going into a depth of 3,500m from 2,500m previously.

However, its plans will depend on whether oil prices can recover to at least the US$50 per barrel level, according to Chan.

The group has five producing wells in the Central Asian country, with roughly 43 million barrels of oil condensate reserves and 576 billion cu ft of natural gas reserves.

Chan explains that given the current environment, Sumatec will attempt to maintain its profitability for the next two years and any increase in its earnings will only come in 2018.

“Given the level of oil prices, there is no point in spending more simply to improve our profitability in the short term, as it would mean that we would need to double our capex (capital expenditure). We are better off waiting until the oil price recovers to about US$50 per barrel,” he says.

He adds that the production cost of its existing wells is somewhere between US$20 and US$25 per barrel and, given the depressed oil prices, Sumatec has no intention to re-enter the old wells as it would not gain much profit from them. “It is quite risky to re-enter the old wells at this point in time. We prefer to drill new wells when [the oil] price recovers.”

Sumatec has set aside US$27 million for its capex this year as well as US$40 million for 2017 and US$55 million for 2018.

“The capex includes the construction of the pipeline. We have two years to complete the project and we will do it in tandem with the drilling of new wells,” says Chan.

For the nine months ended Sept 30, 2015 (9MFY2015), Sumatec recorded a 44.4% increase in net profit to RM38.23 million from RM26.48 million in the previous corresponding period. However, its 3QFY2015 net profit fell 35.4% to RM9.36 million from RM14.5 million the year before. The higher earnings was partly due to foreign exchange gains of about RM16.7 million.

To recap, Sumatec had on Oct 23 last year proposed to place out 348.27 million shares, or 10% of its issued and paid-up capital, to finance its oil and gas operations in the Rakushechnoye oil and gas field. Based on the indicative issue price of 15 sen per share, it expects to raise gross proceeds of RM52.24 million.

Prior to that, it had proposed a rights issue of up to 5.52 billion new rights shares, together with up to 2.76 billion rights warrants, at an indicative issue price of 20 sen per rights share for the acquisition of the Buzachi Neft oilfields in Kazakhstan.

Due to the low oil prices, however, Chan says the group is deferring the rights issue as it is difficult to carry out the exercise in the present environment. “For the rights issue, we need to place out when the share price is at least 14 sen, but we are now at just 12 sen.”

The par value of Sumatec’s shares is 14 sen.

Funds raised from the private placement are meant to enhance the group’s production levels and allow it to embark on a new well-drilling programme.

Sumatec’s share price has declined 45% over the past one year, against the backdrop of declining oil prices. Its five-year high of 61 sen was achieved more than a year ago on Aug 19, 2014, according to data compiled by Bloomberg.

“Currently, there is not much profit to be made when oil prices are roughly US$30 per barrel. So, for us, it is better to keep it in the ground and wait for a better time to extract it and sell. Furthermore, there are many gas reserve fields along the pipeline that are just waiting to be explored. Good prospects awaits us over the next five years,” Chan says.

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