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Flare's Fair - Oxford Catalysts Group (OCG)
6/5/2010
(119264)
Flare’s Fair
We have been here before and come to grief, looking at a relatively new company with revolutionary technology carrying great promise. We know what happens – assuming the technology works – it takes forever.
Refining the production process gets bogged down and complicated, scaling it up looks tricky, potential customers have too much invested in existing technology to spend on something to replace it, partners prod around and poke forever without placing orders, and the money trickles out of the door. If you’re lucky, revenues start to flow just as your temples turn white. If you’re not … well, we know about that, too.
So don’t imagine that the decision to recommend Oxford Catalysts Group (OCG) came easy. The temptation to shrug it aside as just another high-tech punt of perpetual promise, always a rolling year or two away from fruition, was great. But OCG is over - well, almost over - most of the hurdles. And if it makes, it, watch out. It could be very good.
It came to market back in April, 2006. Anyone who bought then at 174p would by now have been familiar to all of the frustrations above. It floated too early, raising £15m, and has seen the shares down under 30p as recently as last May. Now, at 64.5p, it is capitalised at £38m, little more than half the flotation level – but it is twice the company and more.
All being well, by the end of the year OCG could be well on the way towards proving it can be an important player in the environmentally approved game of converting waste gas, and wood chips and other bio-mass into synthetic fuels. Everyone should love what it does, and investors can rejoice in the prospect of a steady flow of orders at nice fat profit margins.
OCG floated on the back of smart science from Oxford University, developing catalysts which aid the production of ‘clean’ synthetic fuels. In November 2008, it acquired Velocys, an American company, for $35m, partly financed by raising £10m from a share issue at 125p. Velocys was backed by clever American science and was a world leader in designing and developing microchannel process technology for producing synthetic fuels and commodity chemicals, with over $160m of investment in the technology behind it.
The fit looks ideal. OCG creates the catalysts (substances which alter the rate of a chemical reaction but are chemically unchanged at the end of the reaction), and Velocys designs the process which uses them.
That means OCG now has technology with the potential to make small scale projects viable in converting gas to liquid (GTL), in biomass to liquid (BTL), and in coal to liquid (CTL). All of this focuses slap bang in the middle of the rush to find alternative sources of energy, using resources which cannot be used or are wasted at present to create liquid synthetic fuels.
Perhaps the greatest immediate opportunity lies in waste gas. There can’t be one of us who has not seen pictures of flames flaring from an oil rig as they burn surplus gas and wondered at the waste and pollution. Each year, they burn off the equivalent to the combined natural gas consumption of Germany and France, or a quarter of the gas consumed in the USA.
It is a nonsense. It pumps 400m tonnes of CO2 into the atmosphere annually. Some countries have banned it, and there is a World Bank sponsored programme seeking to eliminate it or reduce it significantly over the next decade.
Alongside the 5.3 trillion cubic feet (tcf) of gas which is simply burnt or allowed to blow away each year, maybe 11 tcf is reinjected into oil wells each year, pumped back into the ground. All of this problem gas could be used instead to produce as much as 1.8bn barrels of clean fuel every year.
The problems arise because the gas comes with oil production and cannot be used because it is too far from a suitable market, or too close to an area which has enough gas already. Maybe half of the 6,300 tcf proven world reserves of natural gas is stranded in this fashion, potentially going to waste.
Some could be retrieved by converting to liquefied natural gas (LNG) so it can more easily be transported. But sadly the majority of gas fields have reserves below 1 to 5 tcf, and are too small to warrant the investment. Conventional GTL technology can only be applied to larger fields – the top 6% or so.
A key part of the conversion involves the Fisher-Tropsch process. That has been around for decades and helped power the Nazi war effort. It uses reactors which are truly massive in scale, impossible to fit onto any oil rig.
OCG has developed a reactor vessel which is very much smaller, using chunky metal plates which place the special catalyst in microchannels instead of large tubes. It can be accommodated on a floating rig platform, taking up maybe a quarter of the space. Instead of being scaled up by building ever larger elements, it is simply enlarged by stacking more and more identical units together, giving greater control of the technology.
There is no point in attempting to explain or evaluate the technology here. It is way beyond normal comprehension. What counts is that a whole raft of people who understand such things are backing the innovations with hard cash.
The big one comes in a partnership with Brazilian oil and gas giant Petrobras and Japanese companies Toyo Engineering and MODEC. Toyo is an engineering procurement and construction company with a Tokyo market capitalisation of some £450m and revenues of £2.4bn. MODEC has a Tokyo market capitalisation of £450m and revenues of £1.5bn, and is one of the world’s leading contractors in construction and installation of floating production storage and offloading vessels.
Together, Petrobras and the Japanese companies are committed to spending tens of millions of dollars (maybe more than $30m) on incorporating a GTL facility on board a floating platform. Petrobras will site it offshore in the giant Tupi oil discovery by Fortaleza, Brazil and operate it as a 2,000 barrels a day joint demonstration and testing facility. Delivery is expected early in 2011 with a planned nine month evaluation period. All costs of the demo are to be met by Petrobras. Kobe Steel of Japan, who have been working for some time with OCG, will supply the reactors.
Obviously the involvement of Petrobras is highly exciting. It is one of the world’s largest customers for offshore oil production vessels. Brazil is a signatory to the Kyoto protocol, and Petrobras will not be allowed to flare gas. Since it is likely to be drilling in an area where each well will be high cost, the company will be anxious to avoid drilling simply to pump surplus gas back into the sea bed, so will be seeking to process the surplus gas.
It is worth nothing, however, that OCG is not alone in offering a possible solution to Petrobras. It is also building a syncrude plant with Compact GTL, a private UK company.
Shortly before the Petrobras agreement, OCG announced a memorandum of understanding with PTT, the Thai energy company, to develop a small-scale onshore GTL plant with initial $5m of funding from PTT over two years. There is also a framework for future investment by PTT in other applications of OCG’s technology.
There is more, but not in GTL. In October, OGC announced that SGC Energia would provide $5.9m to complete the commercialisation of the Fisher Tropsch technology. A demonstration unit has been built and is being installed at Gussing in Austria, and should be ready in the next few weeks. SGCE is likely to provide total funding of up to $10m, and appears to have in mind the possibility of installing several small plants across Latin America.
SGCE is an alternative energy operation owned by Joao Pereira, one of the five richest men in Portugal. The Gussing plant will take biomass pellets created from local wood chippings, convert them into gas and then into a liquid fuel which can be used in ordinary vehicles. This bio-mass production is carbon neutral.
The plant is relatively small and aims to produce 10,000 gallons a year, but hopefully will demonstrate the process to potential clients. The demonstration will run for six months – in effect to the end of this year – when the whole lot will be shipped to the Wright-Patterson Air Force Fuel Research Center in Ohio for use in synthetic fuel. The American Air Force is heavily committed to synthetic fuel, and bio-mass to liquid is considered one of the few fuel options available for jet and turboprop engines alongside fossil kerosene.
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Velocys, the US end of OCG, has a $1m grant for a $3.8m project with the University of Dayton Research Institute. And a piece of Velocys kit is being added to small demonstration unit in conjunction with the Air Force. Altogether there is access to $7.7m in US grants.
OGC emerged at the end of 2009 with revenues of £8.7m, losses of £3.8m, and a cash burn of £4.3m. It also had £12m cash or near cash, and with the likely burn at about £4.5m a year looking forward, has enough for two to three years.
Comforting as that may be, it is nothing alongside the company’s ability to persuade others to spend money developing and proving the technology. The list of partners and collaborators is impressive – Petrobras, SGCE, Toyo Engineering, MDEC, PTT and Kobe Steel – but it is remarkable that these companies (plus American grants) have contributed $50m or so without requiring any equity issue which would dilute OCG shareholders.
People with real scientific understanding are committing hard cash to advancing OGC’s technology , effectively gambling more than the market capitalisation of the company that it will work.
If it does, prospects are bright. OGC will earn from designing the plant and from supplying the catalysts (it does not make anything, simply contributes brain power). And it could earn substantial amounts.
The first plant could be worth between $150m to $250m. No-one knows the terms of a deal which has not been done yet, but there are estimates that this could generate maybe $20m upfront for OCG. In addition, there are unofficial estimates that income from catalysts for one plant could exceed $1m a year. Once one plant has been shown to be commercially viable, orders for others and larger ones could follow quite quickly. That might not mean immediate cash flow, but the market would be likely to project substantial future income.
What could go wrong? OCG has an experienced board to guard progress. Chairman Pierre Jungels got lucky today when Rockhopper, where he is also chairman, found oil in the North Falklands Basin. He has wide oil industry experience, and was formerly chairman of Enterprise Oil. Chief executive Roy Lipski once worked for Goldman Sachs, and other directors have wide experience. Non-executive Andrew Jamieson, who joined on February 1, is especially interesting. He was with Shell from 1974 to June 2009, and his portfolio includes r and d on all aspects of gas processing for Shell.
The board will be watching out for some limited competition – a small company has been touting the idea of a ship-mounted LNG plant for smaller gas discoveries - and no-one can ever be sure that competing technologies are not in the wings. The technical obstacles ought to have been overcome. Any remaining problems could be in the engineering, building the plants.
It appears that an oil price above $60 a barrel could be quite important, though that might be pushed aside by the environmental advantages OCG can offer. There have been questions about the ability to scale up from small demonstration plants, but since this appears mainly to involve adding more identical units rather than major design advances, this might not be too important. And the availability of raw materials – especially waste gas – looks to be no problem, while the market for synthetic fuels is vast.
In the end, of course, we are looking at a technology which appears to work, and has performed well enough so far to persuade powerful people to commit large chunks of cash. But until these things actually start running, no-one can be sure.
The shares are a relatively tight market, a few thousand at a time with a fairly large spread, nominally 62p to 67p. It appears that original backer IP2IPO has been a seller, recently going down to 9%, but this is deceptive. It has apparently been making stock available to some new buyers. Over 60% is held by big investors or the board, and there are suggestions of a solid institutional following (there are eight brokers aboard) and frustration that would-be new buyers cannot secure sufficient volume to make it worth their while coming out to play.
A sale by IP2IPO last month actually went to chief executive Lipski, who bought 60,000 at 62.5p, taking his stake to 2.32m. Clearly he believes there are good things to come.
Though the current market weakness has sent the price a touch lower, and there could be further general declines to spark small selling, there could be a flurry of interest when the official start of the Gussing demo is announced. That is only a few weeks away.
The board is clearly hoping that the trial will lead to a first order from SGCE. There is speculation that it could come before the trial ends in December. That could transform the share rating.
Beyond that, there are news points with the start and progress of the Petrobras demo plant in 2011. Inevitably, it looks as if Petrobras could be the initial customer for the GTL plant on a floating platform, all being well. Other companies are in the background.
There are no profits, no great revenues, and no significant losses to worry about, unless something unexpected happens. The best broker guess so far is that revenues will start to take off in 2012, at which point the company should at least break even. If the share price is to move, however, it ought to respond within the next 12 months.
Obviously the shares must rank as speculative, simply because the business depends on an as-yet unproven technology. Given the bullish background and strong industry support, however, the downside ought to be limited. And the upside looks substantial, given time.
Ends.
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