unconventional gas in poland

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Unconventional gas in PolandSpecial focus - 22 November 2010

Could Poland become another Norway?

Aurelian: Drilling for tight gas in Poland started

BNK Petroleum: Pure shale gas, early E&Pin Europe

FX Energy: Conventional gas play, with largeE&P area

San Leon: Immense resources, what next?

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Sector Report Unconventional gas in Poland

Erste Group Research Sector Report November 22, 2010 Page 2

Table of contents

Executive summary ......................................................................................................................................................3Investment case............................................................................................................................................................5Potential triggers/risks ..................................................................................................................................................8Peers.............................................................................................................................................................................8Market overview............................................................................................................................................................9Company profiles

Aurelian Oil & Gas ......................................................................................................................................................21

BNK Petroleum...........................................................................................................................................................27FX Energy...................................................................................................................................................................35San Leon Energy ........................................................................................................................................................47

Contacts......................................................................................................................................................................53

Disclosures .................................................................................................................................................................54

Analyst: Radim Kramule +420 224 995 [email protected] pl-aek-user10 from 213.227.88.2 on 2011-02-08 03:42:56 EST. DownloadPDF.



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Executive summary

The energy position of Europe could change thanks to unconventional gas. Thesearch for this gas is relatively new in Europe and many skeptics forecast various

risks or uneconomical geology. However, similar skepticism was seen in the US,while the country managed to increase its NG reserves by 46% since 1999 to thecurrent 6.93 Tcm and unconventional gas resource estimates are said to be as highas 200 Tcm. Shell and NPC put European unconventional gas reserves at 29 34Tcm (some 60 years of consumption), while Poland itself could be sitting on asmuch as 1.36 Tcm of this gas type, while some estimates go as far as 3 Tcm. Withannual consumption of approx. 14 billion cm (Bcm) p.a., this would represent 100years of consumption for Poland (or more than 200 years in the upper case).

Why is it worth looking at unconventional gas prospects in Poland (Europe)?

- Poland is a net NG importer, with a 70% share in total consumption, whiledemand is likely to grow (low per capita gas consumption).

- The EU has a restrictive CO2 emission plan, while gas-fired PPs emit only

ca. 50% of CO2 of coal-fired. Poland has ca. 90% coal-fired PPs and plansto build 4-5 GW of installed gas-fired PPs. This could increase demand forgas by 12-15%.

- Polish gas prices are set by the local regulator and seem to be quiteinelastic in the downward direction (PGNiG has recently applied for a 10%price hike).

- Attractive E&P fiscal terms (low corporate taxes, low royalties).- Can benefit from US technological advancement (know-how transfer).- Environmental concerns could be counterbalanced by Polands aim for

energy security independent of Russia.- Large estimated resources and similar geology (Permian base).

Fiscal terms Poland USA

Corporate income tax 19% 35%Acreage costs/acre USD 0.55 USD 250-30tsd

Royalties 1%-2.5% 12.5-20% non-proven areas Source: BNK Petroleum, PKN Orlen

Polish gas = PGNiG? Not totally correct, but the market is dominated by themajority state-owned PGNiG, which produces, imports, explores for and distributesNG in Poland. It also has the biggest number of oil & gas exploration licenses inPoland (89 out of 221). However, other interesting small E&P companies operate inPoland. The interesting prospects for Polish unconventional gas were recentlydemonstrated by Marathon, ExxonMobil and ConocoPhillips, which acquired severalE&P licenses in Poland.

How then to play the unconventional gas story in Poland (Europe)?

- PGNiG is definitely an option, with a large number of E&P licenses. Lotosand PKN also plan to focus more on the E&P segment.

- Interesting small-cap publicly traded E&P companies operate in the country,e.g. Aurelian, BNK, FX Energy and San Leon.

- Small-cap E&Ps have the advantage of large upside potential (unlike big-caps) if their exploration proves successful (however, risks are high as well).Moreover, they can benefit from potential M&A (even from local players likePKN/PGNiG) and farm-out agreements.

- We quite like Aurelian (tight gas)and FX Energy (conventional gas) tospread out the risks, as the companies should come up with strong newsflow, fast production ramp-up and large exploration acreage (note that wedo not run a full model and valuation on Aurelian, suggestions are based

more on the interesting prospects of Polish unconventional gas than anyspecific valuation).




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Aurelian (AUL LN) is a London-based publicly traded company. It has several E&Passets across the CEE region with Poland its biggest one. Aurelian focuses on tightgas development in the Rotliegendes basin, while the Siekierki project (nearPoznan) is currently the most promising project. The company has third partycertified 10.5 Bcm of contingent resources, prospective NG resources of 34 Bcmand 326 MMbbls of prospective oil reserves. Reasonably sized production isscheduled to begin in 2012. The history of the company dates back to 2002.

BNK Petroleum (BKX CN) is a Toronto-listed company with producing &exploration assets in the USA and several E&P licenses in Poland and Germany.The company predominantly concentrates on shale gas plays. BNK had 37.9MMboe of 2P reserves with NG comprising 38%, oil 15% and NG condensates therest. The company does not disclose potential resources. BNK currently holdsalmost 3.5mn acres in Europe (Poland 31% share), so the exploration potentialseems to be promising.

FX Energy (FXEN US) is based in the USA with most of its operations based inPoland. The exploration acreage amounts to 4.25mn acres. 2P reserves stand at 2.6Bcm (15.3MMboe, while the company estimates that more than 80 Bcm of NG could

be in its potential resources. FX predominantly focuses on conventional gasproduction & exploration. Its history dates back to 1995. The company would like tosignificantly ramp up production in the next couple of years.

San Leon (SLE LN) is a London-based E&P company with a diversified explorationportfolio (Morocco, Poland, Italy, the Netherlands). Its history dates back to 1995,but the first E&P license was awarded in 2007. The company does not give clearguidance, but the 2P reserves could be around 15.2 MMboe and almost 3 Bboe ofpotential resources, while Poland could make up around 20% of these estimatedresources.

2H 2010 1H 2011 2H 2011

AurelianUp to 9 spud wells until end2011, seismic, Rom.

Divestment?

2 wells appraisal,Siekierki (seismic) &

partner announc.

First gas end 2011,Siekierki (facility constr.,

well tests)

BNK Petr.Continues drilling andfraccing, new acreage

Continues drilling andfraccing, new acreage,potential farm-outs

Continues drilling andfraccing, new acreage,potential farm-outs

FX EnergyKSK wells to push rate over18 Mmcfe/d, Lisewo well

2 Rigs through 2012, 3Dseismic southeast

Winna Gora productionstart

San LeonPoland (seismic & drilling),Morocco & Italy (seismic)

Poland, Italy, Morocco(drilling)

Poland, Italy, Morocco(drilling)

Source: Company data

It is fair to say that all four companies are relatively small-cap plays. While San Leonis clearly the least advanced in exploring its assets and BNK has the highest levelof reserves. In terms of prospects, we like Aurelian and FX, given theirtight/conventional gas focus and large acreage. Valuation is the key concern,thanks to the lack of significant reserves and production (note that we do not run afull model and valuation on Aurelian, suggestions are based more on the interestingprospects of Polish unconventional gas than any specific valuation).

Mcap EV Reserves Contingent PotentialCompany name EURmn EURmn MMboe MMboe MMboe

Aurelian 240.1 149.0 0.4 62 526 100% Tight gas 7.6 0.5 3.1mn

BNK Petroleum 290.1 209.6 37.9 n.a. 1365-7215* 28%* Shale gas 7.7 0.04-0.2 3.5mnFX Energy 184.7 145.5 15.3 n.a. 479 98% Conv. Gas 12.1 0.4 4.3mn

San Leon 87.1 69.4 15.5 n.a. 2833 11% Gas/oil 5.6 0.03 11.6mn

Resources

CEE

Key

source

Explor.

Acreage

Mcap/

2P+50%2C

Mcap/

Poten. Res.

* BNK does not provide an estimate; the potential resources are likely far higher, given the large acreageSource: Bloomberg, company data, Erste Group




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Investment case

There are hundreds of E&P companies around the globe that are seeking hydrocarbons,typically with relatively large exploration acreage and huge estimated potential resources. At thesame time, CAPEX requirements are immense, with no sure outcome (drilling success). Inaddition, without a significant production flow, such companies issue fresh capital, farm-out theiracreage or are forced to take on debt. The companies in our focus are no exception to the aboveand we do not think that they would be special within their industries. The reason why we haveanalyzed Aurelian, BNK, FX and San Leon and their prospects is more connected to the fact thatthey are active in Poland (which has great potential, in our view) and were able to acquirerelatively interesting assets under favorable terms. We are also fond of the unconventional gasstory, as we believe that Europe could (with estimated reserves of 29-34 Tcf) follow the USdevelopment (albeit on a smaller scale), as the region can benefit from US technological know-how.

Source: E-On

The key differences among the companies are probably in the stage of development, regionalfocus and primary exploration target. The summary of the most important facts is in the tablebelow. In terms of regional focus, Aurelian is a pure CEE player, while FX has the majority of itspotential resources in Poland (some 98%+ estimated). San Leon has the largest explorationacreage, with more than 10mn acres, but we find the company currently unable to develop all ofits projects (farm-out agreements are the only solution). Moreover, it might be quite difficult forSan Leon to coordinate various projects efficiently (geographically distant; some on-shore, someoff-shore). In terms of exploration and production costs, conventional gas development is themost economical one, followed by tight gas, shale gas and coalbed methane (FX Energy shouldtherefore have a clear economic advantage over Aurelian, and Aurelian over BNK).

Europeanunconventionalgasdevelopmentshould benefitfrom US know-how

FX Energyshould haveadvantage overits peers,thanks toconventionalgas




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Exploration area allocation and primary exploration focusAcreage allocation Hydrocarbons aim Polish focus Production?

AurelianPoland 54%; SKK. 10%;Bulg. 8%; Rom. 28% Primarily tight gas

Permian & Carpathianbasins

yes

BNK Petr.Pol. 28%; Germ. 62%; US10% (100% of reserves)

Shale gas; cur. prod.

Gas & oilSilurian, Ordovician &Cambrian shales

yes

FX EnergyPoland 98%; USA 2% (6% ofreserves)

Primarily conventional

gas Permian (Rotliegend)yes

San LeonPoland 11%; Morroc. 85%;

Italy 3%, USA 1% Primarily oil; Shale gas

Permian basin (shale

gas)no

Source: Company data & Erste Group calculations

The production ramp-up seems to be most advanced for FX Energy, which should more thandouble production of NG in 2010. BNK did well in oil in 2009 and its current production level ofca. 1100 boe/d would mean a y/y increase of 17% (from 342 Mboes to 401 Mboes). Aurelianpredicts a significant production boost in 2012, while in 2010 it plans to finish some appraisalwork to boost its reserves (2C resources at 62 MMboe). San Leon had no production in 2009and the company does not provide an outlook. In our judgment, the development of their assets

could take 3-5 years before stable production is in place. News flow from all of the companiesshould be strong in 2010, with Aurelian focusing on boosting its reserves, while FX should rampup production (boosting revenues and profits) and BNK should see improving financials.

Production profiles

0

2000

4000

6000

8000

10000

12000

14000

16000

2007 2008 2009 2010e 2011e 2012e 2013e

inMMcfp.a.

0

50

100

150

200

250

300

inMbo

ep.a.

Aurelian gas BNK gas FX gas BNK oil FX oil Source: Company data, Erste Group estimates (for FX Energy & BNK)

Drilling success and production ramp-up remain key risks for the companies, but similarlyimportant factors include the external environment. Poland (CEE region) has a clear advantagein developed infrastructure and fiscal terms (see table below). Gas pipelines generally runthrough the countryside, while most of the countries are clear importers of energy (Polandimports 10 Bcm p.a., out of 14 Bcm consumed). On top of that, European wholesale gas pricesare still above those in the US, as long-term gas contracts are the rule and prices have been, sofar, based on a basket of commodities (oil, coal, electricity). Should the US and spot pricesremain at the relatively low levels seen recently (for 1H10 at USD 4.7/Mcf), European priceswould also converge.

Productionramping up isthe mostpromising forFX

Local NGproducers canbenefit fromstable gasprices




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Income tax Royalty* Net proceeds

$/mcf @ 5

Poland 19% PLN 5.63/mcm $4.06

Romania 16% 3.3%-13.5% $3.63-4.06

Bulgaria 10% 2.5%-30% $3.15-4.39

Slovakia 19% 5% of rev. (net ofcapital; opex) $4.09

USA 35% 19% $3.38 Source: Aurelian, FX Energy & Erste Group calculations* Net proceeds are calculated at wellhead price of USD 5/mcf, not taking into account any costs, depreciation,amortization

European plans to curb CO2 emissions and the fact that gas-fired plants emit ca. 50% less CO2than coal-fired plants gas should support the European premium to the US prices, in our view(local utilities plan quite extensive CAPEX for gas-fired PPs). The shale gas boom and relativelyvast resources in the US could be partly blamed for the stagnation in gas prices (risks remain forEurope as well), but subdued industrial production across the OECD countries is definitely animportant factor as well. However, we believe that gas prices should recover to levels aboveUSD 5/mcf in the medium term (the energy equivalent oil to gas is approximately 6 Mcf to 1bbl ofoil, while the current price is ca. USD 82/bbl of oil and USD 4/ 6Mcf for gas). European gasprices remain above those in the US and there currently seems to be little reason to for this gapto narrow, as the only other potential source for gas currently stems from more expensive LNG.The potential European shale gas boom could change this, but this is a question of five or moreyears.

Natural gas price comparison

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

1H 2005 3Q

2005

4Q

2005

1Q

2006

2Q-4Q

2006

2007-

1Q

2008

2Q-4Q

2008

1H 2009 2H

2009-

1H2010

2H

2010?

inUSD/mc

f

Polish wholesale avg Henry Hub avg Belgium Zeebrugge avg Source: PGNiG, EIA & Bloomberg

Unconventional gas development entails vertical and horizontal drilling with the need to fracturethe source rock. Environmental concerns with regards to underground water and water usage(for fracturing purposes) are rising and could hamper some projects. Some geologists in Polandexpect the commercial development of shale gas to take 5-10 years and see a lack of sufficienttechnologies and oil & gas servicing companies. This is naturally hard to judge, but - for example- Aurelian forecasts tight gas production already as of 2012, FX wants to start drilling horizontalwells targeting tight gas already in 2010 and, supposedly, Lane Energy already started drilling inJune this year. In terms of the economic viability of unconventional gas projects, it should benoted that technological advancement in the US makes unconventional gas production moreand more economical. Looking at reports from 2007, the average break-even price of gas onNYMEX for 10% IRR was at USD 6.86/mcf (OGJ), while some projects required only a

wellhead price of USD 3/mcf (coalbed methane in the Powder River basin), or USD 4.5/mcf inthe case of tight gas sands (S. Piceance Basin) to reach the break-even point. For instance,Chesapeake (one of the largest US NG producers, including shale gas) managed to cut costs

CO2 curbs inEurope shouldfurther supportEuropean gasprices




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(production, G&A, depreciation/amortiz. F&D, production tax) per Mcf from USD 4.32 in 2007to USD 3.25/Mcf in 2009. In contrast, in a recent report from PKN on shale gas, quoting third-party research, the break-even point for shale gas production was said to range within USD0.12-0.37/Mcm (USD 4.24-13.4/Mcf), but this referred only to shale gas.

Assigning a fair value to any E&P company is the key concern, given the many assumptions anduncertainties (drilling success, production profile, F&D costs, lifting costs and othercomplications). It is best to look at the value of reserves and resources, but again the potentialresources are typically estimated by the company itself. We have applied, for the time being, aDCF valuation for FX Energy, which has a relatively detailed production profile outlook. We haveused three case scenarios with regard to the possible production curve, with a mid-case DCF fairenterprise value of USD 248mn and a 12M target price of USD 6.0/share. For the remainingthree companies, we have primarily looked at the relative value of reserves to market cap.Generally speaking, the companies are currently traded with a premium to their peer groupmedian. FX is traded with the highest premium to its peers, but this should be justified by the factthat it has primarily conventional gas reserves (less expensive to develop and produce). Thelarger the exposure to CEE, the larger the premium to peers (esp. US ones), in our view, as thecompanies should clearly benefit from better fiscal terms and higher European gas prices.Investors that want to bet on Polish gas development and this interesting investment case wouldprobably do well in diversifying their portfolio, which should include FX Energy, Aurelian and, toa lesser extent, BNK Petroleum. It should be well noted that we have no formal valuation onAurelian or BNK so these suggestions are based more on the interesting prospects of Polishunconventional gas than any specific valuation. We see too much risk in San Leon, as we findthe company over-exposed to large acreage with no clear development strategy.

Mcap Net debtCompany name EURmn EURmn

Aurelian 240.1 -43 Tight gas 7.6 0.46 3.1mn 20-30mn

BNK Petroleum 290.1 11.1 Shale gas 7.7 0.04-0.2 3.5mn n.a.FX Energy 184.7 -23.6 Gas/oil 12.1 0.39 4.3mn $ 24mn

San Leon 87.1 13.9 Conv. Gas 5.6 0.03 11.6mn n.a.

Calculated Median (17 companies) 5.6 0.42

2010

Capex

Key

source

Mcap/

reserves

Mcap/

Poten.

Explor.

Acreage

Source: Company data, Bloomberg and Erste Group calculationsPotential triggers/risks

We have identified several triggers for the companies, which include primarily:

Successful drilling and the build-up of reserves/resources Hydrocarbon prices Takeover or favorable farm-out agreements Growth in the price of exploration acreage

Among the key risks are:

Standard E&P risks (dry holes, production failures, external prices, etc.) Changes in legislation (taxes, extraction fees) Financing issues (dilution of existing shares at a discounted share price) Environmental and operational concerns in Europe (water population and usage,

population density, depth of drilling)

Peers

The peer group selection is a very tricky issue. However, we tried to concentrate on similarlylarge E&P companies in the US and UK. The selection was inspired by names mentioned in

reports presented by the analyzed companies. For reference purposes, we have also includedChesapeake and PGNiG. All of the data in the table regarding reserves and resources wastaken from the respective companies presentations. The comparison is made simply on theMcap and EV to reserves/resources basis, as we find it the most straightforward. Moreover, only

Valuation ofE&Pcompanies isalways trickysince theytypically lackdecentproduction

Peers aredifficult to

compile, aseach companyfaces differentrisks




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FX and BNK are comparable on other relative ratios, but we have not opted for such acomparison.

Peer comparisonMcap EV Reserves Contingent Potential

Company name EURmn EURmn MMboe MMboe MMboe

Aurelian 240.1 149.0 0.4 62 526 100% Tight gas 7.6 0.5BNK Petroleum 290.1 209.6 37.9 n.a. 1365-7215* 28%* Shale gas 7.7 0.04-0.2FX Energy 184.7 145.5 15.3 n.a. 479 98% Conv. Gas 12.1 0.4

San Leon 87.1 69.4 15.5 n.a. 2833 11% Gas/oil 5.6 0.03Abraxas Petr. 224.1 259.0 24.9 n.a. n.a. USA Shale gas 9.0Approach Res. 293.2 207.9 36.5 n.a. n.a. USA Shale gas 8.0

Credo Petr. 59.0 49.1 4.8 n.a. n.a. USA Oil 12.4Double Eagle Petr. 39.8 85.9 25.6 n.a. n.a. USA Shale gas 1.6

Gasco Ener. 28.7 39.0 8.8 n.a. n.a. USA Shale gas 3.3Warren Res. 211.9 256.3 22.6 n.a. 100 USA Gas/oil 9.4 2.1Matra Petr. 28.1 10.8 n.a. 65.0 n.a. Russia Oil 0.9

Afren Petr. 1445.3 1344.3 189.0 n.a. 940 Africa Oil 7.6 1.5Northern Petr. 117.6 74.2 102.9 n.a. 8400 W. Europe Gas/oil 1.1 0.0

Desire Petr. 439.7 263.5 229.0 n.a. 5187 Falklands Gas/oil 1.9 0.1Roxi Petr. 21.6 127.1 2.4 74.6 n.a. Kazach. Oil 0.5

Regal Petr. 54.2 74.1 169.0 n.a. n.a. Ukraine Gas 0.3KOV 168.5 147.0 4.4 54.5 301 Brun./Ukr. Gas 5.3 0.6PGNiG 5619.62 5458.8 768.8 n.a. n.a. Poland Gas 7.3

Chesapeake 10616.3 20956.2 2633.3 n.a. 13333 USA Gas 4.0 0.8

Median (excl. PGNiG) 5.6 0.4

Resources

CEE

Key

source

Mcap/

2P+50%2C

Mcap/

Poten. Res.

Source: Bloomberg, company data & Erste Group calculations

The companies are currently traded with a decent premium to the median on the Mcap toreserves (including 50% 2C resources) and in line according to prospective resources. FXEnergy has the highest relative Mcap to reserves ratio, which can be explained by its moreadvanced production profile (near-term production ramping up). We think that the companiesexposed to CEE should be traded with a premium on Mcap to reserves, compared to thoseoperating in the US, as anticipated net cash proceeds from the CEE region are calculated to begenerally higher than in the US (lower income taxes and royalties). At the same time, none of

the four companies is really a bargain within our peer group universe. Moreover, Chesapeake,which is a large-cap developed key US gas and shale gas player, trades at only 4.0 times itsreserves and 0.8 times its prospective resources. Polands PGNiG also seems to be aninteresting stock, given the facts that the Mcap of 7.3 times its reserves is still a reasonablevalue (prospective resources are unavailable) and the firm is also engaged in gas distributionand storage. We acknowledge that none of the companies has a bargain price. What shoulddefinitely attract investor attention are the large and inexpensive exploration areas (which can besold in the future at a profit), operations in CEE (advantageous fiscal terms) and the anticipatedstrong news flow concerning drilling and production (FX and Aurelian).

Market overview

The European gas market is somewhat specific, as it is characterized by LT contracts and a verydense pipeline network. There are currently three key sources supplying the region with gas the North Sea (Norway, the Netherlands, the UK), Russia and Middle East/Africa. Historically,Russian gas was mainly fuelled to the CEE region, while WE had to rely on the other twosources. Despite many comments concerning European dependence on Russia, the EUproduced 269 Bcm (-4.9% y/y) of gas in 2009, or 58% of its consumption (total 464 Bcm in2009), according to BP.

Analyzedcompaniesappear to beno bargain atpresent vis--vis their peers

Long-termcontractsdominateEuropean gasmarket




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EU NG production & consumption (Bcm)

274 279285 290

298 290 282271

283269

443454 454

475490 498 490 485 494

464

0

50

100

150

200

250

300

350

400

450

500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

production consumption Source: BP annual oil & gas review (6/2010)

Clearly, Russia sells the most NG in Europe, with 113 Bcm in 2009 (24% of annualconsumption). Algeria, Qatar and Libya follow suit, with combined deliveries of 75 Bcm. Formore details, see below.

2009 Gastrade to Europe in Bcm

112.7

95.7

49.7

30.0

18.5 16.512.8 12.2 9.9 9.6 7.5 6.6

4.0 2.6 2.3 1.5 1.3 1.0 1.8

0

20

40

60

80

100

120

Russia

Norw

aypipe

Neth

erlan

ds

Alge

riapipe

Qatar

Alge

riaLNG

Germ

any UK Libya

Nige

ria

Trinida

d&To

b.Eg

ypt

Denm

ark

Belgi

um

Norw

ayLNG

Uzbe

kistan

Oman

Spain

Othe

rs

Source: BP annual oil & gas review (6/2010)

The European Union (including EFTA members) is currently estimated (as of end-2009) to besitting on 4.4 Tcm of proved NG reserves, with the largest share belonging to Norway (ca. 10years of consumption and 17 years of production). On the global scale, EU reserves represent anegligible amount, as the majority of currently known reserves are in Russia (CIS) and theMiddle East. Russia sits on 24% of known global NG reserves.

Russia isbiggestexporter of gasto Europe

EU hascurrently only2.3% of globalknown NGreserves




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NG proved reserves distribution (187.5 Tcm)4% 1%

4%

2%

41%

8%

9%

31%

USA

Rest of NA

Total S. & Cent. AmericaRussia + CIS

EU

Middle East

Africa

Asia-Pacific

Source: BP & own calculations

However, things could change with unconventional gas exploration. Europe has every incentiveto boost its gas resources, as it is likely to run out soon, while it also wants to curb CO2emissions (gas emits half the CO2 of coal) and increase its energy security. Europe is yearsbehind the US in terms of exploration and development (seismic, licensing, technology), but itcan definitely benefit from the accumulated know-how in the US, which can be applied locally.The estimated volumes of unconventional gas range from 34 to 36 Tcm (E.On), eight timescurrent reserves. The distribution of resources seems to be concentrated in the northern parts ofEurope the North Sea, Sweden, the UK, Germany, France, Poland and the Baltics, but also inthe Carpathians (Romania). Polands share of resources is expected to be 29-34 Tcf (ca. 1 Tcmor 3% of the European figure), while Advance Resources estimates the figure to be as high as 3Tcm for Poland.

The majority of the gas is transported via a relatively dense pipeline network (see below),

whereas LNG imports are relatively minor. There are several projects underway (Nabucco, NorthStream and South Stream) to increase the capacity of pipelines, as well as LNG re-gasificationterminals. In 2009, there were 13 terminals operating, nine under construction and 25 planned.With gas prices down significantly at the moment, many plans are likely to be postponed, butLNG will continue to play an ever-more important role (Ukraine plans a 10Bcm LNG terminal,while Poland and the Baltic states would also like to build terminals). However, LNG will alwaysbe more expensive than local production and conventional gas export via pipelines.

European pipeline network

Source: Gazprom

Volumes of NGreserves couldgrow by factorof 8 in Europe

LNG poses

littlecompetition tothe pipelinenetwork




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The European (global) gas price recovery is probably the most questionable factor for gas E&Pplayers. According to IEA, global gas demand fell by 3% in 2009 and the agency expectsEuropean gas demand to recover to 2007 levels only in 2013 (to still below the 2008 level). Ontop of that, IEA estimates 200 Bcm of spare production capacity for NG, while LNG supplycapacity is to rise by 50% by 2013. IEA also mentions US shale gas as a key supply source, withsome shale gas plays already profitable at USD 2.5/MMbtu ( Mcf). Furthermore, recent studiesshow that some unconventional gas fields can be more profitable than conventional ones,depending on the quantity of resources in place (technology advancement, greater length ofhorizontal drilling). Gas-fired power generation should be the key driver for gas demand forOECD countries, but most of the projects are only being prepared with commissioning starting in2012 and beyond.

Prior Perception New Understanding

Source: Advanced Resources (3/2010)

Gas pricing formulas in Europe are generally based on long-term contracts. In the above text,we have shown the price gap between US and European (Polish) gas prices. Typically, Russiansupplies are agreed for decades, with booked quantities and specific pricing formulas, which arebased on a basket of inputs (spot oil prices, spot gas, FX, production costs, transit costs). The

graph below depicts US gas prices (Henry Hub spot) and HH forwards until 2018. The US is notcomparable to the European market (shale gas boom), but has the most comprehensive andlongest data available (good for global gas price indications). Clearly, gas prices droppedsignificantly between 2008 and 2010 and, unlike crude oil, have not recovered yet (note the dropin demand and bearish demand outlook).

Futures nicely depict seasonality in prices and are heading slowly upwards (USD 5.3/MMbtu in2012). What should be pointed out is the price comparison for a barrel of WTI crude and anMMbtu of oil. This ratio fluctuated around 8-10 times until 2008, while not long ago it peakedclose to 22 times. Futures (WTI & HH) multiples slightly favor higher prices for NG than forcrude, which should slowly bring the ratio below 16 in 2018. However, the energetic equivalentof 1bbl of crude is ca. 6 Mcfe ( 6 MMbtu) of gas. Therefore, the price ratio between crude andgas should be more or less close to 6. From this perspective, NG is definitely strongly

undervalued in comparison to crude oil and we are inclined to believe that, with a greaternumber of gas-fired PPs, NG could outperform crude in the medium term.

Natural gasprice recoveryremains anissue for E&Ps

European NGpricing isbased onseveral factors

Natural gasprice isstronglyundervalued incomparison tocrude oil price




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Gas prices and gas vs. crude oil

6

8

10

12

14

16

18

20

22

Dec18

Dec15

Jun15

Dec14

Jun14

Dec13

Jun13

Dec12

Jun12

Dec11

Jun11

Dec10

30.6.1

0

31.1

2.0

9

30.6.0

9

31.1

2.0

8

30.6.0

8

31.1

2.0

7

29.6.0

7

29.1

2.0

6

30.6.0

6

multiples

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

inUSD/MMbtu

Forwards (LME) WTI/HH NG Henry Hub NG (left axe) Source: Bloomberg & Erste Group calculations

To sum up, there seems to be a relatively abundant amount of gas (unconventional) around thatis quite fairly distributed. The drop in demand, increasing LNG supply (with gas transforming intoa tradable commodity) and shale gas developments lead to NG price pressures (with thecrude/NG price multiple at record levels). On the other hand, CO2 emissions curbs in Europeinduce electricity producers to switch from coal to alternatives, while gas-fired plants are thefastest available alternatives (ca. three years to construct, half the CO2 emissions). Naturally,energy demand in Asia should also help balance the supply/demand of NG. We therefore

remain fairly optimistic about the NG price prospects in the medium term, with a calculatedwellhead price of USD 5.5-6.5/Mcf in Europe.

Focus on Poland

Thus far, we have been describing the general market overview in Europe and the US, whilePoland was touched on only marginally. Poland is the sixth largest EU country, with a populationof almost 40mn. Its 2009 nominal GDP arrived at PLN 1,342bn (EUR 335.5bn), while GDP percapita stood at EUR 8.8tsd (EUR 22.9tsd in the EU). Poland is an agricultural state, with a 3.7ppshare of GDP, but is also doing well industry-wise (32pp, vs. Germanys 29.8pp). The countryhas no nuclear power plant, with the majority of electricity generation coming from coal (above90%). Total consumption of NG in Poland is around 14 Bcm (367.5 MMcm/capita; see below). Incomparison to its neighbors, Poland is lagging behind, as Germany saw NG consumption of 951MMcm/capita and the Czech Republic 796 MMcm/capita in 2009. There is definitely a strongconvergence story for Polish NG consumption growth.

NG iscurrently anabundantcommodity,but will bemore andmore desired

one

Natural gasconsumptionin Polandlags behindits neighbors




14/56



NG market in Poland

4318.1 4277.1 4276.1 4083.4 4105.2

14008.7 14305.513562.1

14347.6

13241.1

0

2000

4000

6000

8000

10000

12000

14000

16000

2005 2006 2007 2008 2009

inMMcm

Domestic production Imports Russian imports Tota l NG Source: PGNiG

Among the key triggers for Polish NG demand should be its energy sector. Poland is currentlyplanning 4-5 GWs of installed gas-fired PP capacity by 2015. More realistic estimates calculatewith 1.5-2 GWs by 2015. There are currently two projects soon to be finished, with installedcapacity of 630 MW. Assuming some 50% efficiency, six hours of daily operation and energyconversion of 1 MWh = 3.413 MMbtu, we would see extra NG consumption of 270-280 MMcmp.a. (2% of Polands annual consumption). Assuming an additional 1.5-2 GWs installed, thedemand for NG could rise by ca. 650-860 MMcm p.a. (4.6-6% p.a.). Naturally, the longer thedaily working hours, the more NG consumed. For the time being, though, we assume only peakload would be served.

The dominant Polish gas distributor, importer and producer is clearly PGNiG. It sold 13.28 Bcmof NG in 2009 and produced some 4.1 Bcm of NG in 2009 (including foreign assets). PGNiGwould like to boost NG production to above 6 Bcm by 2015, but at the same time it recentlysigned a new contract with Gazprom with 38% higher volumes (currently approx. 7.5 Bcm, newly10.2 Bcm p.a.). What is also interesting is the length of the contract, which was originally to havelasted until 2030+ and was signed only until 2022 (speculation about an unconventional gasboom?). As mentioned earlier, the Polish pricing mechanism is based on long-term contractswith Russia and local industries/consumers are offered prices based on wholesale tariffs agreedwith the local regulator (PGNiG recently succeeded with a 6.1% hike) and in turn the wholesaleprices calculated by PGNiG are based on Russian price contracts, crude oil prices, FX, cost oflocal production and transit fees.

There are manygas-fired PPsplanned to bebuilt in Poland

Poland hassigned new LTcontract for gasdeliveries withRussia




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Natural gas prices in Poland wholesale tariffsa ura gas pr ces n o an - w o esa e ar s

493

541582

651

709

779

898

998

910

966

4.3 4.75.1

5.9 6.5

8.0

10.6

9.18.0

9.8

0

100

200

300

400

500

600

700

800

900

1000

1100

1H 2005 3Q 2005 4Q 2005 1Q 2006 2Q-4Q

2006

2007-1Q

2008

2Q-4Q

2008

1H 2009 2H 2009-

1H2010

2H 2010?

0

5

10

15

20

25

30

in PLN/Mcm in USD/Mcm in USD/Mcf (right axe) Source: PGNiG

Clearly, wholesale prices in Poland seem favorable for local producers (even though wholesaleprices can differ substantially from wellhead prices). The proposed hike in wholesale tariffswould bring the price of gas above USD 9/Mcf, which is an 80% premium to the US spot market.Note that the realized Polish NG prices of FX Energy in 3Q 2010 reached USD 5.3/Mcf (up 14%y/y).

The key conclusions regarding the Polish gas market can be summarized as follows:

Relatively inelastic gas prices in the downward direction (since 2005) Large share of imports in total consumption (70%); therefore, almost unlimited demand

for local production (if economical) Low per capita gas consumption (48% of Czech NG consumption and 38% of German),

convergence story Current NG reserves estimated at ca. 110 Bcm (or eight years of consumption, acc. to

BP), while unconventional gas reserves could increase it more than ten-fold to anestimated 1.36 Tcm (100 years of consumption) while Advanced Resources put thefigure at 3 Tcm.

Energy mix favors coal (90%+ of capacities). New capacities outside coal will be needed

(gas, nuclear, renewable). Gas-fired plants could boost local NG demand.

Unconventional gas in Poland

There are 221 E&P licenses granted in Poland, according to figures from June 2010 (PKN).Clearly, the biggest player on the Polish E&P scene is PGNiG, with 89 licenses. More than 20entities hold the remaining licenses (thanks to farm-in/-out agreements, the situation changesquite often). Companies bearing the licenses naturally concentrate primarily on crude oil andconventional gas exploration. However, recently, the rush for unconventional gas led severalcompanies that already held licenses to consider its exploration (some hold purelyunconventional E&P licenses, e.g. Exxon and Mazovia Energy). Among the biggest globalnames recently active in Poland are ExxonMobil (five licenses), Chevron (four licenses) orMarathon oil (seven licenses). For the differences between conventional and unconventional

gas, please see the special section below. It should be noted that no unconventional gasproduction is yet in place (according to the available information, not even in Europe).

FX Energy hasreached USD5.3/Mcf realizedNG price for 3Q2010

Some 25internationaland localnames holdcurrently 221E&P licenses inPoland




16/56



Licenses in Poland

Source: FX Energy

In the table below, there is a list of E&P companies holding licenses in Poland. FX Energy hasthe second largest number of licenses. The big global names among the exploring companiessuggest that the unconventional gas prospects in Poland are interesting (note that 158 licensesare for conventional sources exploration, 52 for both unconventional and conventional and 11 forunconventional only, with Exxon holding 3 out of the 11). Naturally, current licenses owners canbenefit from potential farm-out/-in agreements.

Exploration licenses in Poland (6/2010), Total 221

PGNiG 89 PKN Orlen 5FX Energy 21 ExxonMobil 5

DPV Service 21 CalEnergy 4Aurelian 12 Chevron 4

Conoco (3 Legs) 9 Avista 3Petrobaltic (Lotos) 8 Realm Energy 3EurEnergy (Mazovia) 7 Cuadrilla Polska 2

Marathon 7 PL Energia 2San Leon 6 Gas Plus 1

BNK Petr. 6 Strzelecki Eneria 1RWE Dea 5 Source: PKN Orlen

Exxon holds 3pureunconventionalhydrocarbonexplorationlicenses




17/56



Probably the biggest question marks with regards to unconventional gas development in Poland(Europe) are the speed of exploration/production, environmental concerns and economicviability. Key issues are as follows:

Unconventional gas production requires fracturing (pumping highly pressured water,sand and chemicals in a well) and findings in the US show that water pollution doesoccur. On the other hand, producers argue that standards have improved and potablewater does not typically lie below a depth of 1.5km, where fracturing takes place.

The fluid requirements are immense. The average amount of fluid used in one wellfracturing amounts to 7.5-11.3 mn liters, while 450-680 tons of sand is needed (PKNdata). Some counterbalancing can be achieved with new recycling techniques.

A drilling campaign is more extensive for unconventional gas, as it requires severalindependent drills to tap a reservoir (negative implications for land requirements).

There are only about 100 land-based drilling rigs in Europe, compared to 949 in the US(according to The Times). This could hamper fast production take-off in Europe,according to some skeptics.

Costs of unconventional gas wells (horizontal) are likely to be higher in Poland (USD 5-12mn), as the depth of reservoirs is greater than in the US.

Commercial production may take 4-5 years to develop, according to Polands chiefgeologist. The institute has issued 56 licenses to drill (April figure) and was said to bereceiving new applications (PGNiG was to start drilling within a month).

The IEA said in November 2009 that European unconventional gas production isforecast to take off in the second half of the period to 2030, but should nonethelessremain a relatively small part of overall output.

On the other hand, the Polish authorities seem to be in favor of E&P development. The fiscalterms were already touched on, but we can recap the highlights as follows:

Corporate income tax at 19% (compared to 35% in the US) Acreage costs per acre at ca. USD 0.55, compared to USD 250-30,000 in the US Royalties almost non-existent at 1-2% (US 12.5-20% in non-proven areas)

There are two major geological areas in Poland that bear potential resources of natural gas thePermian basin (northern and central parts) and the Carpathians in southeast Poland. ThePermian basin (Rotliegend) in Poland is an extension of geology that stretches from the UK tothe Netherlands and Germany. The European Permian basin (formed 299-251mn years ago) isa thick sequence of sedimentary rocks deposited in a large sedimentary basin. The Rotliegend isthe lower portion of the Permian sequence and consists of over 600 meters (2,000 ft) ofsandstone and evaporites. It is overlaid by a 1,000-meter (3,300 ft) thick sequence of evaporitesknown as the Zechstein Formation. BNK Petroleum estimates the shale depth of Baltic Polandreservoirs at 7,000 to 12,500 ft (2.1-3.8km). Other countries have been producing gas fromthese geologies for several decades, while Poland is simply under-explored. It should be notedthat the 5 Tcf (142 Bcm) mentioned on the map below is the current estimated NG reservesfigure from conventional reservoirs.

Several issuescould seriouslyhamperunconventionalgasdevelopment

Permian andCarpathiansbasins areholding NGreservoirs




18/56



Source: FX Energy (yellow acreage belongs to FX)

The shale basin in Poland extends from the coast (between Slupsk and Gdansk) towardsWarsaw and continues towards Lublin and Zamosc. The northern part of the basin should havepotential shale gas reserves at a depth of 1,200-2,500 meters and the southern one at 2,500-4,500 meters, while the eastern part should range within 2,500-3,000m and the western partfrom 4,000-4,500m (PKN data). For a comparison, the most developed shale gas area in the US(Barnett shale in Texas) has deposits from 1,900 to 2,600m. Naturally, deeper reservoirs aremore expensive than shallower ones, as every meter of drilling costs extra money (from USD0.8-2mn for a 1,500m well, but USD 6-8mn for 3km wells). Aurelian and FX Energy have theirlicenses concentrated somewhere in the middle, while FX looks to be closer to the coast (north).

The Carpathian basin stretches across several CEE countries, with Romania and Bulgaria likelyto bear the biggest share of potential resources. However, it extends quite nicely to southeasternparts of Poland as well (see below). Currently, the belt is said to bear ca. 7 Bbbl of liquids androughly 20 Tcf of gas (HIS).

Carpathian basin

Source: Aurelian (yellow acreage belongs to Aurelian)

Depth of shalebasin in Polandis greater thanin US




19/56



To sum up, Poland seems to be well positioned for interesting E&P activity for unconventionalgas. The companies involved can benefit from attractive fiscal terms, promising geology, ahistory of hydrocarbon production (significant amounts date back to the 1970s), an invitinglandscape (flat terrain), a stable gas pricing mechanism (regulated) and a favorable demand-domestic supply balance (ca. 70% of NG is imported). Probably the most promising issue withregards to Poland is the estimated figure of potential resources, which currently stands at ca. 1-3Tcm (71-200+ years of annual consumption). The biggest concerns that could halt thedevelopment are definitely environmental issues (water pollution), population density (heavydrilling required) and the depth of reservoir rocks (sometimes twice as deep as in the US).

What is unconventional gas?

First of all, it should be well noted that what is now considered unconventional might soonbecome conventional, thanks to technological progress. The key difference is the relative levelsof difficulty of extracting NG economically. Unconventional gas does not typically flow freely froma reservoir rock and needs to be stimulated by pumping water, sand and chemicals into thereservoir, fracturing it and freeing the gas to flow to the surface. What is also typical is thehorizontal drilling technique applied for unconventional gas development. There are six main

categories of unconventional gas deep gas, tight gas, shale gas, coalbed methane,geopressurized zones and Arctic (sub-sea) hydrates.

Source: E.On

Deep gas typically lies 15,000 feet (4.6km) or further below ground. Lately becoming moreconventional.

Tight gas gas that is stuck in a very tight formation underground (unusually impermeable), like

sandstone or limestone. Extraction requires various techniques, including fracturing andacidizing.

Shale gas gas deposited in a very fine-grained sedimentary rock, which is easily breakable inthin, parallel layers. However, gas extraction requires fracturing.

Coalbed methane located in coal seams, often near surface. Methane used to be a by-product in coal mining, while nowadays it is becoming increasingly important. Key challenge isremoval of water.

Geopressurized zones underground formations that are under unusually high pressure fortheir depth. Formed by clay layers and absorbent materials, such as sand or silt. Probably holdthe largest deposits of NG in the world, but their commercial extraction is the most challenging.

Methane (Arctic) hydrates formations made up of a lattice of frozen water, which creates acage around molecules of methane. Complicated to extract, economically and environmentallyquestionable.

Poland isattractive forhydrocarbonexploration

Unconventional gas needsto bestimulated toflow tosurface




20/56



It should be noted that each type of rock formation requires a different drilling technique. Thecommon factor is the horizontal drilling. The hydraulic fracturing technique creates fractures thatextend from a borehole into rock formations. A hydraulic fracture results after pumping a fluidinto the well bore at a rate sufficient to increase the pressure down the borehole, cracking thesurrounding rock formation. In order to keep this fracture open after the injection stops, they addin a solid proppant to the fracture fluid. The proppant, which is commonly sieved-round sand,pumps into the fracture. This sand is higher in permeability than the surrounding formation andthe propped hydraulic fracture then becomes a conduit through which the fluids flow back to thewell. The technology is evolving, with advances coming in terms of horizontal drilling length (from1,500 feet up to 5,000) and intensity of stimulation (increasing the number of stimulation stagesfor one horizontal well). Also some horizontal drilling techniques enable drilling in a ray (up to 8directions) to maximize the drilled well.

An example of number of stages on a single horizontal well

Source: Advanced Resources

General summary

Europes long-term dependence on foreign hydrocarbon supplies, the ageing of the North Seafields and the determination to curb CO2 emissions will pose major challenges in the years tocome. The relatively new and under-explored unconventional gas reservoirs create aninteresting opportunity to deal with some of the outlined problems. We believe that the EU

should be open to unconventional gas exploration and production. Moreover, European pricingmechanisms create a very stable environment for producers, which can benefit fromtechnological know-how from the US. The number of drilling rigs, environmental concerns andthe economic viability of unconventional gas projects could prolong the commercial productiontake-off. However, we remain optimists, as several companies in Poland are already drilling andcommercial production could start within 2-3 years.

Energydependence ofEurope onexternal

sources willhelpunconventionalgas




21/56



Company Report Oil & Gas UK November 22, 2010

Aurelian Oil & Gas

Not ratedAurelian Oil& Gas

Radim Kramule, (Analyst) +420 224995213 [email protected] 52 weeks

1520253035404550556065

Aurelian Oil & Gas DJ EURO STOXX Oil & Gas

EUR mn 2006 2007 2008 2009

Net sales 0.4 2.8 1.9 3.0

EBITDA -3.2 -7.4 -0.8 0.5

EBIT -3.3 -7.7 -4.9 -0.0

Net result after min. -1.4 -9.6 -11.6 -1.0

EPS (EUR) -0.04 -0.26 -0.09 -0.00

CEPS (EUR) -0.03 -0.25 -0.06 -0.00

BVPS (EUR) 1.86 1.54 0.34 0.25

Div./share (EUR) 0.00 0.00 0.00 0.00

EV/EBITDA (x) nm nm -22.7 163.1

P/E (x) nm nm nm nm

P/CE (x) -19.6 -2.0 -2.9 -225.8Dividend Yield 0.0% 0.0% 0.0% 0.0%

AurelianOil &Gas

Performance 12M 6M 3M 1Min EUR 227.3% 49.3% 27.8% 13.7%

Share price (GBP) 60.00 Reuters AUL.L Free float 37.5%

Number of shares (mn) 339.5 Bloomberg AUL LN Shareholders Lord Sainsbury (12.9%)

Market capitalization (EUR mn) 239.5 Div. Ex-date Kulczyk Investments (10.1%)

Enterprise value (EUR mn) 227.7 Target price Homepage: www.aurelianoil.com

Will investors feel hydrocarbon aura soon?

- Aurelian has vast potential resources and large acreage (3.1mn) in the CEE region. It enjoys a soundbalance sheet and a good position for potential farm-outs (financing capital-intensive E&P). Its tight gasfocus seems like a viable strategy, given technological advancements. The risks for Aurelian involve the

still relatively long time before it can start producing at interesting rates, with uncertain success for itsdrilling rate (50%, for the time being) and the need for additional finance (farm-outs, capital increases,new debt). Should all go well, the company could multiply its current production of 2.6 MMcf/d by afactor of 38x. The current Mcap to 2C resources stands at EUR 7.6/boe.

- Aurelian is a London-based company with exploration assets spread throughout the CEE region. Itcurrently has 372 Bcf of 2C resources (62 MMboe) and more than 500 MMboe of prospective resources.The company managed to successfully raise EUR 39mn (106.4mn new shares @ 37 euro cents) inFebruary and the company is currently sitting on almost EUR 50mn in cash. The expected monetaryvalue (EMV) of Aurelians current estimated resources stands at EUR 1.35bn (CPR report 12/2009), oralmost 6 times its current MCap.

- The company currently has five producing wells (out of 14 drilled) with relatively small output (2.6MMcf/d in 2009, total 159 kboe), primarily in Romania. The indicative production profile of the companyputs 2010 and 2011 average daily rates at only 2.6 and 1.8 MMcf/d, respectively. Nevertheless, at thebeginning of 2012, the company would like to achieve 15 MMcf/d and then 100 MMcf/d by 2015. Themassive increase in production rates entails an extensive drilling campaign and news flow.

- Poland is currently the key area of focus for Aurelian. The company has been active in Poland since2003, when it acquired its Poznan license. The company is a 90% license owner of the Siekierki area(near Poznan), where 93% of its 2C resources lie, with a mid-case EMV of EUR 478mn. Aurelian isalready drilling and first production from Siekierki could start as early as 2011. In total, Aurelian plansnine Exploration & Appraisal wells within the next 24 months, with the majority of investments flowinginto the Siekierki development. Currently, the biggest upside is the ability of the company to move 2Cresources into reserves (successful drilling campaign).




22/56



Investment case

Aurelian is a London-based company with exploration assets spread throughout the CEE region(Poland, Bulgaria, Romania and Slovakia). It currently has 372 Bcf of third party certified 2Cresources (62 MMboe) and more than 500 MMboe of prospective resources. The companymanaged to successfully raise EUR 39mn (106.4mn new shares @ 37 euro cents) in Februaryand is currently sitting on almost EUR 50mn in cash. On top of that, Aurelian has signed a EUR75mn credit facility to develop its assets. The expected monetary value (EMV) of Aurelianscurrent estimated resources stands at EUR 1.35bn (CPR report 12/2009), or almost 6 timescurrent MCap. The upside potential is huge, but one cannot expect Aurelian to tap theseresources immediately. The focus area of the group is currently the Permian basin in centralPoland and the Carpathian belt in southern Poland/Slovakia.

Source: Aurelian

The table below provides a summary of Aurelians exploration/production blocks in respectivecountries with EMV where applicable. Aurelian also divided its activities between core and non-core, as it would like to sell its Romanian and Bulgarian assets to finance its E&P activities inPoland and Slovakia. Aurelian is producing from the Bilca license in Romania and has threeappraisal areas (Poznan and two in Romania). All other areas are in the exploration phase, forthe time being. An example of a hopefully successful farm-out agreement signed recently byAurelian (Dec. 2009) is the partnership with PGNiG in the Polish Western Carpathians (PGNiGreceived a 40% interest in Karpaty West and a 20% interest in Karpaty East). In exchange forthe interests, Aurelian received ca. 2 tsd km2 of seismic data, access to an extensive databaseand wells drilled to be reprocessed. Aurelian CEO Bainbridge estimated that the data receivedwould cost ca. USD 40mn today to replicate all the work. Implicitly, PGNiG bought the licensesat a 68% discount to Aurelians EMV (EUR 99.2mn combined EMV value of the two interests).Applying the same logic to the total EMV, we would arrive at EUR 406.4mn (32% of EUR1270mn), almost two times the current Mcap.

Aurelian sitson 62 MMboeof 2Cresourcesand 500+MMboe ofpotential

PGNiG andAurelian -partners inCarpathianexploration




23/56



Country LicenseEMV

(CPR)

Net to

Aurelian

Working

interestOperator

Poland (permian)Poznan

(Siekierki) 478mn 346 Bcf 90% Aurelian

Poland (permian) Kalisz (Exp.) - - 50% Aurelian

Poland (permian) Cybinka (Exp.) - - 35% Aurelian

Poland (permian) Torzym (Exp.) - - 35% AurelianPoland (carp.) Karpaty West 33mn 193 Bcf 60% Aurelian

Poland (carp.) Karpaty East 430mn 237 MMbbl 80% Aurelian

Poland (carp.) Bieszczady 158mn 89 MMbbl 25% PGNiG

Slovakia (carp.) Medzilaborce - - 50% AurelianSlovakia (carp.) Snina - - 50% Aurelian

Slovakia (carp.) Svidnik 136mn 408 Bcf 50% Aurelian

Bulgaria (carp.) Golitza Block B 6mn 9 Bcf 30% JKX

Bulgaria (carp.) Golitza Block B1 5mn 76 Bcf 30% JKX

Romania (carp.) Brodina Block 9mn 15 Bcf 34% AurelianRomania (carp.) Bilca Production 5mn 2 Bcf 63% Aurelian

Romania (carp.) Cuejdiu Block 6mn - 45% AurelianRomania (carp.) Bacau Block 1mn - 41% Aurelian

Romania (carp.) Suceava 3mn - 50% Aurelian

Coreare

a

Non-corearea

Source: AurelianThe company currently has five producing wells (out of 14 drilled) with relatively small output (2.6MMcf/d in 2009, total of 159 kboe) in Romania. The indicative production profile of the companyputs 2010 and 2011 average daily rates at only 2.6 and 1.8 MMcf/d, respectively.Nevertheless, at the beginning of 2012, the company would like to achieve 15 MMcf/d and then100 MMcf/d by 2015. The massive increase in production rates entails an extensive drillingcampaign and news flow. There is a good chance that Aurelian could start production earlier,thanks to the ongoing spudding at Siekierki. The majority of the production increase shouldcome from Siekierki, as Aurelian calculates with 93% of 2015 production coming from this field.The key risks to the anticipated production profile are definitely in the success drilling rates.What should also be pointed out is that Aurelian already forecasted the first production from its

Poznan license to come on-stream in 2009 (2007 Annual Report). Investors should note thatnew management was appointed in 2009, including new exploration manager ChristopherBrown.

Production profile Aurelianan

1022 516.5 956.5 949 657

5475

14600

28470

36500

0

5000

10000

15000

20000

25000

30000

35000

40000

2007 2008 2009 2010e 2011e 2012e 2013e 2014e 2015e

inMMc

fp.a.

Source: Aurelian

Poland is currently the key area of focus for Aurelian. The company has been active in Polandsince 2003, when it acquired its Poznan license. The company is a 90% license owner of the

Jump inproductionrate shouldcome at theend of 2011

Siekierki field isthe key focusarea of thecompany




24/56



Siekierki area (near Poznan), where 93% of its 2C resources lie, with a mid-case EMV of EUR478mn. The field is planned to start producing in 2012, with peak production in 2014-2015, whilea strategic partner entry into the project is likely (financing exploration/appraisal costs). In total,Aurelian plans 8-9 Exploration & Appraisal wells within the next 24 months, with the majority ofinvestments flowing into the Siekierki development (the company holds EUR 49mn to financethis project plus the credit facility). Currently, the biggest upside is the ability of the company tomove 2C resources into reserves (successful drilling campaign). If fully successful, the value ofAurelian could increase by 40-60%, in our view. The Mcap to 50% of 2C resources is close toEUR 7.5/bbl, while moving the majority of 2C resources into reserves would basically mean thatthe Mcap to reserves would fall to approx. EUR 4/bbl (clearly an attractive level).

Aurelian, according to the latest news, has successfully drilled the Trzek-2 well by using MFHW(multi-frac horizontal well) technology. The first results showed approx. 100m of gas column (onthe lower range of expectations) and good geological structure. The company is now drillinghorizontally up to 1,500m. The MFHW technology has been widely used across Europe(Germany, Holland) and in North America. The Siekierki project calculates with 3,760m ofvertical drilling to reach Rotliegendes reservoirs, which are estimated to be 100-200m wide. Thecompany plans to use up to a 7-stage frac for each well. Key entries to the project are asfollows:

Initial estimated rate between 8.6 and 15.3 MMcf/d for 18 months Production rate declines to 60% in year two and to 80% of previous years as of year

three Recoverable reserves of 16-28 Bcf per well (12-22 total wells required to be drilled for

mid-case 346 Bcf resources) EUR 18mn for each of the first two wells and EUR 14mn thereafter Well location close to Trzek-1 (a well that was supposed to start producing in 2009) Construction of gas processing plant is scheduled to begin in early 2011, first gas to be

processed at YE11.

Siekierki is definitely the number one project for Aurelian. The company holds a 90% interest

with a farm-out plan to finance its development, which we find logical, given the requiredCAPEX. The other most promising area lies in the Carpathians (Poland, Slovakia).

Source: Aurelian

Recently, the company updated its operations highlights and outlook for the next 12-24 months.Financially, the results were flat, with EUR 355tsd gross profit for 1H10 (up 3.8% y/y). Apartfrom the successful drilling at Siekierki, the company has moved forward with the Bieszczady

Aurelian isalready drillingMFHWtargeting tightgas in Trzek 2

Aurelian has

several otherpromisingprojects

Strong recentnews flow andheavy programfor comingmonths




25/56



Block (together with PGNiG, Aurelian has a 25% share), with first well spudding starting inOctober and targeting 100MMbbls gross of oil. The company continued to interpret seismic datain Slovakia and Romania (Cuejdiu Thrust) and a two-well Bulgarian exploration programtargeting 60 Bcf commenced in September 2010. In Romania, the company had a successfuldiscovery of 2 Bcf (Climauti-1) and six seismic surveys have been finished (leads of 147 Bcfhave been identified so far in Romania). The news flow from the company is very strong and itkeeps adding interesting prospects to its portfolio. The table below summarizes the key projectsfor the next couple of months.

Description of the anticipated events

December4Q Results of 2 wells drilled in Bulgaria (targeting 60 Bcf)& Update on strategic decision concerning Romania

January

1Q Gas processing plant construction start

& Results of Bieszczady well drilled (100 MMbbls)

2Q Results of 2nd MFHW2H Results of 3 wells in Carpathian Thrust Fold

Not specified Completion of 8 seismic surveys interpretation

2nd MFHW spudding with results in 2Q

Flow test results of Trzek-2 (Siekierkie, 1st MFHW)2010

2011

Source: company data

Aurelian has vast potential resources and large acreage (3.1mn) in the CEE region. It enjoys asound balance sheet and a good position for potential farm-outs (financing capital-intensiveE&P). The external environment for Aurelian was discussed in the general part. The companywill mainly produce gas, if successful. We do not expect a fast recovery in gas prices, but,thanks to new gas-fired PPs and LT contracts with Russia, European prices should stay aboveUSD 5.5/Mcf. Its tight gas focus seems like a viable strategy, given technological advancement(US), but naturally it is a more expensive technique than conventional drilling (while drillingsuccess rates are said to be higher). The risks for Aurelian are definitely the still relatively longtime before it can start producing at interesting rates (2012+), with an unclear success drillingrate (50% for the time being) and the need for additional finance (farm-outs, capital increases,new debt).

The key factors that could influence the share price development of Aurelian are summarized asfollows:

Positive: Successful drilling campaign and ability to move 2C resources into reserves Faster than expected production ramp-up Attractive farm-out agreements Take-over target for large players

Negative: Unnecessary farm-outs, which dilute the acreage and net resources for Aurelian Financing issues and dilution (Aurelian has 340mn shares out, with authorized share

capital of up to 600mn shares) Prolonged appraisal/exploration (environmental issues, access to drilling rigs) Changes in legislation (higher taxes, royalties) Hydrocarbon prices

Externalenvironment isattractive inCEE




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Income Statement 2004 2005 2006 2007 2008 2009(IFRS, EUR mn, 31/12) 31/12/2004 31/12/2005 31/12/2006 31/12/2007 31/12/2008 31/12/2009

Net sales 0.00 0.00 0.38 2.81 1.85 2.98

Cost of goods sold -0.14 -0.43 -0.16 -1.90 -4.14 -0.78

Gross profit -0.14 -0.43 0.22 0.91 -2.29 2.20

SG&A -0.00 -0.90 -2.09 -2.35 -2.84 -1.79

Other operating revenues 0.00 0.00 0.00 0.03 0.19 -0.46Other operating expenses 0.00 0.00 -1.48 -6.31 0.01 0.04

EBITDA -0.14 -1.32 -3.15 -7.44 -0.82 0.52

Depreciation/amortization -0.00 -0.01 -0.19 -0.29 -4.12 -0.53

EBIT -0.14 -1.32 -3.34 -7.72 -4.94 -0.01

Financial result 0.03 -0.05 1.07 0.89 0.53 -0.41

Extraordinary result 0.00 0.00 0.86 -2.67 -7.23 -0.52

EBT -0.11 -1.38 -1.42 -9.50 -11.64 -0.95

Income taxes 0.00 0.00 0.00 -0.09 0.00 -0.01

Result from discontinued operations 0.00 0.00 0.00 0.00 0.00 0.00

Minorities and cost of hybrid capital 0.00 -0.00 0.00 0.00 0.00 0.00

Net result after minorities -0.11 -1.38 -1.42 -9.59 -11.64 -0.95

Balance Sheet 2004 2005 2006 2007 2008 2009(IFRS, EUR mn, 31/12)

Intangible assets 3.54 3.54 9.05 24.33 34.59 40.23

Tangible assets 0.00 4.01 5.85 7.79 5.45 5.00

Financial assets 0.00 0.00 0.00 0.00 0.00 0.00

Total fixed assets 3.54 7.55 14.90 32.12 40.04 45.23

Inventories 0.00 0.00 0.00 0.01 0.01 0.00

Receivables and other current assets 0.52 1.43 1.44 3.88 7.27 4.65

Other assets 0.00 0.00 0.00 0.00 0.00 0.00

Cash and cash equivalents 1.40 4.61 56.49 29.30 6.02 13.99

Total current assets 1.92 6.04 57.94 33.19 13.29 18.64

TOTAL ASSETS 5.46 13.59 72.84 65.31 53.33 63.87

Shareholders'equity 5.22 3.93 65.48 56.36 45.95 58.22

Minorities 0.00 0.00 0.00 0.00 0.00 0.00

Hybrid capital and other reserves 0.00 0.00 0.00 0.00 0.00 0.00

Pension and other LT personnel accruals 0.00 0.00 0.00 0.00 0.00 0.00

LT provisions 0.00 0.00 0.00 0.00 0.00 0.00Interest-bearing LT debts 0.00 8.44 5.85 3.09 1.98 1.62

Other LT liabilities 0.00 0.00 0.00 0.00 0.00 0.00

Total long-term liabilities 0.00 8.44 5.85 3.09 1.98 1.62

Interest-bearing ST debts 0.00 0.00 0.00 0.00 0.61 0.64

Other ST liabilit ies 0.25 1.23 1.52 5.86 4.79 3.40

Total short-term liabilities 0.25 1.23 1.51 5.85 5.40 4.04

TOTAL LIAB. , EQUITY 5.46 13.59 72.84 65.31 53.33 63.87

Cash Flow Statement 2004 2005 2006 2007 2008 2009(IFRS,EUR mn, 31/12)

Cash flow from operating activities -0.33 -0.86 -0.81 2.49 -5.02 1.05

Cash flow from investing activities -1.88 -1.63 -8.26 -28.66 -17.74 -5.97

Cash flow from financing activities 2.26 5.70 60.31 0.09 -0.14 12.58

CHANGE IN CASH , CASH EQU. 0.05 3.21 51.89 -27.19 -23.28 7.97

Margins & Ratios 2004 2005 2006 2007 2008 2009Sales growth nm 638.2% -34.0% 60.9%

EBITDA margin nm nm -829.5% -265.1% -44.4% 17.3%

EBIT margin nm nm -879.5% -275.3% -267.0% -0.5%

Net profit margin nm nm -372.4% -342.0% -629.2% -32.0%

ROE -4.3% -30.2% -4.1% -15.7% -22.8% -1.8%

ROCE -7.4% -22.9% -22.0% -46.7% -33.5% -1.2%

Equity ratio 95.4% 28.9% 89.9% 86.3% 86.2% 91.1%

Net debt -1.4 3.8 -50.6 -26.2 -3.4 -11.7

Working capital 1.7 4.8 56.4 27.3 7.9 14.6

Capital employed 3.8 7.8 14.8 30.2 42.5 46.5

Inventory turnover nm nm nm 631.7 690.5 173.3

Source: Company data, Erste Group estimates




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Company Report OIL & GAS USA November 22, 2010

BNK Petroleum

Not ratedBNK Petroleum

Radim Kramule, (Analyst) +420 224995213 [email protected]

USD mn 2006 2007 2008 2009

Net sales 0.0 1.0 7.9 8.0

EBITDA 0.0 -0.7 -0.2 -3.0

EBIT 0.0 -1.2 -4.5 -9.4

Net result after min. 0.0 -1.2 -5.1 -12.6

EPS (USD) -12.08 -0.08 -0.12

CEPS (USD) -3.09 -0.00 -0.06

BVPS (USD) 550.07 1.71 1.28

Div./share (USD) 0.00 0.00 0.00 0.00

BNKPetroleum

Share price (CAD) 2.80 Reuters BKX.TO Free float 68.6%

Number of shares (mn) 143.5 Bloomberg BKX CN Shareholders Quantum Partners (19.5%)

Market capitalization (USD mn / EUR mn) 394 / 290 Div. Ex-date Nicholson Ford (6.29%)

Enterprise value (USD mn / EUR mn) 415 / 305 Target price Homepage: www.bnkpetroleum.com

Stable US production with large acreage in Europe- BNK Petroleum is a shale gas-focused E&P company with production and know-how in the US (Polish

assets are at very early stage). It was spun off from Bankers Petroleum in July 2008 together with its USassets. The company is listed in Toronto. BNK has a strong track record of adding 2P reserves, whichgrew from 7.8 MMboe in 2007 to 37.9 MMboe in 2009, with a BNK-assigned value of USD 241.2mn (USD6.4/boe). BNK is currently traded at a premium to its reserves, with its reserves estimated NPV (pre-tax).

BNK is also sitting on 3.5mn acres (net) of exploration area, which is at an early stage of development.The company does not disclose its potential resources, but, based on its Oklahoma project, the numbercould be anywhere between 1.4 and 7.2 Bboe. The current Mcap to reserves stands at EUR 7.7/boe.

- Financing of exploration projects looks to be partly secured, as BNK successfully raised USD 43.3mn inMay through a capital increase, with 15.8mn new shares and additional capital in October/November.This should leave BNK with enough cash for E&P for the next 12 months. Among its core strategies isthe farming out of acquired licenses to finance the initial exploration costs (USD 20-50mn/project). BNKplans to retain 25-50% of the licenses and remain an operator where attractive. Farming-out seems likethe best option, given its current financial position.

- The 1H10 results showed an improvement, with revenues reaching USD 8.5mn, up 78% y/y, on higherproduction (+21% y/y) and hydrocarbon prices (+61% y/y). The net result stayed in red territory at USD -0.6mn, compared to a USD 6.7mn loss a year ago. BNK was producing at 1162 boe/d in 2Q (up 7.1%

compared to 1Q, +47% y/y). The company does not give any production targets or outlook, but onecannot expect fast additions without new assets or additional extensive drilling.

- BNK Petroleum clearly focuses on shale gas plays. It has drilled 39 wells (30 horizontal) since 2006 in itsprincipal production property (Tishomingo Field in Oklahoma), with first production in the fall of 2007.The same focus is on its remaining assets in the US (Texas, NY, Mississippi & Alabama) and in Europe(Poland and Germany). The advantage of BNK is definitely in its know-how and proved production rates,while its downside seems to be its very early stages of exploration (it can take years to developadditional assets, especially the European ones). Thanks to the recent dilution, the company is tradedwith a premium on Mcap to reserves in comparison to its peers. One positive aspect is the firms abilityto subscribe fresh capital and secure finances for exploration.

EV/EBITDA (x) 0.5 -2.2 -12.5

P/E (X) -0.1 -1.1 -9.1

P/CE (X) -0.1 -16.1 12.9

Dividend Yield 0 0 0

Performance 12M 6M 3M 1M

in USD 137.3% 23.9% 50.5% 10.2%

52 w eeks

0

0.511.522.53

3.5

BNK Petroleum




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Investment case

BNK Petroleum was spun off from Bankers Petroleum in July 2008 together with its US assets.Since then, it has been adding exploration assets, primarily in Europe. The company is listed inToronto. BNK has a strong track record of adding 2P reserves, which grew from 7.8 MMboe in2007 to 37.9 MMboe in 2009, with a BNK-assigned value of USD 241.2mn (USD 6.4/boe). Thecompany is currently traded with a premium, with its reserves estimated NPV (10% discountrate). BNK is also sitting on 3.5mn acres (net) exploration area, which is in the early stage ofdevelopment. The company does not disclose its potential resources, but, based on itsOklahoma project, the number could be anywhere between 1.4 and 7.2 Bboe (taking intoaccount the size of the Oklahoma acreage of 13.5 tsd acres net to BNK). Naturally, not all of theprojects will work, so the calculations could be somewhat misleading. However, the potentialresources could definitely match those of BNKs peers after farm-outs.

2P reserves BNK

0

5000

10000

15000

20000

25000

30000

35000

40000

2007 2008 2009

inMboe

Proved Probable Source: BNK Petroleum (3rd party certified by MHA Petroleum Cons.)

The calculation of the NPV of 2P reserves by MHA Petroleum was based on the December 2009reserves figures (USD 241.2mn). Future net revenue is calculated after the deduction of forecastroyalties, operating expenses, capital expenditures and abandonment costs, but beforecorporate overheads and other indirect costs (interest, taxes, etc.). MHA uses a standard 10%

discount rate to arrive at the NPV, while it used the following set of hydrocarbon priceassumptions in its calculation (see graph below).

BNK hasstrong trackrecord ofaddingreserves

Value of 2Preserves isbased on set ofassumptions




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Model NPV imputs vs. Futures

3.7%2.4%1.0%-0.3%-1.9%-3.7%-7.0%-7.9%

-5.4%

41.8%42.5%43.4%44.5%46.3%39.4%

34.9%51%15.1%

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

inUSD/bbl

0

2

4

6

8

10

12

14

16

18

20

inUSD/MMbtu

WTI WTI futures NG (Henry Hub) NG (Henry Hub) futures Source: BNK Petroleum (Sproule forecast 1/2010) & Bloomberg

We have compared the assumptions in the NPV calculations with the current WTI (crude) andHenry Hub (NG) futures. The WTI projections vs. futures differ only marginally (discount until2015, premium afterwards); nevertheless, the difference for NG is rather striking (more than40%, as of 2014). Unfortunately, we do not know the production function that the MHA used andcannot run the calculation. We would estimate the NPV of current reserves at somewherearound USD 210-230mn, given the most recent production split (see below). The share of gasreached a similar figure in 2009 (i.e. 38% on boe produced). All said, the NPV is an indicator ofvalue, but BNK will incur costs down the road. The corporate and other costs amounted to morethan USD 10mn in 2009; however, excluding special items, we would estimate the amount atUSD 5mn+. This would lead to an undiscounted value of USD 50 in a 10-year period and NPVnet to shareholders of ca. USD 160-210mn.

1H 2010 Production split

19%

37%

44%

Oil Gas NGLs Source: BNK Petroleum

NG prices inthe NPVcalculationswere too high




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The financing of BNKs exploration projects received a significant boost recently with freshcapital being issued. The company successfully raised USD 43mn in May through a capitalincrease, with 15.8mn new shares (USD 2.74/share) and an additional share capital issue inOctober/November, which brought an additional approx. USD 65mn (additional approx. 24.5mnnew shares). This should leave the company with proceeds to carry on with the plannedexploration and drilling for the next 12 months. The underwriters of the first issue were primarilyfinancial institutions with the aim of additional public re-sale, while the second issue wasprimarily a private placement to Quantum Partners L.P (now holding approx. 19.5% of theshares outstanding). BNK used USD 12mn to buy out its overriding royalty interest and net profitinterests in its Tishomingo Field from Wells Fargo (part of its USD 26mn credit agreement) andUSD 2.8mn of outstanding debt. This should allow BNK to free its cash flow to finance additionalprojects. Investors should expect an additional share issue and farm-outs for E&P.

Among BNKs core strategies is the farming out of acquired licenses to finance the initialexploration costs (USD 20-50mn/project). BNK plans to retain 25-50% of the licenses andremain an operator where attractive. Farming-out seems like the best option, given its currentfinancial position, despite the potential negative implications for future net proceeds. Forinstance, the company sold a 27% interest in its 375tsd acres in the Palo Duro basin in Texas forUSD 19.5mn (some USD 195/acre) and USD 10mn for acreage in Oklahoma, Mississippi andAlabama (USD 112/acre). Applying the same logic to the European acreage, BNK wouldtheo

unconventional gas in poland

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