"By far NZOG's biggest near-term challenge is how best to deploy up to $NZ209 million of likely new equity, the potential exercise proceeds of 139 million $NZ1.50 options, which expire on June 30," McDouall Stuart noted in its latest report on Wellington-headquartered NZOG.
"For now, NZOG is playing a straight bat, offering little insight into how it would invest such a windfall. The market is eagerly awaiting direction on how the company intends to generate a market return on (the options) money, and by doing so, take NZOG to its next stage of development.
"NZOG will need to demonstrate purpose and balance in defining its forward strategy to justify investors' confidence in supporting what is shaping as the biggest NZX equity raising to date in 2008."
"A war chest of this scale brings with it enormous challenge," the broker added.
McDouall Stuart said that despite NZOG's share price being "in a holding pattern" leading into the June 30 option expiry, the company's record as the top 50 performer on the New Zealand Exchange for 2008 remained intact with a share price gain of about 35.7% gain so far this year.
NZOG's shares were trading on Tuesday at about $A1.25-1.28 on the Australian Securities Exchange and about $NZ1.55-1.59 on the NZX. Trading in the NZOG options ceased on Monday.
The current and projected earnings from the Tui, Amokura and Pateke oil pools, coupled with the extra likely to be raised through the options, would mean that NZOG would "increasingly have the financial backing to assess the full spectrum of options available to achieve reserve growth".
However, McDouall Stuart added that there was a significant challenge involved in deploying discretionary capital effectively.
"Our view is that NZOG is likely to favour diversity - an expanded exploration program, acquisition and farm-in targeting and capital reconstruction all appear very much on the table."
Recently NZOG has become increasingly open about considering overseas opportunities, although investors concerned about the heightened risk profile of moving offshore would need comforting that similar opportunities are not present in New Zealand, the broker cautioned.
An early return of capital was unlikely, though the scope for enhanced dividend payments certainly existed, it added.
The broker also said NZOG's two core petroleum assets - the offshore Taranaki Tui Area oil field (12.5%) and the more southern Kupe gas-condensate field (15.0%) - were both performing strongly.
McDouall Stuart had upgraded its June 2008 financial year forecasts further on the back of Tui's continued strong performance (over 14 million barrels since July last year, compared to the pre-production forecast of less than 10MMbbl) and the strength of world oil prices.
The broker projected full-year net profit after tax of $NZ131 million ($A105 million) on revenue of $NZ244 million ($A195 million).
Profitability for the June 2009 year was expected to ease substantially, with the anticipated decline in Tui's production profile, while the June 2010 year was expected to show a significant recovery as Kupe came onstream in mid-2009 along with a fifth Tui development well, Tii-4H, that is expected to be commissioned in early 2010.
McDouall added the Momoho prospect, which is being drilled between Kupe South-4 and Kupe South-5 by the Ensco Rig 107, was considered to offer "very good prospectivity".
"We assign a probability of success against Momoho of one on three, less than 2P, but around twice the probability of success (POS) of a genuine wildcat."
Kupe operator Origin Energy believes Momoho could contain about 100 billion cubic feet of recoverable gas, while NZOG estimates Momoho's potential at 200 billion cubic feet equivalent (Bcfe).
However, McDouall said even discoveries of just 125 petajoules (117 Bcf) of gas at Momoho and the nearby Kupe Northwest prospect, and discounted for a 33% POS, should add 5 cents to the NZOG share price.
"Should either well stream be successful and liquids-heavy, upside would be substantially greater. "
Kupe's estimated 2P (proven and probable) reserves are 254 petajoules of gas, 14.7MMbbl of condensate and 1.1 million tonnes of LPG.
Further upwards revisions to the existing Tui and Kupe 2P reserve bases would also result in value uplift, at very little marginal cost.
"The case for building-in further risked exploration upside to NZOG will grow as the company firms up its forward exploration program, which we expect it to do over the balance of 2008," McDouall Stuart added.
