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What investors need to know about Aurora Oil & Gas Limited’s latest announcement

Oil and gas exploration and production company, Aurora Oil and Gas Limited (ASX: AUT), has released a summary of an independent reserves estimate evaluation of its Sugarkane field reserves, showing a 54% increase on its mid-year 2013 update to 164.9 million barrels of oil equivalent (mmboe) on a gross reserves basis (121.5mmboe net).

Despite the announcement of a significant uplift in reserves, Aurora’s share price remains in the doldrums, dropping 1.5% to $2.69 a day after the announcement, indicating that the reserves upgrade was not enough to sway short term sentiment. This could have been due to the larger fall out experienced by Australian equities, with the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) dropping 1.75% on the back of larges losses on Wall Street.

Although readers must be mindful of the broader implications from poorer than anticipated economic data, this could represent a good buying opportunity. The pertinent question to ask is what caused Aurora’s share price decline? Was it the broader economic environment, or was it some issue picked up in Aurora’s most recent announcement?

Reserves upgrade

The 54% upgrade in Total Proved (1P) reserves is attributed primarily to Aurora’s 40 acre spacing development (downspacing program).

A question that comes to mind is whether this program will be able to contribute positively to Aurora’s bottom line. In other words, is it worth the effort to drill more wells in a smaller area for the additional production, and is the upgrade to reserves a credible one, given there is a potential risk that increased well densities may reduce production rates beyond the levels assumed in the methodology?

Although Aurora ranks first amongst the believers, investors should pause and reflect on the potential downsides and risks inherent in this strategy, especially in the context of tight oil or unconventional type resources that have comparatively higher decline rates when compared to conventional wells.

Despite questions around production rates and expected ultimate recovery of reserves, oil and gas production in the Eagle Ford Shale and the United States continues to grow, with the US Energy Information Administration (US EIA) forecasting that crude oil production in the United States will peak in 2019 at around 9.61mmbbl/d.

Eaglebine Play has potential

Although there is no evidence to suggest this will occur in the near future, Aurora has yet to assign any reserves to its recently acquired 14,000 net acreage in the Eaglebine play of East Texas, indicating that there may be further uplift to its overall reserves position in future.

Foolish takeaway

Although readers should take note of potential headwinds from the US economy and scrutinize the high decline rates associated with shale assets, Aurora’s future appears to be bright given its significant upgrade to its Eagle Ford reserves, and potential for further upside through its Eaglebine acreage. In addition to the increased reserves level and potential, Aurora Oil and Gas has flagged a positive outlook for 2014 with production anticipated to increase ~47%, on the back of a solid 2013 which saw a 100% increase in gross production to 7.78mmboe (net 5.74mmboe).

With a significant increase to both reserves and its production outlook, Aurora appears to be well placed for a gallop (or at least a canter) in the Year of the Horse. Giddy up!

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Motley Fool contributor Sid Narsey does not own shares in any of the companies mentioned in this article.

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