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Hurricane Energy plc (HUR.L) released a very exciting RNS this morning here, giving an update on appraisal drilling on its Lancaster development. The 60 day well confirmed all objectives were met, with the results coming in significantly better than prognosis. The key points from the RNS were as follows:
- Hydrocarbon column: 620m, deeper than the 2014 well by 320m.
- Assisted Flow Rate:11,000 confirmed vs 9,800 boe per day expected
- Pressure: As prognosed.
- Crude quality: 38 API, a light crude oil which should fetch a price fairly close to the Brent benchmark.
For those without a petroleum background, what does all this mean? The 2C, i.e. The mid case contingent reserves were 207mm Boe prior to the pilot hole being drilled (Note – if you are not familiar with reserves classifications please see my article here) with the best case reserves being 456MM Boe. The hydrocarbon column as mentioned above has come in significantly in excess of prognosis, therefore the best case of 456 MM Boe is likely to be well within reach. It is no surprise therefore that Hurricane Energy have today stated the result ‘materially derisks the plans for field development’. Hurricane Energy share price have responded accordingly, up a stonking 55% to 38p, capitalising the company at £377m as at market close.
What’s the background? What is the Lancaster Development?
The Lancaster development is an exciting Oil appraisal prospect West of Shetlands in the UK and 15km from the BP operated Schiehallion Field. The Schiehallion field is currently under a £3bn redevelopment after already producing 400 mm Boe since 1998. The field is expected to be bought back on stream this year with expected production at 130,000 Boe per day and an estimated remaining resource of 450 mm Boe. Even in a low oil price environment the West of Shetland basin is an extremely exciting area and the last part of the UK Continental Shelf to have its resources substantially tapped into. Hurricane are definitely exploring in an interesting area.
Hurricane’s prospects are in fact in even more exciting. The company is exploring in basement reservoirs, a part of our geological history overlooked by the majors operating in the North Sea. ‘Unlike sandstone reservoirs that hold oil in the rock and have provided much of the world’s oil over decades, fractured basement rock is very hard and brittle, composed of rocks such as granite. Billions of cracks have been created when the basement structures moved through tectonic action, resulting in seismic scale faults and highly connected fracture networks’
‘For Hurricane it is these faults and fractures that are most interesting because that is where, under the right conditions, significant volumes of oil accumulate.’
Assuming the Lancaster project does now press ahead with the Field Development plan (FDP), the project is expected to be an FPSO with subsea infrastructure tied into two wells (see fig 2 below). This would be an estimated 20,000 Boe per day with Hurricane Energy stating they expect first oil to be Q3 2019 on this FDP.
So what are the next steps for the Lancaster Field and what is the potential news flow?
It does look very promising for the Lancaster field, today’s announcement pretty much confirms commerciality and introduces a whole lot more potential further upside too. Hurricane will now immediately sidetrack into a horizontal well (see Fig 3 below) to confirm production rates and build up a deeper knowledge of the reservoir characteristics across the field.
More detailed lab results will also be gained from both the pilot hole and the sidetrack, once completed. We are then likely to see a revised CPR (the last one was done in 2013) and a need to rework the FEED (Engineering) studies, to devise the most appropriate FDP. My expectation is that the FDP could look a lot different to Fig 3 above. This FDP was developed with a 53 Million case in mind, as mentioned we could be looking at a field 10 times larger than this.
The important question, how much is Hurricane worth after today’s announcement?
It is still fairly hard to value Hurricane Energy. There aren’t any Lancaster project economics in the public realm so I have had to develop my own NPVs. My numbers are extremely high level but at the 20,000 boe per day base case and with 1C resources of 58mm Barrels I estimate a conservative NPV of £271m. The numbers though get very interesting if Hurricane can get a FDP away with much higher production rate than 20,000 boe and a resource level towards the best estimate of 456 mm Boe. Based on todays result I believe this is a real possibility.
If Hurricane can get a field development plan for Lancaster in place which can achieve 40-60k boe per day then the economics look splendid. This production rate I estimate would give an NPV between £800m and £1.2bn, significantly above today’s market cap. This is with only running the economics until 2026, the Lancaster field life is probably around 20-30 years if the best case contingent resources of 456MM Boe is achieved. I have also been quite conservative in my assumptions so potentially even more significant upside too on the NPVs. So in summary todays market cap of £377m looks pretty cheap given the potential upside.
Note, these numbers are very high level, you can find my workings for my NPVs stated above here. Please review carefully my assumptions before taking any investment decisions.
Are there any other upsides?
Tons. According to the the CPR done back in 2013 the total 2C resources relating to prospects other than Lancaster were 237 mmBoe, nearby prospects such as Lincoln are quoted by Hurricane as being tie in opportunities to the Lancaster development. If this comes to fruition then all of a sudden Hurricane Energy could have on its hands major development, similar to the Schiehallion area mentioned above.
Hurricane previously also considered farming out part of the Lancaster area to a JV partner ahead of the current appraisal drilling programme. The farm out was delayed due to the partners not being able to fund a drilling programme this year. In hindsight this was a smart move for Hurricane as the shareholder value from any farm out now will be much greater. I wouldn’t even rule out a major sniffing around, perhaps BP making an approach for Hurricane given their local area expertise, or am I getting carried away?
Other upsides? In my model I don’t have the return of ‘$100 oil’ until 2026, if we do get back to higher oil prices quicker than this then we could see further significant upside on the NPV figures quoted above. I’ve also ignored any potential North Sea tax reliefs, I wouldn’t be surprised to see some sort of enhanced field allowance or other tax credits in the next budget, just to satisfy the political pressure to ensure continued oil production in the North Sea.
This feels like a ramp. There must be some risks?
I agree this is the most bullish article I’ve written for a while, but it is important to be balanced. If long term oil prices are substantially lower than that I have assumed in my model then the NPVs noted above in Fig 4 will drop significantly. For example, the 40k boe per day case mentioned above would result in an NPV of £360m on a 20% reduction in oil price each year, very close to the existing market capitalisation.
The NPV of Lancaster is also very sensitive to CAPEX, I have made some assumptions above on CAPEX figures but these are my estimates, even if I am correct with my estimates there is still a risk of CAPEX overuns. Laggan Tormore the last major West of Shetland project started production at 90,000 boe in 2016, but the project was 40% over budget. At FID it was anticipated to cost £2.5bn but it finally came in at £3.5bn and with a one year delay. In summary CAPEX overuns and lower oil prices could destroy all value for Hurricane.
There is also a risk that the current sidetrack discovers issues and subsequent appraisal brings the fields size and production profile down significantly. It is therefore important to understand that although significant derisking occurred today there is still a speculative side to this investment.
BUY – Target 55p
On balance still a buy, my target of 55p would capitalise the company at £540m, still leaving plenty of room for further derisking towards a 40k boe a day production scenario on Lancaster, i.e £850m of NPV. There would also still be plenty of further upside with a 60k+ boe day production case, with or without the other prospects nearby. Considering this then Hurricane could easily be a $1bn company ahead of first oil on Lancaster in 2019. Appraisal disaster, CAPEX overuns and lower oil prices could destroy shareholder value, but these are issues not unique to Hurricane. As long as Hurricane is part of a diversified portfolio then you have yourself a potentially very good investment here.
Disclaimer – I have a position equal to 1% of my net assets in Hurricane Energy. I have no further positions in any of the other stocks mentioned and to my knowledge nor do any close family, friends nor associates.
This post is purely my opinion and should not be taken as financial advice. I welcome any alternative comments and will consider adjusting posts based on information made available to me.