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I covered Hurricane Energy (HUR.L) here shortly after the Lancaster Pilot hole flow test in September 2016, tipping the shares at 38p with a BUY target of 55p. This initial share price target was reached last week, returning investors 45% in just shy of 7 months. There has been plenty of positive newsflow in the past few months, so I take a look at what has happened since my first tip and whether I believe there is further upside from here.
Hurricane Energy plc is engaged in the exploration of oil and gas reserves offshore of UK. Based on its most recent CPR the Company has two basement reservoir discoveries and has approximately 450 million barrels of 2C Contingent Resources on its acreage.
Vital Statistics as at 23rd February 2017 market close:
|Current Share Price||52.75p|
|All Time High||58p – 7th Feb 2017|
|52 Week Low/High||58p – 7th Feb 2017
10.05p – 1st March 2016
|Enterprise Value||C£635m, minimal cash/no debt|
|Fully Diluted Market Capitalisation||£652m, 30m share options outstanding|
|PE/EPS||Not applicable for where Hurricane is in the cycle|
WHAT HAS HAPPENED SINCE SEPTEMBER?
There have been three key developments for Hurricane Energy since my last post, they are 1) further progress on the Lancaster Early Production System (EPS), 2) an exploration discovery on the Lincoln prospect and 3) the exploration spud of the Halifax prospect on newly acquired ‘out of round’ licence acreage. Let’s take at look each in turn:
1) Lancaster Early Production System (EPS) development
Hurricane via RNS confirmed in November 2016 that it had signed Heads of Terms with Bluewater Energy Services for the use of the Aoka Mizu Floating Production Storage Unit. For oil and gas novices this is essentially a floating platform which will be hooked up to the two subsea production wells planned for the development. For the anoraks among us, you can find the full specs of this little beauty here.
The Aoka Mizu has been deployed at the Ettrick and Blackbird fields for Nexen Petroleum UK since 2009. However, after just 7 years the field is now being decommissioned and the Aoka Mizu was retired from its duty. Hurricane and Bluewater have though reached an agreement to salvage poor Aoka from the Nautical graveyard and instead do various upgrades to bring her to the Lancaster field.
I covered the concept of the EPS in my previous piece but there have been some slight revisions to the core assumptions worth noting; Plateau production is now expected to be 17,000 barrels oil per day on producible reserves of 62 Million Barrels, previously reserve estimates were 53 million barrels. OPEX per Boe is now estimated to be $26 compared to $35 back in May 2016, a big improvement and most likely linked to improved terms on the FPSO lease. Moving in the other direction though CAPEX per Boe has increased from $318m to $400m.
It is worth remembering that the EPS is designed to produce for a period of 18-24 months and will unlikely form part of a larger Lancaster field development. One of the reasons for the EPS is that there is no existing production on the UKCS from basement reservoirs. The EPS will therefore give a long term indicator of reservoir performance and establish decline rates. This information, if positive, will allow the full field development to become ‘bankable’ and of course prove many doubters wrong in the process. The Hurricane team do though have an option to extend the FPSO for a further 10 years which gives flexibility on how a potential full field development plan could pan out. I have crunched the numbers and I believe a 15 year development on the EPS alone could given an NPV £430m on an unrisked basis. More on that later though….
2) Exploration Success on Lincoln
Hurricane announced a placing and open offer to raise £70m in late October. The proceeds were to fund a two well exploration campaign on two prospects nearby to Lancaster. One was the Lincoln prospect, which can be seen on Figure 2 below:
The Lincoln well was completed late in December taking around 40 days to drill down to a True Vertical Depth (TVD) of 2,135m. The initial results were very encouraging, a significant hydrocarbon column was encountered of at least 660m. This led Hurricane to state that ‘250 million barrels of recoverable oil for the Lincoln prospect may be conservative.’ We also later learnt that the Lincoln is likely a separate reservoir from the Lancaster, with no impact on the existing reserves of Lancaster. Furthermore the undrilled Warwick prospect is also likely to be part of the larger Lincoln field.
The well was not tested though, so as yet we don’t know whether the oil will flow nor we have no indication of the API of the crude, i.e. a sweet or heavier hydrocarbon. It’s clearly encouraging news though and I have prepared a very crude (pun intended) valuation below which I believe could place an unrisked valuation of at least £1bn on this prospect alone. Clearly though a few more ducks need to be lined up yet before we start throwing these figures around with more credence!
3) Halifax Drill in Progress
Halifax is the second of the two drill prospects and was acquired through an out of rounds licence application which gave us the P2308 licence. A previous well was drilled on this licence in 1998 by Arco, which revealed hydrocarbon shows just above the basement. Hurricane believe their seismic model indicates a well fractured basement similar to Lancaster and the belief therefore is that Lancaster actually extends well beyond the existing licence boundary of P1368, as illustrated on figure 2.
Given the Halifax well could be a critical input to the the broader full field Lancaster development, this well is also planned to be Drill Stem Tested (DST) if hydrocarbons are indeed present, which will give an early indication of flow rates. The Halifax well was spud on 16th January and although not explicit in the announcement I assume the targeted TVD of the well is circa 1620m, i.e. inline with Lancaster. Although this well is 500m shallower than Lincoln given the ferocious swell in the West of Shetlands around this time of year I don’t think we will hear anything until the first week of March at the very earliest. The DST piece, not conducted at Lincoln needs a particularly stable weather.
It is not uncommon to have some drilling delays in the West of Shetlands during the Winter months, rapid demobilisations during peak swell can often lead to integrity issues downhole. There could of course be a cost factor associated with any overruns, assuming a rig rate of $300,000 per day then we a probably looking at a total cost of around $42m for Lincoln/Halifax campaign to the end of Q1. Hurricane raised $85m (£70m) for the drilling campaign, to order Lancaster long leads and complete the FEED on the EPS. I therefore don’t believe there is much for shareholders to worry about at present, at least until we get further into in March without news. It’s also worth noting that in the grand scheme of what Hurricane are chasing then any overruns will likely be a pittance in the long run.
WHAT’S NEXT? WHAT NEWSFLOW CAN WE EXPECT IN THE COMING WEEKS?
The last year for Hurricane has been pretty much perfect, nothing could have gone better in my view, but what can investors look forward to over the next few months? The most material news of course is likely to be the Halifax result, but there are also two other catalysts for a share price move.
a) Halifax Well Result
As mentioned above we are likely to hear something from operations within 3 weeks. The chances of geological success are always slim so brace yourself for disappointment. But if the Halifax well ‘comes in’ then what reserves could we be talking about? Hurricane have not teased us with any figures at this stage, I think the only thing we can say is a ‘material uplift’. I therefore have discounted Halifax from my valuation (addressed later), but of course this represents a huge upside to the share price. Conversely, I also expect the share price to take a large knock if Halifax does not come in as prognosed and the speculators exit. This could represent a buying opportunity in my opinion though, the resources in the CPR will be more than enough to make Hurricane a major independent player, with our without Halifax.
b) Independent Reserve Report
My expectation is for a revised CPR shortly after Halifax is completed, so probably around April/May. I think we will likely see some shift in the categories for Lancaster and Lincoln, i.e. from prospective to Contingent and probably within contingent resources too. We will also likely see some upwards revisions of the numbers. Perhaps the most significant though will be the first reserve booking on Lancaster, I am expecting at least 60 MM Boe to be booked to the 2P category, i.e. commercial reserves.
The Hurricane team have already put out their own views on the potential size of Lancaster and Lincoln, so I would be very surprised if the revised CPR itself causes much of a reaction upwards in the share price, this document will be critical though in the financing process…
c) Financing the EPS
Hurricane needs to raise around $400m to fund the EPS, with the stated strategy being to bring a partner in through a farm out process. The Oil and Gas M&A market is really picking up at the moment so I would be really surprised if management can’t achieve this objective. The obvious candidate is likely to be BP given the proximity to its operated Schiehallion Field. Funding a share of this project would be a drop in the ocean for BP and potentially give them access to a much larger prize. It would also be a PR coup for BP, a British company investing in the next generation of North Sea oilfields. I am sure this would have the government and BP PR guys salivating. There are plenty of other matches for Hurricane too, but whomever it needs to be someone with a strong balance sheet.
A cautionary note, BP et al are notoriously hard to negotiate with and the issue for Robert Trice and the board will not be whether they can generate interest in Lancaster, it will be at what level of NPV that a potential partner places on the assets. I have every faith that Hurricane will do the deal which maximises shareholder value and with that in mind they are certainly not dependent on the traditional ‘farm out’ method. Looking at the deal put together by Sirius Minerals to fund a major project at sole risk then Hurricane can have every confidence that they can achieve what would be smaller fund raise. I have therefore in my own valuation have assumed a mix of 50% Debt and 50% equity.
SO LOTS OF INFORMATION, BUT WHAT IS THE UPDATED VALUATION?
Hopefully you are still with me after this long piece! Cutting to the chase, my own risked valuation is 75p per share as illustrated in figure 4, i.e. a 42% upside based on the current share price. This is inline with the latest broker targets of 69p-91p.
Now for the caveats; this valuation is something I have put together using very high level assumptions, I have had no input from the company other than the core assumptions on the Lancaster EPS which are in the public realm. The Lincoln and Lancaster Full field valuations are particularly high level given they are Pre-FEED assets. However, for those who want to get behind the valuation in more detail, my workings are here and please do go through them adjusting for areas where you might be more bullish or bearish.
I have tried to be as prudent as possible, assuming equity dilution, large risk factors, no success on Halifax and the assumption that we won’t get to $100 oil prices until 2043! I have also tried to keep things simple, assuming 100% field share.
Any further risks or upsides to consider?
The biggest risk to this company in the long term is being unable to get satisfactory long term production from the EPS. As all of the prospects are basement plays any disappointment could scupper the chances of the entire greater Lancaster region being developed. We won’t really get a feel for that though until the end of 2019. Before then the financing of the EPS is perhaps the key near term risk, I am fairly confident that an attractive financing can be put together, but the use equity and convertible debt could reduce the NPV per share significantly. The usual combination of CAPEX overruns and oil prices are also a risk too, but this is far from unique in this sector.
As a final note I would like to give credit the Hurricane Management team, what Robert Trice and his team have achieved in one year puts the boards of many junior oil companies to shame. Hurricane have managed to raise equity at premium at the very bottom of the oil M&A market, they have secured an out of round licence award and worked up a drill ready prospect in just a few months, not to mention further progress on the EPS. Amazingly they have achieved this with just 15 or so Full Time employees. We don’t know how the story will end but I don’t think anyone can claim management were not committed!
Buy – Target 75p (42% upside)
There is still plenty of upside at the current share price levels in my opinion, even without Halifax. As development proceeds there is plenty more growth to come and I expect we will be see £1 within 12-24 months, barring any major disasters. The stock is though still somewhat speculative, so make sure it is part of a diversified portfolio.
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.