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Defining EPS development volumetrics

Hurricane Energy 28 April 2016 Update

Hurricane Energy

Defining EPS development volumetrics

Fund-raising and FY results

Oil & gas

28 April 2016

Price

13.5p

Market cap

£86m

£/US$1.44

Net cash (£m) at end December 2015

9.9

Shares in issue
(excludes 347m share issue announced 18 April)

635m

Free float

88%

Code

HUR

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

17.4

38.2

(6.9)

Rel (local)

13.7

31.0

3.0

52-week high/low

18.38p

9.40p

Business description

Hurricane is an E&P focused on UKCS fractured basement exploration. It owns 100% in three licences, including the 200mmbbl Lancaster discovery.

Next event

Lancaster 7 Wells

Q316

Analysts

Sanjeev Bahl

+44 (0)20 3077 5700

Ian McLelland

+44 (0)20 3077 5756

Will Forbes

+44 (0)20 3077 5749

Elaine Reynolds

+44 (0)20 3077 5713

Hurricane Energy is a research client of Edison Investment Research Limited

Hurricane’s 2016 well programme aims to firm up volumes in Lancaster’s mapped structural closure, oil that Hurricane plans to monetise through a two-well EPS development. More clarity on volumes will support concept definition and should provide the basis for further farm-out discussions, taking the Lancaster field through to EPS first oil in 2019. Hurricane’s £52m fund-raise, announced on 18 April, was carried out at a 46% premium to market and will provide capital for the Q316 Lancaster 7 Wells drilling programme consisting of a multi-objective vertical pilot well and horizontal production test. Our RENAV for Lancaster, including net cash and net of corporate overheads, stands at 34p/share, down from our last published 47p/share as a result of fund-raising equity dilution, a 10$/bbl reduction in our long-term oil price assumptions and higher risk assigned to full field development volumes outside mapped structural closure.

Year
end

Revenue
(£m)

EBITDA*
(£m)

PBT*
(£m)

Operating
cash flow (£m)

Capex
£m)

Net (debt)/
cash (£m)

12/14

0.0

(8.5)

(9.0)

(4.7)

(36.5)

15.9

12/15

0.0

(5.4)

(5.5)

(2.6)

(3.4)

9.9

12/16e

0.0

(4.6)

(4.5)

(4.4)

(43.0)

11.8

12/17e

0.0

(4.6)

(4.6)

(4.5)

(16.7)

(9.3)

Note: *EBITDA and PBT are normalised, excluding intangible amortisation, exceptional items and share based payments.

High-spec rigs available at lower cost

Hurricane and Transocean have entered into a rig contract for the harsh weather, semi-sub Transocean Spitsbergen for the forthcoming Q316 drilling programme. We believe that current market dynamics have enabled Hurricane to contract the high-spec rig at an attractive day rate and at short notice. Final permitting and authorisation to drill are expected in the coming months, with a pilot well to be drilled this summer.

Potential for EPS first oil in 2019

Assuming the Lancaster 7 Wells are drilled in 2016, the company believes it will be able to make a final investment decision for the EPS phase by H117. Sourcing a suitable FPSO and shipyard for topside modification works will be key to ensuring first oil can be achieved by 2019.

Valuation: Significant upside remains

Our updated valuation reflects fund-raising proceeds and associated equity dilution. We also make some changes to our model to reflect updated assumptions for our base case two-well EPS, full field development and farm-out dilution. In addition, our long term oil price has moved from 80$/bbl long to 70$/bbl real. The net result is a decrease in our RENAV from 47p/share to 34p/share.

Funded 2016 well programme

On 18 April 2016, Hurricane Energy announced that it had conditionally raised £52.1m gross through the proposed issue of 347m new ordinary shares at 15p/share. The net proceeds of the fund-raise are earmarked for drilling a pilot well and a horizontal well on Lancaster in Q316 (Lancaster 7 Wells: £43.9m) and for general corporate purposes (£5.4m).

In our view, Hurricane’s 2016 well programme is well timed, taking advantage of high-spec rig availability at an attractive price. The company has not released the contracted day rate for the Transocean Spitsbergen, but we understand that costs reflect recent reductions seen in deepwater rig rates which are down by more than 60% since peak. While Hurricane’s fund-raise at 15p/share is dilutive to our NAV, we believe it is sensible of Hurricane to take advantage of current availability and low day rates in the high-spec, deepwater rig market.

Lancaster 7 Wells – Q316

The company’s 2016 well programme incorporates a pilot well and a horizontal sidetrack on Lancaster and is known as Lancaster 7 Wells. The three objectives of the Pilot Well are as follows:

Data acquisition to confirm hydrocarbon distribution and depth of the oil water contact: Hurricane’s two-well EPS is aimed at recovering hydrocarbons trapped above mapped structural closure; to date there has been no definitive oil down to (ODT) to calculate this STOIIP volume. Confirmation of the ODT from the planned 2016 pilot well will reduce STOIIP uncertainty and assist in the selection of suitable facilities for EPS development. In 2013, RPS Energy estimated the range on conventional basement STOIIP in Lancaster at 140-383mmbbl gross.

Evaluation of the properties of a potential aquifer below the 205/21-4 well oil water contact: the existence and strength of aquifer pressure support will be an important consideration in progressing Lancaster through to EPS and full field development. Aquifer pressure support has potential to prevent early gas breakthrough, but may have negative implications for water cut and the design of water-handling facilities.

Determining the properties of the overlying Victory sandstone (Commodore sandstone), which has potential to be significantly thicker and better quality at the well location: in 2013, RPS estimated Victory conventional STOIIP in Lancaster at 3-28mmbbl gross. The 2016 well has potential to lead to an increase in Pmean STOIIP if logs suggest a thicker and/or better quality reservoir section at the selected well location.

On completion of pilot well operations, the well will be plugged and abandoned and a horizontal well will be drilled and tested from the same borehole. The horizontal will be flow tested to clean up the well and look to replicate the results of the 2014 flow test. A longer duration shut-in and pressure build-up test than 2014 should provide further information on reservoir quality and continuity away from the wellbore.

A successful outcome from the 2016 well programme has the potential to materially de-risk EPS development, potentially providing Hurricane with more favourable terms for an EPS and/or full field farm-down. Importantly, we should see more certainty on the size of recoverable resource for the EPS phase of development, giving us greater confidence in the mid-case volumetrics that drive our valuation.

Transocean Spitsbergen

The Transocean Spitsbergen is a 2009 Aker H-6e semi-sub with harsh environment, ultra-deepwater capability currently ready stacked in Norway, according to RigLogix. We understand that Hurricane’s’ rig contract remains contingent on completion of the fund-raising and is available to commence work in Q316. Hurricane has not released details on cost contingency or risk-sharing arrangements with Transocean; well AFE stands at £43.9m.

Exhibit 1: Transocean Spitsbergen harsh environment, ultra-deepwater semi-sub

Source: Transocean

EPS and full field development

Hurricane believe that the results of Lancaster 7 Wells should allow it to make a final investment decision to progress Lancaster’s EPS development phase. EPS is planned for first oil in 2019, which should provide long-term production data to de-risk and optimise full field development and provide shareholders with an acceptable risked return on capital.

Two-well EPS development – first oil in 2019

EPS or development of Lancaster will involve recompleting and tying back two horizontal wells (recompletion of wells drilled in 2014 and 2016) to a leased FPSO. The minimal facility FPSO, which is limited to oil separation, produced water clean-up and fuel gas power systems. Tanker offloading will be required as there is no alternative export infrastructure. Total cost from the end of 2016 through to first oil is estimated by Hurricane at $240m excluding letters of credit.

Ours EPS production profile is based on two wells producing at start-up with an IP rate of 8mb/d. We assume per well EUR in the EPS phase is inline with average full field development EUR as per Hurricane's 2013 CPR. There is potential upside to this assumption as the EPS phase development focuses on the monetisation of oil within mapped closure as successfully tested by well 205/21a-6 in 2014. We view our assumption as conservative and expect to update post the Lancaster 7 wells programme.

Exhibit 2: EPS production profile

Source: Edison Investment Research

Exhibit 3: Lancaster EPS key assumptions

Lancaster EPS – two wells

Capex to first oil post 2016

$240m

First oil

2019

Average well IP rate

8,000b/d

Per well EUR

17.9mmbbl

No. of wells

2

Total recovery

36mmbbl

FPSO lease rate

$235k/day

Lancaster EPS – two wells

Capex to first oil post 2016

First oil

Average well IP rate

Per well EUR

No. of wells

Total recovery

FPSO lease rate

$240m

2019

8,000b/d

17.9mmbbl

2

36mmbbl

$235k/day

Source: Edison Investment Research

We model first oil in line with company guidance in H119, giving an unrisked, forward-looking IRR (gross basis) of 48% based on our oil price deck, which assumes Brent long-term at 70$/bbl (real). We note that delivery of first oil in 2019 will be dependent on EPS FPSO and modification yard availability.

Full field development – first oil in 2024

Full field development (FFD) of Lancaster is aimed at recovering remaining oil from Lancaster’s mapped structural closure, in addition to oil from basement reservoir and Victory sands below mapped closure. We currently model 36mmbbl recovery in the EPS phase and 164mmbbl through FFD. Hurricane’s 2013 CPR splits Lancaster volume between above and below mapped closure (61mmbbl and 139mmbbl respectively).

Our FFD development largely follows assumptions made in the company’s 2013 CPR, adjusted for the latest cost information and improved per well flow rates after Hurricane’s success at well 205/21a-6 in 2014. Our base case assumes a purchased FPSO development delivering first oil in 2024, with peak production of c 70mb/d as shown in the production profile below.

Exhibit 4: Full field development production profile

Source: Edison Investment Research

Exhibit 5: Lancaster FFD key assumptions (excludes EPS phase)

Capex to first oil post 2016

$1,338m

First oil

2024

Average well IP rate

8mb/d

Per well EUR

18mmbbl

No. of wells

9

Total recovery

164mmbbl

FPSO lease rate

$500k/day

Source: Edison Investment Research

Our unrisked forward-looking IRR of a combined EPS and FFD development of Lancaster on a gross basis and at an Edison (70$/bbl real long term Brent) price deck, is estimated at 41%.

Development funding

Hurricane is funded through the 2016 well programme, although further funds will be required to progress Lancaster through to EPS and FFD. We assume Hurricane’s net capex through to EPS and FFD first oil is funded via farm-down and an FFD reserve-based lending (RBL) facility (we assume $250m net RBL in our base case). Based on our forecasts, we expect the company to require more funds in 2017. Our financial forecasts assume £9.3m of net debt at year-end 2017. Taking a view on asset dilution through farm-out, our analysis assumes a farminee will require a 25% forward-looking, post-carry IRR to invest. On this basis, we believe that Hurricane will need to farm down a 58% equity interest in Lancaster i to fund both EPS and FFD. This dilution is reflected in the working interests we apply in our NAV, with Hurricane retaining a 42% working interest in both EPS and FFD.

Valuation and financials

Our RENAV moves from 45p/share to 34p/share to reflect the issue of new shares, macro and asset-level updates. Despite this RENAV downgrade, we continue to see more than 149% upside from the current share price and believe there is potential for our RENAV to increase over the course of 2016 as EPS development is de-risked through the Lancaster 7 Wells programme.

Key changes to our last published model include:

1.

inclusion of new shares issued and net proceeds from Hurricane’s proposed £52m fund-raise;

2.

addition of the Q316 Lancaster 7 Wells programme in capex projections;

3.

changes to FFD geological risk to reflect a moderately higher risk of developing volumes outside structural closure;

4.

partial de-risking of EPS development, with Hurricane retaining a higher equity interest post farm-down (from 34% WI to 51%). Farm-down dilution assumes the farminee generates a post-carry IRR of 25%;

5.

$240m of development capex required to take EPS through to first oil after the 2016 drilling programme;

6.

increase in well IP rates from 6,000b/d to 8,000b/d to reflect the positive results of Hurricane’s 2014 appraisal programme; and

7.

updated macro assumptions which move from 80$/bbl Brent long-term real to 70$/bbl.

Exhibit 6: Hurricane Energy valuation summary – FFD purchased FPSO (base case)

 

 

 

 

Recoverable reserves

 

Net risked

Value per share

Asset

Country

Diluted WI

CoS

Gross

Net

NPV/boe

value

Risked

NOSH: 979.4

 

%

%

mmboe

mmboe

$/boe

$m

/share

Net (debt)/cash post fund-raise

100%

100%

51

4

SG&A (2 years)

100%

100%

(12)

(1)

Core NAV

 

 

 

 

 

 

40

3

Contingent

Lancaster EPS - two wells

UK

42%

70%

36

15

10.6

112

8

Lancaster FFD (post-EPS)

UK

42%

44%

164

69

10.8

331

23

RENAV

 

 

 

200

84

 

483

34

Source: Edison Investment Research. Note: NPV/boe assumes a farm-out will be full capex carry for Hurricane.

Our RENAV remains highly sensitive to long-term oil price assumptions, with a post farm-down NAV break-even at c 50$/bbl Brent. At higher oil prices, our RENAV is several times the current share price, as shown in Exhibit 7 below.

Exhibit 7: RENAV sensitivity to long-term oil price assumption

Source: Edison Investment Research. Note: Retained working interest adjusts with oil price to ensure farminee achieves a 25% IRR post-carry.

At this stage, we do not include value from other discoveries and prospects as there is no clarity on when appraisal/exploration wells will be drilled and/or funded. This blue-sky exploration/appraisal portfolio is potentially worth a further 12p/share on our estimates. We have not conducted detailed dilution analysis for this portfolio of assets and as such may be overestimating the commercial chance of success.

Exhibit 8: Hurricane Energy valuation summary – exploration/appraisal portfolio

 

 

 

 

Recoverable reserves

 

Net risked

Value per share

Asset

Country

Diluted WI

CoS

Gross

Net

NPV/boe

value

Risked

 

 

%

%

mmboe

mmboe

$/boe

$m

/share

Discovery - on hold

Whirlwind

UK

100%

13%

192

192

2.1

53

4

Strathmore

UK

100%

10%

32

32

0.3

1

0

Long-term exploration upside

Lincoln

UK

100%

7%

150

150

3.5

35

2

Tempest/Typhoon

UK

100%

8%

175

175

2.8

40

3

Lancaster prospective resources

UK

100%

5%

53

53

6.4

17

1

Whirlwind prospective resources

UK

100%

8%

85

85

2.5

18

1

Long-term exploration upside NAV

 

 

 

687

 

163

12

Total long-term valuation including blue-sky upside

 

 

 

771

 

602

43

Source: Edison Investment Research

Exhibit 9: Financial summary

 

 

£000s

2014

2015

2016e

2017e

Dec

 

 

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

0

0

0

0

Operating Expenses

(8,489)

(5,366)

(4,646)

(4,646)

EBITDA

 

 

(8,489)

(5,366)

(4,646)

(4,646)

Operating Profit (before amort. and except.)

 

(8,584)

(5,448)

(4,741)

(4,741)

Exploration expenses

0

0

0

0

Exceptionals

0

0

0

0

Other

0

0

0

0

Operating Profit

(8,584)

(5,448)

(4,741)

(4,741)

Net Interest

(441)

(75)

224

182

Profit Before Tax (norm)

 

 

(9,025)

(5,523)

(4,517)

(4,559)

Profit Before Tax (FRS 3)

 

 

(9,025)

(5,523)

(4,517)

(4,559)

Tax

19

0

0

0

Profit After Tax (norm)

(9,006)

(5,523)

(4,517)

(4,559)

Profit After Tax (FRS 3)

(9,006)

(5,523)

(4,517)

(4,559)

Average Number of Shares Outstanding (m)

621.4

632.2

979.4

979.4

EPS - normalised (p)

 

 

(1.4)

(0.9)

(0.5)

(0.5)

EPS - normalised and fully diluted (p)

 

(1.4)

(0.9)

(0.5)

(0.5)

EPS - (IFRS) (p)

 

 

(1.4)

(0.9)

(0.5)

(0.5)

Dividend per share (p)

0.0

0.0

0.0

0.0

Gross Margin (%)

NA

NA

NA

NA

EBITDA Margin (%)

NA

NA

NA

NA

Operating Margin (before GW and except.) (%)

NA

NA

NA

NA

BALANCE SHEET

Fixed Assets

 

 

177,653

176,231

219,146

235,711

Intangible Assets

177,308

176,012

176,012

176,012

Tangible Assets

215

89

43,004

59,569

Investments

130

130

130

130

Current Assets

 

 

17,409

10,771

12,625

830

Stocks

0

410

410

410

Debtors

1,553

420

420

420

Cash

15,856

9,941

11,795

0

Other

0

0

0

0

Current Liabilities

 

 

(1,487)

(271)

(271)

(271)

Creditors

(1,487)

(271)

(271)

(271)

Short term borrowings

0

0

0

0

Long Term Liabilities

 

 

(7,281)

(3,221)

(3,221)

(12,549)

Long term borrowings

0

0

0

(9,328)

Other long term liabilities

(7,281)

(3,221)

(3,221)

(3,221)

Net Assets

 

 

186,294

183,510

228,280

223,721

CASH FLOW

Operating Cash Flow

 

 

(4,677)

(2,558)

(4,422)

(4,464)

Net Interest

0

0

0

0

Tax

0

0

0

0

Capex

(36,542)

(3,407)

(43,010)

(16,660)

Acquisitions/disposals

0

0

0

0

Financing

16,783

22

49,287

0

Dividends

0

0

0

0

Net Cash Flow

(24,436)

(5,943)

1,854

(21,123)

Opening net debt/(cash)

 

 

(14,022)

(15,856)

(9,941)

(11,795)

HP finance leases initiated

0

0

0

0

Other

26,270

28

0

0

Closing net debt/(cash)

 

 

(15,856)

(9,941)

(11,795)

9,328

Source: Company accounts, Edison Investment Research. Note: Financials assume £9.3m of debt funding in 2017.

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60325 Frankfurt

Germany

London +44 (0)20 3077 5700

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London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

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US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

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