Resolution CPR published ahead of farm-out

Egdon Resources 25 April 2019 Update
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Egdon Resources

Resolution CPR published ahead of farm-out

Resource update

Oil & gas

25 April 2019

Price

5.75p

Market cap

£15m

Net cash (£m) at end January 2019

1.8

Shares in issue

260.0m

Free float

47%

Code

EDR

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(15.4)

(23.9)

(5.5)

Rel (local)

(18.6)

(30.2)

(5.7)

52-week high/low

12.50p

5.63p

Business description

Egdon Resources is an AIM-listed onshore oil and gas exploration company. The group has conventional and unconventional assets in the UK.

Next event

Springs Road update

Q219

Analysts

Sanjeev Bahl

+44 (0)20 3077 5700

Carlos Gomes

+44 (0)20 3077 5700

Egdon Resources is a research client of Edison Investment Research Limited

We have re-visited our conventional valuation of Egdon post the company’s interim results (to end January 2019) and the recent resource assessment for Resolution. We also factor in a decrease in our short-term gas price expectations, lower than previously forecast production for FY19 and the removal of the risked value for Biscathorpe-2 exploration. As a result, our RENAV is reduced by 1.2p/share to 11.5p/share. These reductions are partly offset by an increase in our valuation for Resolution (from 3.2p/share to 7.1p/share), driven by Schlumberger’s 2019 resource assessment and our revised economic model. We continue to believe that significant uncertainty remains regarding the commerciality of Resolution ahead of further appraisal, but we believe recent industry interest in SNS Zechstein gas appraisal increases the likelihood of a farm-out.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

EBITDA
(£m)

Net cash (debt) £m

Cashflow from operations (£m)

07/17

1.0

(2.2)

(0.7)

(1.2)

6.1

(0.4)

07/18

0.8

(1.7)

(0.8)

(2.2)

2.8

(1.6)

07/19e

2.2

(2.1)

(0.2)

(0.5)

0.6

(0.3)

07/20e

2.7

(1.8)

(0.8)

0.1

(0.4)

0.6

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Resolution resource upgrade

Schlumberger has provided an assessment of un-risked 2C recoverable gas (excluding Carboniferous) for the Resolution field at 206.4bcf (1C 100bcf and 3C 389bcf), versus Egdon’s last published internal estimate of 2C 337bcf. We continue to believe that there is significant uncertainty around recoverable resource and hence commerciality ahead of further appraisal. Key resource uncertainties include limestone fracture porosity, matrix porosity and gas recovery factor. Egdon is actively looking for a farm-in partner to fund the acquisition of 3D seismic, followed by an appraisal well.

Springs Road: Improved drilling performance

Egdon has a 14.5% carried interest in the Springs Road-1 shale gas appraisal well operated by IGas. Further details on the core and log analysis is expected in Q219. The drilling performance (rate of penetration) has been ahead of operator expectations and reports of gas indications in the Millstone Grit, deeper parts of the Bowland Shale and the Arundian Shale are encouraging. We expect to review our probabilistic UK shale valuation model as further details emerge from SR-1.

Valuation: Funded through to mid-2020

Based on our current forecasts, Egdon is funded through to the middle of CY20, with activity at Springs Road fully carried and planned 3D seismic at Resolution expected to be funded by a farm-out. Our current valuation is 1.5p/share for producing assets, cash and net of SG&A, rising to 11.5p/share if we include risked exploration potential. Maintaining our last published UK shale model, we estimate an indicative P50 value of c 100p/share for Egdon’s UK shale acreage of 188,000.

Resolution resource update and economics

Resolution was discovered by Total in 1966 with the 41/18-2 well in the Southern North Sea (SNS). The discovery sits close to the North Yorkshire coast, but is expected to be developed as an offshore field as the crest of the structure is c 6km offshore. Egdon has mapped the structural closure as extending southwards from P1929 into P2304 and has been independently assessed by Schlumberger to contain 2C resources of 206.4bcf (P50) and 230.6bcf (Pmean) un-risked (Exhibit 1). Schlumberger’s resource assessment excludes the potential for underlying Carboniferous sandstones, which Egdon continues to believe contain significant additional gas potential. Our valuation of Resolution increases from 3.5p/share to 7.1p/share but we flag that valuation uncertainty remains high ahead of further appraisal.

Exhibit 1: Schlumberger’s estimate of Resolution’s un-risked contingent resources (bcf)

Source: Egdon Resources. Note: *Mean estimates for each interval and in aggregate.

Egdon estimated that rates of between 17 million and 22 million cubic feet per day could be achieved from a well on the structure with fracture stimulation. The P2304 licence contains a second smaller gas discovery, Endeavour, confirmed by wells 41/24A-1 (1969, Total), 41/24A-2 (1981, Total) and 41/24-3 (1993, Conoco) which tested at rates of up to 34 million cubic feet of gas per day and 1,280boed of condensate from the Plattendolomit, a Zechstein carbonate unit which is slightly younger than the Roker Dolomite (also known as the Hauptdolomit) reservoir tested in the Resolution discovery well. As with P1929, P2304 contains additional prospectivity in deeper gas bearing Carboniferous sandstones underlying the proven Zechstein reservoir sequences. The Carboniferous play is due to be tested onshore at Kirby Misperton in the Third Energy KM-8 well and this should provide further data for input into Egdon’s evaluation of the Carboniferous potential.

Exhibit 2: Resolution 41/18-2 discovery well

Exhibit 3: Location of Resolution and Endeavour

Source: Egdon Resources

Source: Egdon Resources

Exhibit 2: Resolution 41/18-2 discovery well

Source: Egdon Resources

Exhibit 3: Location of Resolution and Endeavour

Source: Egdon Resources

Exploration of the Zechstein has not been a primary exploration target in the UKCS (UK continental shelf). The nearest offshore Zechstein production to Resolution is from the Hewett field, which is located in Blocks 48/29 and 48/30 and c 200km to the south west. Hewett has been producing since 1986. Closer to P1929, there are several onshore fields in the Vale of Pickering which have been producing from the Zechstein Kirkham Abbey formation since 1995, including the Third Energy operated fields Kirby Misperton, Pickering, Malton and Marishes.

However, in 2019 there is likely to be a renewed focus on the Zechstein in the offshore. In February, Cluff Natural Resources (CNR) farmed out 70% including operatorship of its P2252 licence to Shell. The licence holds Pensacola, a Z2 Zechstein reef prospect that CNR estimates holds 309bcf of P50 un-risked prospective resources. The prospect sits c 20km to the north east of Resolution and this summer CNR plans to carry out a 3D seismic survey of over 400km2. Meanwhile, Netherlands-based ONE-Dyas is due to spud its Ossian-Darach exploration well in May 2019 targeting a Zechstein reef in the Ossian prospect, which is also to the north east of Resolution on the northern edge of the SNS.

Data from the 41/18-2 Resolution discovery well have demonstrated that the Z2 Zechstein reservoir is a tight carbonate with low matrix porosity. Although it is thought that there could be sweet spots of higher porosity across the prospect, production would rely on the presence of natural fractures together with the application of fracture stimulation. Egdon’s existing model is based on reprocessed 2D seismic and the company is planning to acquire 3D seismic in Q319, pending a farm-out, to further define the fracture networks and de-risk an appraisal well. The appraisal well would be designed to maximise the intersection of the wellbore by fractures; to achieve this it will be a horizontal well.

Significant uncertainty remains around gas in place and recoverable resource

Due to the nature of the reservoir, the estimation of gas in place (GIIP) is subject to some uncertainty, given that the extent and distribution of fractures across the structure is currently based on data from the discovery well and 2D seismic. The planned acquisition of 3D seismic will assist in refining this estimation. Similarly, the variation in reservoir quality due to the presence/absence of fractures results in some uncertainty in estimating the recovery factor. Schlumberger has assigned a recovery factor of 58% to the Zechstein Roker Dolomite (which holds 68% of the estimated contingent resources in P1929). This is consistent with recoveries from analogous Southern North Sea reservoirs. Recovery from the Zechstein in Hewett is 50%, and was reported to be 65% in the Wissey field. Recovery from the small onshore fields has been lower however, at around 12%, due to early water breakthrough. Although water breakthrough is a key potential hazard in fractured reservoirs, the testing carried out at the 41/18-2 Resolution discovery well did not find any evidence of water and both Egdon and Schlumberger have not seen water breakthrough occurring in their reservoir models.

We have modelled the development of a potential commercial gas discovery based on Edgon’s proposed development concept, which involves the use of a small unmanned platform tie-back to onshore gas processing facilities. Key metrics from our asset model are provided in the table below and represent a 12-well development with an estimated gas recovery of 201bcf. Our gross un-risked NPV of $319m is based on a UK gas price of $7/mcf inflated by 2.5% pa. However, we note that at this stage there is significant uncertainty with regards to recoverable gas and well costs for a prospective development.

Exhibit 4: Resolution standalone development economic estimates

Recoverable gas (bcf)

201.0

Recoverable liquids (mmbbls)

2.4

Capex cost to first gas ($m)

365.2

Capex + abandonment cost ($/boe)

12.0

Opex life of field ($/boe)

4.8

Realised gas price 2022 ($/mcf) inflated by 2.5% per annum

7.5

Project IRR (%)

32%

Gross project NPV12.5 un-risked ($m)

319.0

Source: Edison Investment Research

When valuing Resolution, we have had to take a view on the commercial chance of success (CCOS) and the potential value Egdon could retain post farm-out. When considering the CCOS we have not conducted a probabilistic valuation of the asset at this stage to determine the likelihood of commerciality which we describe as NPV(12.5) exceeding zero. Ahead of appraisal, we assume there is a 50% chance of Egdon attracting appraisal funding in the form of a farm-out and confirming that Resolution can be developed commercially. Asset valuation is highly sensitive to the realised gas price and well productivity (initial production (IP) rate and per well estimated ultimately recovery (EUR)), therefore post-appraisal confirmation of these inputs will provide for a greater certainty regarding the potential for a commercial development. We will review our 50% CCOS assumption once appraisal well data are made available.

Egdon is actively looking to farm-out Resolution to fund a 3D seismic campaign and drilling an appraisal well. We believe this is likely to be in the form of a multi-phase farm-out, based on recent precedents. The term of the Clough Resources farm-out of PL2252 to Shell in February 2019 involved the incoming partner taking a 70% operated stake while paying 100% of 3D seismic and associated costs.

It is uncertain how much working interest/value Egdon would be able to retain through multiple farm-outs in order to fund its share of 3D seismic, the drilling of an appraisal well and ultimately full field development (gross capex mid-case estimated at $365m). Ahead of farm-out, we use a broad-brush approach assuming 15% value retained through multiple farm-outs, although we expect to refine this estimate once a funding deal has been concluded. Our previously published valuation of Resolution had assumed a higher value retained through farm-out (50%) but lower CCOS (15%) – little detail was available on potential farm-out terms or CPR audited resource at the time.


Changes to valuation and forecasts

Changes to our NAV valuation are highlighted in Exhibit 5 below. Key moving parts across Egdon’s producing assets include lower production at Ceres (in H119 and going forward) and to a lesser extent, a reduction in our short-term commodity price deck since our last publication.

Short-term gas price expectations: CY19 reduced to 52.9p/therm ($7/mcf) down from 58.7p/therm ($8/mcf), inflated by 2.5% for future forecast periods.

Short term oil price expectations: We have reduced our short-term Brent oil price expectations for CY19 from $74.4/bbl to $65.2/bbl and for CY20 from $75.1/bbl to $62/bbl based on the EIA’s last published short-term oil price forecasts. Our long-term oil price forecasts remains 70$/bbl Brent inflated by 2.5%.

The removal of Biscathorpe from our risked exploration NAV is in part offset by our increased risked resource valuation for Resolution, as shown in Exhibit 5 below.

Exhibit 5: Changes to Egdon valuation

New valuation

(p/share)

Old valuation

(p/share)

Change

(%)

Reason

Core NAV

1.2

2.7

-126.3%

Lower Ceres production estimates and short-term commodity price deck, NAV rolled forward and cash position lowered. Large decrease in relative terms, but small in absolute terms

Exploration value

10.3

10.0

3%

Biscathorpe exploration removed. Net Resolution risked resource value increased

Total RENAV

11.5

12.7

-10.4%

Source: Edison Investment Research

As discussed earlier in this note, we assume that Egdon retains 15% of the net value in Resolution following the combination of appraisal and development farm-outs. We intend to re-visit this assumption once an appraisal farm-out has been concluded.

Edison’s indicative shale valuation remains unchanged and is based on acreage. We expect to review the underlying inputs in our UK shale model based on the latest information on potential IP rates, per well EUR and well costs from Cuadrilla, IGas and Egdon.

Exhibit 6: Egdon valuation

Assets

Country/

WI

CCoS

Net

NPV/boe

NPV12.5

Risked

$1.3/£; no of shares in issue: 260m

licence

%

(%)

(mmboe)

($/boe)

($m)

/share (p)

Net (debt)/cash 31 January 2019

2.3

0.7

G&A (three years)

(3.2)

(0.9)

Production

Keddington

UK

45%

100%

0.06

(12.5)

(0.8)

0.0

Ceres

UK

10%

100%

0.41

6.9

2.8

0.8

Fiskerton

UK

80%

100%

0.07

1.9

0.1

0.0

Wressle (Ashover Grit)

UK

30%

60%

0.15

22.2

1.9

0.6

Core NAV

3.2

1.2

Exploration

North Kelsey

UK

80%

12%

4.94

11.3

6.7

2.0

Louth

UK

65%

20%

0.85

10.1

1.7

0.5

Wressle (upside)

UK

30%

25%

0.46

16.7

1.9

0.6

Broughton

UK

25%

23%

0.11

16.7

0.4

0.1

Resolution

UK

15%*

50%

5.56

8.6

23.9

7.1

Appraisal and exploration NAV

 

 

 

 

 

34.7

10.3

RENAV

 

 

 

 

 

37.9

11.5

Indicative shale valuation P50

UK

50%

67%

344.3

102.3

Source: Edison Investment Research. Note: *15% value retained post multiple farm-outs.

Key assets include Resolution, which makes up 62% of our conventional NAV and Egdon’s option on UK shale gas through its 188,000 net acres of land position. We note that the bulk of our valuation is in exploration and appraisal assets which carry a high level or risk and uncertainty relative to producing assets.

Financials

Key changes to our financials outlined below:

Commodity price changes are highlighted in the previous section of this note

Removal of Biscathorpe from our risked conventional valuation (-3.6p.share)

Reduced production expectations for Ceres in FY19

We have reduced our absolute revenue and cash flow forecasts by £1m and £0.9m, respectively in FY19 due to lower production at Ceres and delays at Wressle. These reductions are small in absolute terms but material in relative terms as highlighted in Exhibit 7.

Egdon ended the period to 31 January 2019 with £1.8m of cash and no debt. Further capital may be required before the end of financial year 2020 (July 2020), based on our forecasts. Key capital intensive activity at Springs Road is covered under existing farm-out arrangements and management expects to bring in a farminee to cover Resolution appraisal costs.

Exhibit 7: Changes to short-term financial forecasts (£m)

Changes to forecasts

FY18
Actuals

FY19
New

FY20
New

FY19
Old

FY20
Old

% change
FY19

% change
FY20

Revenues

0.8

2.2

2.7

3.2

4.2

-43%

-54%

EBITDA

(2.2)

(0.5)

0.1

0.1

(0.1)

N/M

N/M

Operational cashflow

(1.6)

(0.3)

0.6

0.6

0.4

N/M

32%

Source: Edison Investment Research

Exhibit 8: Financial summary

£000's

2016

2017

2018

2019e

2020e

July

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

1,586

1,039

779

2,234

2,732

Cost of Sales (inc DD&A)

(3,206)

(1,576)

(1,754)

(2,522)

(2,573)

Gross Profit

(1,620)

(537)

(975)

(289)

159

EBITDA

 

 

(733)

(1,193)

(2,219)

(466)

91

Operating Profit (before amort. and except.)

 

 

(4,571)

(2,121)

(1,656)

(2,021)

(1,772)

Intangible Amortisation

0

0

0

0

0

Exceptionals

0

0

0

0

0

Other

0

0

0

0

0

Operating Profit

(4,571)

(2,121)

(1,656)

(2,021)

(1,772)

Net Interest

(34)

(42)

(41)

(49)

(52)

Profit Before Tax (norm)

 

 

(4,604)

(2,163)

(1,697)

(2,070)

(1,824)

Profit Before Tax (FRS 3)

 

 

(4,604)

(2,163)

(1,697)

(2,070)

(1,824)

Tax

0

0

0

0

0

Profit After Tax (norm)

(4,604)

(2,163)

(1,697)

(2,070)

(1,824)

Profit After Tax (FRS 3)

(4,604)

(2,163)

(1,697)

(2,070)

(1,824)

Average Number of Shares Outstanding (m)

221

249

260

260

260

EPS - normalised (p)

 

 

(2.1)

(0.7)

(0.8)

(0.2)

(0.8)

EPS - normalised fully diluted (p)

 

 

(1.2)

(0.7)

(0.8)

(0.5)

(0.3)

EPS - (IFRS) (p)

 

 

(2.1)

(0.9)

(0.7)

(0.8)

(0.7)

Dividend per share (p)

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

-102.1

-51.7

-125.2

-12.9

5.8

EBITDA Margin (%)

-46.2

-114.8

-284.9

-20.9

3.3

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

-288.2

-204.1

-212.7

-90.5

-64.9

BALANCE SHEET

Fixed Assets

 

 

27,053

28,495

30,105

30,875

31,447

Intangible Assets

18,370

19,231

19,572

20,854

21,554

Tangible Assets

8,683

9,264

10,534

10,021

9,894

Investments

0

0

0

0

0

Current Assets

 

 

5,270

7,613

4,020

4,399

3,435

Stocks

0

0

8

0

0

Debtors

2,541

1,507

1,240

3,406

3,406

Cash

2,679

6,057

2,772

993

29

Other

50

50

0

0

0

Current Liabilities

 

 

(1,085)

(1,216)

(1,150)

(2,827)

(2,827)

Creditors

(1,085)

(1,216)

(1,150)

(2,827)

(2,827)

Short term borrowings

0

0

0

0

0

Long Term Liabilities

 

 

(1,803)

(2,187)

(2,249)

(2,763)

(2,763)

Long term borrowings

0

0

0

(417)

(417)

Other long term liabilities

(1,803)

(2,187)

(2,249)

(2,346)

(2,346)

Net Assets

 

 

29,435

32,705

30,727

29,684

29,292

CASH FLOW

Operating Cash Flow

 

 

(159)

(422)

(1,629)

(327)

591

Net Interest

0

0

0

(26)

(52)

Tax

0

0

0

0

0

Capex

(2,379)

(1,054)

(1,825)

(1,423)

(1,504)

Acquisitions/disposals

0

0

137

0

0

Equity Financing

0

4,865

0

0

0

Other cash flow

8

5

8

3

0

Net Cash Flow

(2,529)

3,394

(3,308)

(1,773)

(965)

Opening net debt/(cash)

 

 

(5,180)

(2,678)

(6,056)

(2,771)

(576)

HP finance leases initiated

0

0

0

0

0

Other

(28)

16

(23)

423

0

Closing net debt/(cash)

 

 

(2,678)

(6,056)

(2,771)

(576)

389

Source: Company accounts, Edison Investment Research

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New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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United Kingdom

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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

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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