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Testing time for Lancaster

Hurricane Energy 12 July 2016 Update

Hurricane Energy

Testing time for Lancaster

Lancaster drilling

Oil & gas

12 July 2016

Price

17.25p

Market cap

£169m

£/US$1.4

Net cash (£m) at end December 2015

9.9

Shares in issue

979m

Free float

88%

Code

HUR

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(1.4)

68.3

7.8

Rel (local)

(8.1)

58.6

8.5

52-week high/low

18.2p

9.420p

Business description

Hurricane Energy 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

By the end of 2016, Hurricane should have far greater certainty on the size and potential value of its key asset, Lancaster. If post-drill resource estimates remain in line with the pre-drill forecast at P50 200mmbbls, Hurricane remains well placed to attract partner and debt funding assuming an Edison long-term 70$/bbl Brent oil price. A resource base that only justifies an early production system (EPS) development is still likely to be economically viable, but could prove harder to finance in the current market.

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)

(41.2)

13.6

12/17e

0.0

(4.6)

(4.6)

(4.5)

(13.0)

(3.9)

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

Defining Lancaster resource range

Hurricane spudded the first well of a two-well programme on 6 July 2016. The wells consist of an inclined pilot hole, 205/21a-7, followed by a horizontal sidetrack, 205/21a-7z. A key objective is to locate the Lancaster oil water contact to provide better definition of the Lancaster resource range driving EPS and full-field development design. Submission of the field development plan and final investment decision on the EPS phase of the development is expected in H117.

Upside to Edison EPS valuation

Our EPS valuation remains on the basis of 36mmbbls recoverable, volumes in the Lancaster structural closure that could conservatively be recovered through a two-well development (currently Hurricane’s low case). Assuming higher recovery, in line with Hurricane’s base case (53mmbbls) and recent company well productivity simulations, would increase our company RENAV from 41p/share to 45p/share. We expect to revisit our valuation post the 2016 well programme when we will have greater certainty on reservoir characteristics and fracture system performance.

Valuation: Significant upside remains

Our updated valuation reflects Hurricane’s guidance of lower than modelled costs during the EPS phase and the positive translational impact of a stronger dollar. Our RENAV moves from 34p/share to 41p/share as a result. We estimate that Hurricane will have to farm down 55% of its 100% equity in Lancaster full field development to fund the project through to first oil, assuming access to $250m of RBL debt capacity. This dilution in working interest and cost carry is reflected in our base case valuation.

Lancaster: Reducing resource uncertainty

Hurricane is planning to drill two wells on Lancaster in Q316 with a view to obtaining sufficient data to be able to make a final investment decision on the EPS phase of the development by H117. The wells will consist of an inclined pilot hole, 205/21a-7, followed by a horizontal sidetrack, 205/21a-7z.

Exhibit 1: Lancaster well locations

Exhibit 2: Lancaster top basement fault map

Source: Hurricane Energy

Source: Hurricane Energy

Exhibit 1: Lancaster well locations

Source: Hurricane Energy

Exhibit 2: Lancaster top basement fault map

Source: Hurricane Energy

Pilot hole objectives – confirming oil water contact

The pilot hole will be drilled off the crest of the structure and is designed to reach total depth in the water leg. To ensure this is achieved, the well will be drilled to around 100m below the deepest point at which the presence of oil has been established to date in Lancaster (ie 1,781m based on oil cuttings in the 205/21a-4 well). The key objective of the well will be to confirm the oil water contact (OWC), which would then allow the current resource range of 62-456mmboe to be refined. Further objectives are to evaluate the properties of the basement aquifer and to refine the company’s understanding of the overlying Victory sandstone (formerly known as the Commodore sandstone).

Hurricane is planning to acquire a comprehensive set of data in the pilot well. Advance gas chromatography, logging while drilling (LWD) and a full suite of wireline logs will be taken across the Victory sandstone and fractured basement. In addition, an open-hole DST will be carried out over the entire fractured basement section of the well and will include production logging (PLT) and downhole fluid sampling.

Confirmation of OWC will reduce resource uncertainty

The volumes of hydrocarbons trapped in fractured basement reservoirs can exceed the volume that is trapped in the mapped structural closure. For Lancaster, the recoverable volume in structural closure is 61mmbbls, based on a spill point depth of 1,380m true vertical depth subsea (TVDss), and this is the volume that will be targeted in the EPS. If this low case is confirmed by the EPS, then no further development would take place. However, if the OWC is established to be consistent with or deeper than the 2C case of 1,597m TVDss, Hurricane believes that a continuous oil column can be assumed across the reservoir based on current reservoir simulations incorporating results from the 205/21a-6 well. This would positively affect the resource range, as shown in Exhibit 3. The 2C OWC is currently based on oil recovered from a drilling swab and MDT analysis from the 205/21a-4 well, while the 3C case of 437mmbbls is based on oil recorded to 1,781m TVDss in the 205/21a-4 well in post-well analysis.

The ability of the pilot well to determine the OWC is therefore crucial to the future development concept for Lancaster. In addition, the extensive data gathering should allow more certainty around the water saturation in the reservoir, which will assist in establishing the extent and continuity of the aquifer.

Exhibit 3: Conceptual impact to resource range by confirming CPR 2C ODT

Source: Hurricane Energy

Horizontal sidetrack objectives

After data gathering of the pilot well has been completed, it will be abandoned and the top hole section used for the horizontal sidetrack. 205/21a-7z will be drilled at a similar depth to the existing 205/21a-6 well and around 140m above the shallowest estimated OWC. The well will have a 1km horizontal section and is expected to intersect 13 fault zones. It will be positioned close enough to 205/21a-6 to monitor interference between the wells during the EPS, while remaining far enough away to allow for reservoir drainage. Data gathering will be similar to that in the pilot hole, although wireline logging and PLT cannot be taken in a horizontal section. Once the drilling and testing programme is completed on the two Lancaster 7 wells, the company plans to move rapidly into FEED, with FID by the end of H117 and first oil by H119.

EPS development: Conservative estimates

A successful outcome from Hurricane’s 2016 well programme has the potential to materially de-risk EPS development, providing greater certainty on the overall Lancaster resource, as well as volumes recoverable under a two-well EPS.

Our conservative EPS asset valuation stands at 12p/share, with potential to rise to 18p/share if higher per-well recovery is proven (Hurricane base case). Hurricane’s capital markets day (CMD) pointed to slightly lower fixed opex than we had estimated in our standalone EPS valuation. Adjusting our estimates to reflect company guidance and including the translational effect of a stronger dollar increases our risked EPS asset valuation from 8p/share to 12p/share and Hurricane RENAV from 34p/share to 41p/share.

We note that our EPS valuation remains on the basis of volumes recoverable in structural closure at EUR of 36mmbbls (in line with a per-well EUR of 18mmbbl as per RPS Energy’s CPR for full field development). Recent well simulation work being carried out by Hurricane and confirmed by a third party suggests upside to our EUR assumptions, with producers showing no immediate decline and an extended plateau response – an additional 10mmbbls recovered per well compared to RPS’s 2013 CPR assumptions.

Exhibit 4: EPS volumes – potential upside to estimates

Source: Company data, Edison Investment Research

Hurricane expects to test well productivity through the open-hole drill stem test (DST) of the planned horizontal well and to see if the flow rates of 205/21a-6 can be replicated. We see a further 6p/share upside to our EPS valuation if Hurricane can firm-up recoverable volumes in line with a company base case estimate of 53mmbbl.

Exhibit 5: EPS – potential upside from Edison 36mmbbl case

OWC

Porosity

Aquifer support

EPS EUR

Plateau

Gross EPS NPV/boe

EPS IRR % (point forward)

EPS p/share

Edison 36mmbbl case (company low case)

Structural closure only

Low

Passive/weak

36mmbbl

3 years (declining)

10.9

59%

12

Edison 53mmbbl case (company base case)

Structural closure only

Low/Mid

Passive/weak

53mmbbl

5 years

11.3

68%

18

Company EPS mid-case (71mmbbl)

2C depth

Mid

Passive/weak

71mmbbl

7.5 years

Source: Edison Investment Research

The profiles below help visualise the difference in predicted production between RPS CPR assumptions and more recent well simulation work. If Hurricane can prove up its model of a limited well decline for the first five to seven years of production, there is c 10mmbbls of incremental oil recovery predicted per well, which should lead to better full field development economics driven by a lower well count.

Exhibit 6: Company simulation results vs CPR horizontal production profile

Exhibit 7: EPS production profiles

Source: Hurricane Energy

Source: Edison Investment Research

Exhibit 6: Company simulation results vs CPR horizontal production profile

Source: Hurricane Energy

Exhibit 7: EPS production profiles

Source: Edison Investment Research

We model first oil in line with company guidance in H119, giving an unrisked, forward-looking IRR (gross basis) of 59% 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 depend on EPS FPSO and modification yard availability, successful execution and costs in line with company estimates.

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 46%.

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 £3.9m 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 55% equity interest in Lancaster to fund both EPS and FFD. This dilution is reflected in the working interests we apply in our NAV, with Hurricane retaining a 45% working interest in both EPS and FFD.

Other forms of funding being considered for the EPS phase of development include export credit finance available to fund yard costs, which we understand make up the bulk of pre-EPS first oil capex.

Valuation and financials

We make a modest change to our valuation at this stage and expect a further update post the Lancaster 7 wells programme. As a result of lower anticipated EPS development costs, as set out at Hurricane’s CMD, we see better returns and net NPV for Lancaster EPS development. Our net risked NPV/share for Lancaster EPS rises from 8p/share to 12p/share as result (0.5p/share of this increase is driven by a foreign exchange translation impact as we move from $1.45/£ to $1.4/£).

Exhibit 8: 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%

(11)

(1)

Core NAV

 

 

 

 

 

 

40

3

Contingent

Lancaster EPS - two wells

UK

45%

70%

36

16

13.9

158

12

Lancaster FFD (post-EPS)

UK

45%

44%

164

74

11.0

359

27

RENAV

 

 

 

200

90

 

557

41

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 9 below.

Exhibit 9: 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 13p/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 10: 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

2.3

59

4

Strathmore

UK

100%

10%

32

32

0.3

1

0

Long-term exploration upside

Lincoln

UK

100%

7%

150

150

3.6

36

3

Tempest/Typhoon

UK

100%

8%

175

175

2.9

41

3

Lancaster prospective resources

UK

100%

5%

53

53

6.9

18

1

Whirlwind prospective resources

UK

100%

8%

85

85

2.8

19

1

Long-term exploration upside NAV

 

 

 

687

 

174

13

Total long-term valuation including blue-sky upside

 

 

 

771

 

735

54

Source: Edison Investment Research

Exhibit 11: 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

Exceptional

0

0

0

0

Other

0

0

0

0

Operating Profit

(8,584)

(5,448)

(4,741)

(4,741)

Net Interest

(441)

(75)

225

189

Profit Before Tax (norm)

 

 

(9,025)

(5,523)

(4,516)

(4,552)

Profit Before Tax (FRS 3)

 

 

(9,025)

(5,523)

(4,516)

(4,552)

Tax

19

0

0

0

Profit After Tax (norm)

(9,006)

(5,523)

(4,516)

(4,552)

Profit After Tax (FRS 3)

(9,006)

(5,523)

(4,516)

(4,552)

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

217,337

230,282

Intangible Assets

177,308

176,012

176,012

176,012

Tangible Assets

215

89

41,195

54,140

Investments

130

130

130

130

Current Assets

 

 

17,409

10,771

14,436

830

Stocks

0

410

410

410

Debtors

1,553

420

420

420

Cash

15,856

9,941

13,606

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)

(7,112)

Long term borrowings

0

0

0

(3,891)

Other long term liabilities

(7,281)

(3,221)

(3,221)

(3,221)

Net Assets

 

 

186,294

183,510

228,281

223,729

CASH FLOW

Operating Cash Flow

 

 

(4,677)

(2,558)

(4,421)

(4,457)

Net Interest

0

0

0

0

Tax

0

0

0

0

Capex

(36,542)

(3,407)

(41,201)

(13,041)

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)

3,665

(17,497)

Opening net debt/(cash)

 

 

(14,022)

(15,856)

(9,941)

(13,606)

HP finance leases initiated

0

0

0

0

Other

26,270

28

0

0

Closing net debt/(cash)

 

 

(15,856)

(9,941)

(13,606)

3,891

Source: Company accounts, Edison Investment Research. Note: Forecasts assume £3.9m of debt at the end of 2017.

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DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Hurricane Energy and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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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

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

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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