Bowleven — Update 6 March 2016

In the last year, Bowleven has successfully completed the farm-down of its key asset (Etinde) leaving it with a still material 20% interest and enough cash resources to fully fund its share of development costs with some spare to devote to other business development. The gross 2C contingent resources of 290mmboe are material, which could be further increased with the two (fully-carried) wells which will appraise the promising horizons previously drilled. Drilling these wells has the potential to be material to Bowleven, as success could more than triple the existing resource base.

Since last year, the possibility of unlocking a greater resource (from Intra Isongo) has delayed the development concept for Etinde. We continue to assume development for Etinde to supply gas to an onshore fertiliser plant (to be built by Ferrostaal) on a 20-year contract, but this is now one of four development concepts that could be implemented. Additionally, this has meant a delay and our initial expectations of project timing were too optimistic (we modelled FID in late 2014, but we now expect FID to be in mid-to late 2017). If the appraisal of Etinde proves up more significant resources, we would still model these as flowing to a proposed LNG plant (although we now model first gas in 2022), but exploitation via another LNG project or an onshore power plant are also possible.

Elsewhere in the portfolio, the results of the extended well tests of the Bomono wells support plans to supply around 5-6mmscfd to a small-scale power generation plant, which should link to a sub-station very close to the wells. We model first gas in early 2017 and a 15-year plateau for now but expect further information as plans firm up. Longer term, we model a larger (50MW) gas supply contract, although the eventual size of any project would very much depend on a fuller appreciation of the full resources at Bomono (and could be much larger).

The core NAV of 45p/share is dominated by the company’s cash pile and the value of its share of the Etinde development (helped by the carry on two appraisal wells). As the Etinde development progresses and cash balance decreases, we expect the value of the project to grow materially towards first gas. In addition to this, we add risked, DCF-derived values for Etinde Phase 2 and exploration in Bomono to get to a RENAV of 60p/share. Further value could be added by the material appraisal wells planned at Etinde (currently expected to be in 2016) and exploration in Kenya and Zambia. However, until we receive visibility of the well timing and funding within the next 18 months, we exclude them from our RENAV. To give investors an idea of the impact, we currently value (risked) resources at more than 20p, so success at Intra Isongo, which could more than triple the resource base, could add significant value as and when drilled.

In the current investing environment, balance sheet strength is critical for E&Ps. The 31 October 2015 cash on hand of $120m is therefore an enormous asset for Bowleven, which should be enough to cover its share of development costs for Phase 1 with cash to spare for other projects should it choose (assuming it can raise debt for some funding). Under the terms of the farm-down deal, it will receive $15m by September 2016 (or after the appraisal wells are drilled, whichever is earlier) and a further $25m on FID of the project (most likely in 2017 in our view). Before that, development of Bomono is likely to be a low-capex phased gas development.

We await the appraisal wells at Etinde as a key milestone that could change the profile of development at Etinde. Should the fertiliser development be chosen, we expect the announcement of a gas sales agreement (GSA) as the next step before FID. Given the delays seen thus far on the project, it is understandable that investors are being cautious until FID is taken. Once this happens (which will require parallel decisions for the upstream and fertiliser developments), we believe investors will start to price in the value to a greater extent.

Bowleven is an AIM-listed E&P that owns interests in two permits in Cameroon. It is currently pursuing development of its Etinde permit, where the company estimates gross 2C P50 contingent resources as 290mmboe. As a liquids-rich gas field, the company aims to supply the gas to a fertiliser plant onshore (to be built by Ferrostaal) on a 20-year contract with the liquids sold on the open market, progressing towards FID in 2017.

The onshore Bomono blocks, NW of Douala, are still in the exploration phase, with Bowleven drilling two exploration wells. We model gross recoverable resources of 45mmboe in each well. Finally, the company has interests in two areas in East Africa. Interest in Block 11B onshore Kenya and exploration acreage in Zambia complete the portfolio.

Bowleven holds a 20% interest in the Etinde permit MHLP-7, which contains net contingent P50 resources of 58mmboe (gross contingent resources of 290mmboe). This resource is held entirely within MHLP-7 and represents a material fall from 2014 year-end estimate of 244mmboe due to the completion of the farm-down to Lukoil/NewAge (both 30% WI) and the expiration of the PSC on MHLP-5&6 in December 2014. The block is shallow with maximum water depths of 65m.

The high gas content seen in the discoveries in the region has historically proved an obstacle to the development. Until recently, Cameroon has not had a big enough economy to absorb large volumes of gas, meaning small accumulations have ended up being stranded. The advent of the proposed fertiliser plant solution (one of several possible solutions) means these fields can be consolidated and exploited.

Development options were affected by the strong rates from the IM-5 well, which tested a combined maximum flow rate of over 17.8kboed, exceeding “initial expectations, encountering 95 metres of net pay in the Intra and Middle Isongo reservoir objectives and flowing condensate rich gas at substantial rates on test from both intervals”.

This has led to a re-examination of the potential from the Etinde licence and the promise of much larger volumes within this interval. It is this area that will be further appraised by two wells (probably in 2016) to firm up volumes. We think it was the strength of these tests and the upside potential identified in the Intra Isongo that gave NewAge/Lukoil the impetus to execute the farm-down, despite the fall in oil prices before the completion of the transaction.

Analysis of the data has shown further prospects at the same Intra Isongo interval, while the results of testing at a similar interval at IE-3 tested oil and condensate. Bowleven’s estimates of volumes in place are 1-2tcf (167-333mmboe) at P90 confidence. If we assume a 70% recovery factor for gas this would imply 115-230mmboe. On rough rules of thumb, P50 could be 3x larger than this, equating to 345-690mmboe. Associated liquids will likely add further. We expect wells to be spudded in late 2016/early 2017, but timing remains uncertain, given that Bowleven is no longer the operator and the oil price environment has added material uncertainly. The FID will likely be taken six to nine months after the appraisal wells, so we expect it to be in mid-/late 2017.

We continue to model Bowleven based on options one and two at this time, pending any further announcements/developments. We gave full detail of the development of the fertiliser plant in our initiation note, but a quick summary is below.

The contingent resources at Etinde permit exceed those required for the fertiliser plant (around 180mmboe will be produced in for the fertiliser plant, leaving 110mmboe in the contingent resource base). Unless the fertiliser plant is significantly upsized, another route for the hydrocarbons is needed to fully exploit the resources. As stated earlier, Cameroon has a number of similarly stranded gas-heavy assets and the consolidation of these is planned by GDF to export via LNG (which could be Cameroon LNG or another LNG project BLNG/FLNG).

FEED and due diligence are still being worked through, but the current plan for CLNG is to have an initial 3.5mtpa train. We model production guided by Bowleven; a 200mmcf/d plateau for around 10 years will give further time for liquids production. This should allow more complete exploitation of the current resource, but we note that wells at Intra Isongo could add meaningfully to the resource.

The third option is the supply of a large gas-powered generator for Douala. Cameroon suffers from a lack of electricity (see section on Bomono in later section) and a larger Etinde gas resource could supply a large IPP. This would require a joint venture with a power producer (presumably ENEO), which would be responsible for the downstream electrical plant construction. We would expect the consortium to supply gas at a price to ensure liquids can be sold.

The Perenco/Golar FLNG project at Kribi (FID taken in September 2015) is due to start-up in 2017 and the project has spare capacity (a September press release states that it “is anticipated that the allocated reserves will be produced at a rate of 1.2 million tons of LNG per annum, representing approximately 50% of the vessel's nameplate production capacity”). Piping the gas to this project would be relatively straightforward but over quite a distance (over 90km).

Bowleven currently holds a 100% net interest in two onshore blocks, NW of Douala (though the government continues to hold a 10% back-in right). Bowleven agreed to farm down 20% to Africa Fortesa, the company that drilled the exploration wells at Bomono, but that arrangement has now lapsed.

The Bomono permit was drilled 16 times in the 1950s, proving an active Upper Cretaceous-sourced hydrocarbon system. The company has acquired 500km of 2D and combined re-processed legacy seismic, which has revealed numerous tertiary structural traps with some Cretaceous stratigraphic leads. Bowleven progressed two prospects, Zingana and Moambe.

Two wells were drilled in late 2015 at Moambe and Zingana. Both encountered all prognosed reservoirs and wireline logs were acquired. At Moambe, gas pay was confirmed in the B sand from sample and logs. The wells were completed for production (negating the need to further near-term drilling) with results giving management confidence that an initial gas development of 5-6mmscfd could be supported (the Moambe well reached a maximum sustained rate of 7.3mmscfd, with no signs of reservoir pressure depletion).

A key concern of ours was the ease of monetisation. The level of industry development in Douala has meant gas demand has typically been the limiting factor in the past. Victoria’s Logbaba supplies the greater Doula area, and we were concerned that a further gas source, in the form of Bomono, would not have much market to sell to. However, we are more optimistic for a number of reasons

Although we are optimistic that a larger market for gas should develop, this will not necessarily be a quick process. Gas-to-power allows the company to take advantage of the existing 'pipeline' of the power network and allows it to deal with one, large, well-resourced client. Ambition to supply direct to power generation therefore makes sense.

Moambe and Zingana are over 20km away from central Douala (population 1.9m) and 40km from the Dibamba power station. The fields are, however, closer to the city of Buea (population 90,000).

In recent months, management has sought to guide the market towards a gas to power solution for any Bomono discovery. Early monetisation will be based on packaged power units (which could be bought or more likely leased), to allow associated liquids to be sold to the local refinery at Limbe. It is likely that small-scale units will be piloted first, with an IPP solution possible once volumes and production rates are firmed up.

The production completion of the wells means that initial commercial production could be started quickly at Bomono, providing it with cash flows in short order. An Exploitation Authorisation Application (EEA) was delivered to the government in December 2015.

Bowleven currently holds 100% WI of the Bomono permits (although we expect the government to back in for 10% in time) and the low-capex, phased development concept should allow the company to retain a significant portion of this WI for full development. Revenues from initial production could also contribute to the further development costs.

We assume the small-scale gas-to-power will start in 2017 at Bomono, with a 15-year plateau of 5-6mmcfd. This will require relatively little investment and may lead (subject to resources review after the wells) to a larger project, of perhaps 50MW or more.

Bowleven has a 35% net interest in Block 11B onshore Kenya (14,200km2). The block lies in the NW corner of Kenya, on the border with Ethiopia and South Sudan (and directly north of the Tullow/Africa Oil Lokichar Basin acreage). The company entered the basin by taking a 50% interest in the block from Adamantine in 2012. The company then executed a deal, by which First Oil earned a 30% interest in Bowleven’s share in the block by funding a portion of future expenditure in Kenya, including $9m of the first $10m of BLVN’s obligations under the first exploration phase.

The company completed a full-tensor gravity airborne survey in 2014 and identified five sub-basins. A planned seismic survey was not undertaken due to security and logistical issues in 2015. The first phase of exploration lapsed in May 2015, but the company was granted a one-year extension.

Even with this extension, drilling is clearly some time away and development even further in the future (for example FID on TLW/AOI discoveries are only likely to be taken at the end of 2016, suggesting that first production from any Bowleven discovery is perhaps a decade away). Given this, the stock market is extremely unlikely to give any value at this stage. For illustration only, we have modelled a 200mmbbl field, arriving at a value of under $2/boe. The company has no outstanding work commitments in Kenya.

Following the opening up of the rift play in Kenya, a wave of interest has flowed to other prospective rift plays and Bowleven management believes that Zambia could hold material potential. To this end, the company has picked 100% interests in three blocks (covering 16,250km2), with approvals for a further two blocks pending. Given the frontier nature of the basin, Bowleven has only a minimum commitment of just $500k. Drilling is some way off; we see this as a longer-term option.

William MacDonald Allan (non-executive chairman) has over 20 years’ experience in senior positions within both the industrial and oil services sectors. Until recently, he was chairman of ASCO, an international oil support services group, having previously held the position of CEO for 8 years. Before joining ASCO he was divisional managing director at Alfred McAlpine.

Kevin Hart (chief executive officer) was finance director at Cairn Energy for over eight years, a role that incorporated board responsibility for financial, commercial, legal, risk management and HR matters. Before this, he was a senior associate director with Deutsche Morgan Grenfell Group, specialising in oil and gas sector mergers and acquisitions.

David Clarkson (chief operating officer) previously worked for BP where he held a variety of senior executive positions in the upstream business, including leading major project developments in frontier locations and as technical vice president for projects and engineering.

Kerry Crawford (finance director) joined Bowleven in 2008 as deputy finance director and head of IR. She previously worked at Cairn Energy, latterly in the role as deputy finance director and head of IR. She qualified and first worked as a chartered accountant at Ernst & Young.

Ed Willett (exploration director) has worked in the exploration business for 28 years. He started his career with Carless Exploration in the mid-1980s, working on UK onshore and UK continental shelf assets, before joining Cairn Energy, where he held a variety of technical and management roles across Cairn’s entire portfolio.

John Martin (non-executive director) has more than 30 years’ experience in international banking in the oil & gas industry and until recently was a senior managing director in the oil & gas group at Standard Chartered Bank. He was appointed to Bowleven's board in May 2015.

Philip Tracy (non-executive director) is a chartered engineer with over 40 years of experience in the international oil and gas industry, including 20 years at board level in both publicly listed and private companies. He was appointed as a non-executive director in 2011.

Tim Sullivan (non-executive director) has over 40 years’ experience primarily with Conoco, Getty Oil and Enterprise Oil. Tim co-founded Revus Energy, went on to be deputy CEO of Agora Oil and Gas and is deputy CEO of Origo Exploration. He was appointed to the board in 2009.

In contrast to many E&Ps in the sector, the main store of value in Bowleven is a development asset, though exploration could add meaningfully over time. Bowleven is exposed to the normal geological/technical risks prevalent in oil/gas. Apart from these, we highlight the following as risks:

Traditionally, we value companies with an asset-by-asset NAV derived from DCF modelling. Our valuation includes production, development and contingent resources, while exploration is valued only if the company has a plan and resources to drill in the next 12-18 months. We apply a risking to this value, to take account of geological, technical and commercial uncertainties.

For pre-FID development assets, we apply a maximum 65% CoS. However, given the delays in reaching FID, and the number of options for development, we have reduced the Etinde CoS to 50%. This does not reflect increased uncertainties over the size or quality of resources, but rather that in our initiation we had anticipated FID in six months; more than a year on, this is more than a year away. There is therefore clearly uncertainty in the development approach.

The oil price movement has perhaps also contributed to this risk. For oil, we have reduced our price assumptions to $70/bbl long term for Brent in real terms (from $80/bbl) after a gradual recovery from current prices ($40/bbl in 2016, $50/bbl in 2017). We assume gas prices realised for the fertiliser plant are well below those for LNG, given fertiliser plant gas is effectively an enabler for the liquids production.

Given the uncertainty over the development option, especially with possible additional resources at Intra Isongo potentially being de-risked in 2016, it is difficult to give a value for the Intra Isongo wells. Should Intra Isongo be successful, this could unlock a further tripling of net resources. This would therefore be a material event for the shares.

We give an initial estimate of the potential value of Intra Isongo as an illustrative guide for investors. In this scenario, we assume that it increases gross contingent reserves by 100% (or an additional 58mmboe net to BLVN), with a delay in development to account for further investigation/appraisal and FEED work. In reality, we know that potential resources added may (in the upside case) be more than double this estimate. We also note that any development of this greater resource could push the existing financing resources of BLVN, meaning that external capital will have to be raised. Following our oil principles, we therefore apply a 50% funding risk element to account for this (on top of GCoS of 20%). We caveat that these estimates are very much initial thoughts and are subject to revision as/when the Intra Isongo is drilled/proven up.

Even though the development of Etinde revolves around its ability to sell gas, the majority of its value comes from selling the associated liquids (although the low oil price means it makes up a lower percentage than we had previously anticipated). Therefore, while the gas prices achieved at the fertiliser plant are important, the upcoming GSA is critical to enable the project to go ahead, rather than for headline prices.

Oil prices are more critical; we calculate that a change in long-term oil prices from $70/bbl (of +/-$20/bbl) would see a movement of unrisked Etinde NPV of c 30% However, we caution that this is not the dynamic sensitivity that would happen in reality. If oil prices remain depressed, we would expect to see a fall in costs, partially offsetting the decrease in headline prices. We note that the value of the shares would be far less sensitive given its cash resources. We also note that the contribution from a long-term fixed price gas contract (to which we imagine any of the development options would lead) means that the project economics are far more robust for the partners.

Following the completion of the farm-out of Etinde, Bowleven received $165m in March 2015. This was followed by c $5m (working capital adjustment) to make up the full $170m as defined under the terms of the deal. Bowleven will also benefit from a carry of up to $40m carry for two Etinde appraisal wells (including testing) – given the fall in costs in recent months, we would expect this $40m to more than fully carry the wells. Additionally, Bowleven will receive $15m on completion of appraisal drilling (or September 2016, whichever is earlier) and $25m on Etinde FID (expected in 2017).

These movements mean that at October 2015, Bowleven held $120m in cash and no debt. Bowleven reported a loss of $90m for the 12 months ended 30 June 2015. This includes a $76m impairment charge, which was a result of the revised commodity price and planning assumptions for the development. The group’s current G&A charge is estimated be around $1.1m per month, ($1.5m previously). Further cost-saving initiatives are being implemented to reduce G&A costs. We forecast a December 2015 cash figure of $111m (with no debt).

We assume G&A of $14m pa (more than the company guides for conservatism), and capex in FY15-16 of $28m; this will leave Bowleven with outstanding cash of $104m in June 2016. We assume the appraisal well bonus of $15m is delivered in September 2016 and FID is taken in H217 (calendar), adding a further $25m.

In our initiation, we stated Bowleven would be well-funded for the Etinde fertiliser development as we modelled it. We explicitly assume that the company will be able to raise debt based on the long-term nature of the sales to the fertiliser plant. Bowleven’s estimate of pre-production capex for Etinde (of c $140m, as modelled), means that Bowleven will have to source external capital for the project, but we believe the long-term nature of the gas sales agreement at the fertiliser plant should allow room for debt to be raised, which should be able to fund any shortfall in the company’s cash position. We note, however, that costs have fallen very materially in the last 18 months, and a full development should be able to benefit from these reductions.

The course of the Bomono development is still not clear, and while we expect a small, low-cost, initial development, the company still needs to interpret the full results of the drilling for any larger follow-on phase. If the small power generation project comes to fruition, it should provide the company with useful cashflows it can recycle for larger developments in Cameroon.