Canadian Overseas Petroleum — Update 25 October 2016

On 14 September 2016, COPL announced that its 50%-owned affiliate, ShoreCan, had completed the acquisition of 80% of the share capital of Essar Nigeria. Essar Nigeria’s sole asset is a 100% interest and operatorship of OPL 226 Nigeria. We believe the addition of OPL 226 brings asset diversity, portfolio depth and, importantly, control. The acquired asset provides shareholders with exposure to low-risk exploration/appraisal upside in Nigeria, as well as higher-risk/impact exploration offshore Liberia. Importantly, COPL will have control over the pace of activity on OPL 226 through the ShoreCan JV.

OPL 226 is located 50km offshore in the central delta region of Nigeria and in shallow water ranging between 40m and 180m. The block covers an area of 1530km2 and benefits from extensive seismic data, including 1,750km2 of 2D seismic and 1,300km2 of 3D. Five wells have been drilled on the block and an oil discovery was made in 2001 with the last of these wells, Noa-1.

OPL 226 has generally been thought to be gas bearing (even though oil was encountered in two wells in nearby Anyala) and has historically been underexplored. This has been exacerbated by poor-quality seismic data sets due to the presence of thick soft deposits of mud on the seabed. The block sits on a large-growth, fault-controlled structural complex running in a NW-SE direction and known within the company as the Noa Complex. The Noa Complex benefits from the presence of five wells that can be used to calibrate the 3D seismic and COPL has applied the advanced AVO techniques of extended elastic impedance (EEI) and Joint impedance & Facies inversion (Ji-Fi) to the most recent 568km2 3D survey acquired by Essar Energy in 2012. Based on this detailed technical work, COPL has identified a number of anomalies associated with sand lithology and oil fluid content that tie in with structural and stratigraphic features. Although the Noa Complex is adjacent to the Anyala Complex in OML 83, the company believes that the two areas are isolated from each other by a fault.

The area of initial focus for COPL will be in the vicinity of the Noa-1 discovery well at the western edge of the block. Noa-1 was the only well drilled in the block on 3D seismic and it encountered 20m of good-quality sand typical of the Tertiary sands of the Niger Delta, with porosities around 30% and permeabilities between 800mD and 5D. However, Noa-1 was drilled on the flank of the structure and COPL expects that the sands will be thicker in the crestal part of the field. Producing fields in the Niger Delta can have compartmentalised sands with different oil-water contacts (OWC), but they are also thick and tend to have the same drive mechanism.

The company has identified a drilling location around 2km from the discovery well, which would target this crestal area to prove the presence of oil in the thickest part of the structure. COPL plans to design the well to be completed as a production well, which can then be brought on stream as part of an early production system (EPS) in the case of success. Under the terms of the PSC, there is a commitment to drill one well by December 2017.

OPL 226 has been independently assessed by Netherland, Sewell & Associates (NSAI) as of March 2016. The primary Noa West discovery is estimated to contain gross unrisked 2C resources of 16mmbbls. A further 15 undrilled prospects across the Noa Complex have been assigned gross best estimate prospective resources of 461mmbbls, with a high case of 808mmbbls. In addition, prospective gas resources on the block are estimated at 1.7tcf on a best estimate basis. It should be noted that NSAI’s estimate is based on the 20m sand thickness encountered in Noa-1, so that there is upside to these figures if COPL can demonstrate thicker sands in the crestal area in line with its current models.

The majority of the resources assessed by NSAI sit within the Noa Complex. Once this area has been investigated, the company sees potential for substantial upside to these figures in the foot wall area of the licence to the north-east of Noa-1, where it has identified multiple prospects.

We base our risked valuation of OPL 226 on the notional development of a gross 200mmbl oil field, a subset of prospective resource within the Noa Complex. Noa sits in relatively shallow water with depths ranging from 50m to 180m; we assume a jack-up based production platform and tanker offload from a single buoy mooring. Key inputs that drive our economic modelling are highlighted below.

In addition to the key assumptions in Exhibit 3, we assume first oil in 2020 with production from eight development wells driving peak production of 57mb/d. Our analysis indicates a gross project IRR of 39% at US$70/bbl long-term and an NPV12.5 break-even oil price of US33$/bbl.

We note that the terms of the OPL 226 PSC, signed by Essar Nigeria, are typical of Nigerian contracts, which are subject to high levels of government take. Key elements of the PSC include royalty, cost recovery, tax oil and contractor profit share. While IRRs are strong, NPV per barrel is low in a global context. We model 2.43$/bbl at US$70/bbl Brent. We estimate total government take over the life of the contract at 95% (government share of revenues after all costs) based on our notional 200mmbbl development.

Assuming COPL farms out its equity interest in exchange for a development cost carry through to first oil, we estimate that net working interest would fall from 40% to 15.5% (farminee requiring a 20% IRR). Including cost-carry increases the net value per barrel, which rises from US$2.43/bbl to US$4.6/bbl reflecting the cost carry, partially offsetting this reduction in working interest.

ShoreCan is yet to firm up its work programme for OPL 226, but we expect the JV to look to drill at least one exploration well on the licence over the course of 2017/18. At current rig day rates, the company expects this well to cost c US$28m gross, which would equate to a net cost to COPL of US$11.2m.

As per our previous published research, we provide two valuation scenarios for COPL: firstly, a valuation made on the basis of COPL farming down its LB-13 and OPL 226 working interests in exchange for full development cost carries through to first oil. Key changes to our valuation since the last time we published include:

Please see our note published on 2 August 2016 for further details of COPL’s interest in LB-13, Liberia and asset valuation details.

We also provided an ‘undiluted’ valuation, which reflects the full NPV12.5 risked value of the company’s interests in Liberia and Nigeria. This valuation is more indicative of a CPR or ‘high case’ valuation and is a 28% premium to our farm-out RENAV. Nevertheless, under both scenarios we see material upside from the current share price.

After an equity injection of c C$8m in Q216, COPL is funded to cover SG&A costs for 2016 and 2017 based on our forecasts. Liberia exploration is funded through a US$120m cost carry from partner ExxonMobil, which has the potential to cover COPL for a two-well programme. Recent statements from NOCAL and ExxonMobil suggest that the Mesurado-1 prospect (estimated gross unrisked c.400mmboe) is likely to be spud in November/December 2016, COPL guidance remains Q416. Please see our last published note ‘Liberia – looking for Liza’s conjugate’ for further details.

We expect ShoreCan to look at funding options to drill one well on OPL 226 in 2017/18 at a net cost of US$11.2m. One option to fund this cost would be from cash inflow from the exercise of in-the-money stock options. If all in-the-money options were exercised, we could expect c U$16m of cash inflow over the course of 2017/18.

We provide a valuation sensitivity to long-term oil price assumptions in the graph below. We note that this is on the basis of NPV12.5 asset values excluding the dilutive impact of farm-downs.