Egdon Resources — Update 27 February 2017

On 11 January 2017, the North Lincolnshire County Council planning committee refused planning consent for the development of the Wressle oil field, North Lincolnshire, despite a positive recommendation from the planning officer. Egdon expects to reapply for planning permission after making adjustments to the proposal. This is likely to include results from the company’s ongoing water monitoring programme. The process for reapplication and planning committee review can be protracted and as such in our updated forecasts we do not expect first oil from Wressle until CY18.

At minimum, a six-month delay at Wressle (25% owned by Egdon) is implied by Egdon’s production guidance, which has been revised down from 165boe/d to 100-110boe/d for FY17 (year ending July 2017). We update our production forecast and NAV accordingly. Our Wressle valuation remains broadly unchanged as we delay both production and capex cash flows to CY18 and roll forward our discount date to January 2017. Wressle production also benefits from a higher realised Brent crude price, as we assume a 22% higher Brent crude price in CY18 than in CY17. Our conventional RENAV falls from 22.3p/share to 20.9p/share (c 6%). Our valuation is broadly in line with recent Wressle M&A benchmarks. In September 2016, Union Jack acquired a 3.34% interest at an implied valuation of £17.9m gross and in November 2016 Upland farmed-in to the asset at an implied gross valuation of £18.5m gross (including contingent consideration). Both transactions helped underpin our DCF valuation, which currently stands at $22.4m (£17.2m at £1:$1.3) after production deferment.

Much of the objection surrounding Egdon’s planning application appears to be due to the use of acidisation and proppant squeeze to improve well productivity at Wressle. We note that according to the American Petroleum Institute’s (API’s) briefing paper on acidisation, this technique has been used for almost 120 years, and is now one of the most widely used methods of well stimulation globally (including the UK North Sea). The API views the US regulatory framework surrounding the use of acid as well developed and mature, as are the operational and safety practices employed by operators and service providers.

Exploration and appraisal of the net 7.4mmboe Biscathorpe prospect (Egdon retains a 52.8% interest) is expected in the first half of CY17. Egdon targets thicker sands down-dip of a 1987 BP oil discovery. BP had targeted Biscathorpe at a crestal location, finding oil shows over a 1.2m sand section. Planning permits are in place to enable drilling to proceed. In the event of delays, we expect the partner group to apply for a licence extension as the current PEDL is expected to expire in June 2017. Biscathorpe is included in our conventional RENAV on a risked basis at 6.8p/share. Its net size and high working interest make this a material prospect for Egdon. Management retains the option to farm-down ahead of drilling to preserve capital and reduce net exposure, which we estimate at £1.3m.

The Holmwood prospect is planning approved, after an appeal in 2015, and is set to be drilled in 2017. Egdon remains fully carried for the exploration well by UK Oil and Gas Investments (UKOG). The primary reservoir target at Holmwood are the Portland and Corallian reservoir sands; however, the partner group sees deeper Kimmeridge Micrite potential post the Horse-Hill oil discovery on adjacent PEDL137 - the Horse Hill Kimmeridge Micrite play was de-risked post successful flow test of the upper and lower Kimmeridge units. The primary target, Portland sandstone, is productive at the nearby Brockham field to the north-east and during the flow-test of the Horse Hill discovery in CY16 (323bopd stable dry oil flow). Egdon has an 18.4% interest and net unrisked prospective resource of 1mmbbl within the Portland and Corallian. Kimmeridge Micrite prospective resource estimates offer upside but we do not include them in our valuation at this stage.

Upcoming activity across the Portland sand play include an extended well test at Horse Hill in late 2017/2018. Third party (Xodus) estimates Horse Hill Portland contingent resource of 0.5mmbbl to 3.7mmbbl gross (2C 1.5mmbbl). Europa estimate gross unrisked prospective resource for the Portland/Corallian play on PEDL143 (Holmwood) at 5.6mmbbl gross P50 and 33% GCOS.

In addition to E&A activity, there have been a number of asset transactions and farm-outs across the Horse Hill play. On 6 February 2017, Angus Energy acquired a 12.5% economic interest in Holmwood (PEDL143) from Europa Oil and Gas. The terms of the acquisition are:

As the up-front consideration is essentially limited to back costs and a two-for-one carry with few details on contingent consideration, it is difficult to benchmark against our risked valuation. However, the implied gross PEDL valuation of £6.6m by the cost carry and back costs compares with our risked valuation of $10.0m gross or £8m.

Egdon’s unconventional portfolio remains little changed from our last note (5 December 2016). We continue to value shale acreage on a notional dollars-per-acre basis, including 14th round awards. We use a unit valuation of $400 per acre (transaction values range from $200 per acre to $2,000 per acre). A full breakdown of our conventional and unconventional valuation is provided below.

Key 2017 newsflow for the UK onshore shale sector includes the fracturing of an existing well by Third-Energy at KM-8 to establish flow potential and the drilling and frack of a well at Preston New Road by Cuadrilla. Construction work and site preparation has begun at Preston New Road.

IGas received planning approval to drill two exploratory wells in Springs Road, Mission Springs, North Nottinghamshire in November 2016, but much of recent company newsflow has been driven by the company’s precarious debt position and potential covenant breaches (potential liquidity covenant and leverage covenant breaches were flagged by management in RNSs dated 29 December 2016 and 30 November 2016. We expect the company’s liquidity position to deteriorate after the 30 Jan 2017 mandatory redemption offer to secured bondholders ($2.3m) and as debt interest and bond amortisation becomes due. The board of IGas is in discussion with a number of stakeholders with a view to addressing the company’s capital structure; these include bondholder Trans European Oil & Gas who has proposed the sale of the company’s conventional assets.

Recent government surveys of support and opposition for hydraulic fracturing suggest that the industry needs to do more to aid understanding of the processes involved and how both visible and subsurface environmental impact can be minimised.

The key updates since our last published valuation are:

As can be seen in our RENAV below, conventional producing assets constitute a small part of RENAV at 3.1p/share (including cash and net of G&A) and the bulk value of our conventional valuation lies in appraisal and development (17.8p/share).

As mentioned above, we believe the company’s most valuable conventional assets are the ‘A’ exploration prospect (risked 6.6p/share) and Biscathorpe prospect (risked 6.8p/share). In addition to this, we provide an indicative valuation for Egdon’s shale acreage at (25.7p/share).

In addition to our conventional valuation above, we include a dollars-per-acre valuation from unconventional resources. This is broken down by licence below.

Our short-term financial forecasts assume Wressle first oil in H118, which drives a step up in production to a forecast 155boe/d in FY18 and a material increase in operational cash flow to £0.4m. This is a year later than prior forecasts and reflects the deferment of development activity at Wressle by 12 months. We expect cash generated from operations to be re-invested in appraisal or development of contingent resources as well as in progressing the company’s net shale acreage position. Egdon is actively pursuing farm-down and divestment of non-core assets to manage cash resource and risk exposure.