Egdon Resources — Update 16 May 2016

Egdon’s UK shale gas position is material at 140,000 net acres. It is set to increase by c 50% to 211,000 acres with the inclusion of 14th round licence awards.

A key step towards realising this acreage value will be the appraisal of UK shale to determine gas recovery potential. Appraisal progress to date has been slow, partly due to onerous planning processes despite strong central government support. A number of applications appear to be on the cusp of being approved, which should pave the way for further unconventional exploratory activity – including drilling at Springs Road.

2016-2017 will potentially be a pivotal period for the UK unconventional sector, and shale gas in particular. Subject to planning, there are a number of wells to be drilled or fracked, including Third Energy (Cleveland Basin), Cuadrilla (Bowland Basin) and IGas (Gainsborough Trough). IGas/INEOS also have a material acreage position in the Blacon Basin and are in the process of interpreting 3D seismic data with the aim of identifying sites and submitting applications for hydraulically fractured wells in late 2016/17. (Egdon retains a 14.5% carried interest in the IGas operated Springs Road-1&2 exploratory wells (SR 1&2.)

The progress of key planning applications for the hydraulic fracture and tests of shale are highlighted below. We expect to hear planning newsflow as early as 20 May 2016.

The date for the North Yorkshire County Council to consider the KM-8 planning application is 20 May. Third Energy is seeking planning permission for the hydraulic fracture and testing of an existing well in Kirby Misperton. The planning committee expects to conduct a site visit before making the decision, which Third Energy believes will enable it to see current well site operations and gain an understanding of environmental protection measures in place. The Environment Agency has already issued environmental permits that cover hydraulic fracturing operations.

We see the planning decision for KM-8 as an important catalyst for the advancement of UK shale and believe a fracture and testing could be carried out as early as H2 CY16. We also see potential for a read-across for Egdon’s unconventional gas potential from tight sand/shale at the Cloughton tight gas field to the North West.

In Q115 the Environmental Agency granted Cuadrilla the environmental permits for its proposed shale gas exploration sites at Roseacre Wood and Preston New Road. Planning approval remains outstanding.

On 15 June 2015, Lancashire County Council’s (LCC’s) planning officers issued a recommendation that its Development Control Committee grant planning consent for Cuadrilla’s application at Preston New Road. The committee determined the application on 29 June 2015, refusing planning consent on the basis of the visual impact on the landscape and noise concerns. It also denied consent for the separate planning application to install seismic and ground water monitoring stations around the site. On 23 July 2015 Cuadrilla announced that it plans to appeal the refusal for both the main site and monitoring stations.

On 15 June 2015, LCC’s planning officers issued a recommendation to refuse the Roseacre Wood planning application on traffic concerns. The Development Control Committee refused it on 25 June 2015. However, the committee granted a separate planning application to install seismic and ground water monitoring stations around the site. On 23 July 2015 Cuadrilla announced plans to appeal the refusal after reviewing the proposed traffic routing. The preferred option is a two-way route running to the A583 at the Clifton junction, south of the Roseacre Wood exploration site, going through the Ministry of Defence’s Inskip site and bypassing local villages.

Planning appeal decisions for Roseacre Wood and Preston New Road are expected on 4 July. However, the ultimate decision maker remains Greg Clark MP, Secretary of State for the Department for Communities and Local Government, who will be informed by Wendy McKay’s (the planning inspector) appeal rulings.

IGas is progressing the planning application for SR 1&2; Egdon retains a 14.5% equity interest and is fully carried through the SR 1&2 exploration well. We highlight below why we believe this is a key well in the context of a wider appraisal of UK shale gas resources.

SR 1&2 will be drilled in the Gainsborough Trough (PEDL140). Geological studies and seismic show a localised thickening in the Bowland-Hodder unit, which is believed to be prospective for shale gas, at the proposed well location. The Bowland shale (the main hydrocarbon source rock in the East Midlands) will be the primary target for the exploratory campaign. Sandstone and Millstone Grit overlie the Bowland and provide a secondary target and Carboniferous Limestone a tertiary target. As can be seen in British Geological Society (BGS) 2013 study of the Bowland Shale,1 the gas-mature Bowland unit is exceptionally thick in the Gainsborough trough and at a proposed location for well SR 1&2. Localised thickening of the gas-mature Bowland shale can be seen in the BGS cross-section of the Gainsborough Trough. BGS study work also suggests potential for shale oil in the Lower Bowland-Hodder unit overlying gas-mature shale (lower Bowland-Hodder unit above the gas maturity window).

It is worth noting that much of prospective resource in the Gainsborough Trough lies within the lower Bowland-Hodder unit, which the BGS views as higher risk than the upper unit due to fewer well penetrations. Nevertheless, the few deep penetrations that exist do show high total organic content (TOC) and high gamma log responses. Typically, a TOC value over 2% is used for a potentially viable shale gas resource and the lower Bowland-Hodder unit has been tested at TOCs of 3.5%, 4.9% and 5% in historic wells. There are no analysed samples from the lower unit in the Gainsborough trough.

IGas is applying for approval to drill up to two exploratory wells, one vertical and one horizontal, with operations to be carried out over a three-year period. Further planning applications are likely to be required to allow for fracturing if exploration is a success.

The proposed exploratory well site is within PEDL 140 and is approximately 2.9km north-east of Mission village within the Bassetlaw District in Nottinghamshire. The well pad is planned to be constructed within a Cold War Bloodhound Missile site, close to transport links (A614 and B1396 provide access avoiding Mission village) away from areas of dense population – 10 dwellings/barns are within a 1km radius of the site. A small business currently uses the site, specialising in the sale of ex-army trucks, plant and equipment.

Upcoming planning processes at KM-8, Roseacre Wood and Preston New Road have the potential to pave the way for IGas’s SR 1&2 planning application. Egdon remains fully carried for the exploration phase at SR 1&2 and, given the shale prospectivity of the Gainsborough Trough, we see this as a cornerstone asset within the Egdon portfolio, which alone could justify Egdon’s £11m enterprise value.

Egdon’s production and development strategy continues to focus on maximising production rates, revenues and profitability from existing assets through targeted investment. In 2016, this investment is likely to be directed towards progressing Wressle to first oil.

Production in the six months to 31 January 2016 was up 38% y-o-y to 204boepd, generating revenues of £1.05m up 15% y-o-y, despite the fall in commodity price. The company remains on track to deliver full-year production in line with guidance at 180boe/d and Egdon should benefit from the positive impact of the development of Wressle in H216, which has the potential to add a further 125bopd of net production once on stream.

Elsewhere, Ceres (10% Egdon) continues to produce reliably at rates of 0.8-0.9mmcf/d (135-150boe/d) net to Egdon. Testing of Keddington-5 (45% Egdon) initially saw production dominated by formation water and the operator is considering plans to isolate the zone of water production; Keddington’s gross field rates are c 30bopd from the Keddington-3Z well. At Avington (26.67% Egdon) gross production rates are at c 60-70bopd as the operator trials intermittent production with a view to reducing opex.

Management has provided some guidance on the cost of developing Wressle at Egdon’s analyst presentation. We expect more data to be made available on completion of the Wressle CPR over the coming month, which will form the basis for Egdon’s FDP submission in May 2016. So far, the guidance includes:

At end January 2016 Egdon was debt free, with £5.26m of cash. It was broadly cash neutral during the last reported six-month period, including the impact of working capital movements and minimal capex. We expect net Wressle development capex to first oil (c £0.25m) to be funded from current cash, leaving funds available for discretionary spend on exploration and appraisal (E&A) activity. We forecast end 2016 cash at £2.8m assuming £2.4m of capex spend during the financial year. In light of the cash position, we expect Egdon to be disciplined in its use of cash, looking to farm-down where possible in order to progress E&A activity without having to call on the company’s current cash pile.

Valuation

2016 could prove a breakthrough year for UK shale gas, for which Egdon offers an entry point to investors. We have updated our conventional and unconventional valuation to reflect a lower long term oil price assumption (70$/bbl Brent from 80$/bbl Brent); roll-forward of discount date and updated field operating assumptions (recoverable resource, production profiles, opex & capex). Our updated valuation is split 3.4p/share for core assets including cash and net of G&A and 18.6p/share for risked exploration of which Biscathorpe and the ‘A’ prospect are key components.

In addition to our conventional valuation, we include a deal-based valuation for Egdon’s net unconventional acreage. Recent UK unconventional farm-in transactions have been priced at c 400-2,500$/acre, the top end being achieved by Cuadrilla in June 2013 during a period of relatively high commodity prices (Brent crude was trading above 100$/bbl at the time compared to 44$/bbl today and the UK National Balancing Point gas 65p/therm compared to the 29p/therm for the June 2016 contract). We value Egdon’s acreage at $1,000/acre for PEDL 139/140 (Springs Road) where exploratory plans are progressing, and apply 500$/acre for the remainder of the company’s acreage on sites where planning is yet to be advanced. Our total unconventional valuation equates to 22p/share net to Egdon. At this point we do not include an acreage-based valuation for Egdon’s 14th round acreage, which is yet to be awarded, and intend to include on award and once the associated work programme is formalised.

We note that significant uncertainty remains in relation to our unconventional valuation without further information on the technical feasibility and economics of UK shale.