SDX Energy — FY20 guidance reflecting increased production

SDX expects production to increase significantly in 2020 with the benefit of full year production from South Disouq. The company will look to build on its 2019 drilling success as it continues its campaign in Morocco and commences drilling in South Disouq. Eight wells are planned in H120, and cover the risk range from appraisal/development wells close to existing infrastructure to the exploration wells in a potential new play fairway.

The company is guiding that production will be 6,750–7,000boepd in 2020, an increase of 68–74% on the announced 2019 rate of 4,020boepd driven by production from South Disouq. Having delivered first gas from the field in November 2019, performance has exceeded management expectations and production was ramped up to 50mmscfed three months ahead of schedule. Continuing strong performance is reflected in the guidance, adjusted for CPF uptime.

Elsewhere in Egypt, guidance is lower, with production at Meseda affected by delays in drilling new wells due to approvals and permitting taking longer than previously estimated. The late-life NW Gemsa field is also expected to continue its decline due to increased water cut and falling reservoir pressure. SDX may exit the concession this year if sufficient cost savings are not achieved by the operator. Production is also expected to increase in Morocco to meet an assumed increase in consumption from existing gas customers during 2020.

The 12-well Gharb Basin campaign, targeting 15bcf, has been ongoing since October 2019 and the company has drilled eight wells, resulting in six commercial discoveries to date. Seven of these wells have been appraisal/development wells located close to infrastructure and the company estimates that gross gas reserves of 2.0–2.5bcf have been added to its existing gross Moroccan gas reserves. The eighth well of the drilling campaign, OYF-2, is the first one to step out from the company's core productive area and has confirmed it extends to the north. Both the Upper and Lower Guebbas targets in OYF-2 were encountered, and reservoir thickness and quality were better than pre-drill expectations. Management estimates that approximately 1.3–1.9bcf of gas is recoverable from the horizons encountered. The well will be tested in February. This discovery has also de-risked a further 0.5–1.0bcf of prospective resources in the western compartment of the Lower Guebbas target, which the company expects to recover with a single development well in the future. The rig has now moved to the BMK-1 location, approximately 11km to the north of OYF-2, to further test the extent of the northern expansion of the company's core productive area. If successful, this could de-risk a number of similar nearby prospects. After BMK-1, one more close to infrastructure well and two other potentially play-opening wells in Lalla Mimouna will be drilled to complete the campaign in March.

Preparations are continuing for two exploration wells in South Disouq and drilling is currently expected to commence in mid/late February 2020. Both wells will target the stratigraphic Kafr El Sheik reservoir, which is already producing successfully from the Ibn Yunus well at South Disouq. SDX estimates that the first well, Salah, is targeting gross P50 resources of 70.6bcfe and the second well, Sobhi is targeting gross P50 resources of 32.7bcfe. The company’s share of the exploration wells costs is estimated at $4.0m. In the event of success, the wells will require short tie-ins (of 8.0km and 5.8km) to the South Disouq CPF, with SDX’s share of tie-in cost estimated at $2.5m and $1.9m respectively. With these volumes it is anticipated that Salah would require two further development wells and Sobhi would require one more well to fully produce the resources.

A third well, Young, targeting a deeper Cretaceous reservoir, could be drilled later in the year depending on the outcome of partnering discussions.

In early February 2020, SDX plans to spud an appraisal/development well in the Rabul area of West Gharib which, if successful, could add approximately gross 200–300bopd of production.

Gaffney, Cline & Associates (GCA) carried out an independent technical and economic audit to asses South Disouq reserves. This was based on a better understanding of the structure and distribution of the reservoir around the production wells provided by the reprocessing of 3D seismic data that was carried out in 2019.

The largest contribution to the increase came from Ibn Yunus, where the 2P gas resources increased from 26.8bcf to 46.8bcf. There was also a slight increase at South Disouq’s Abu Madi and Kafr El Sheikh reserves. Together, these resulted in 2P reserves being upgraded to 89bcfe.

We provide a more detailed description of SDX Energy’s assets in our outlook note published in December 2019.

We value SDX using an asset-by-asset NAV derived from detailed DCF modelling. Core value includes production, development and contingent resources that could be developed, while exploration is valued only if wells are planned and funded in the next 12 months. We apply a 12.5% discount rate given the geographical distribution of the assets and the size of the company. We have updated our short-term commodities prices based on EIA latest estimates. However, our long-term oil price assumption remains $70/bbl in 2022, inflated at 2.5% onwards. We assume Moroccan gas prices of $10.85/mcf in 2020 inflating at 2.5%. Key changes include the updated reserve numbers at South Disouq; in our previous note South Disouq was valued on a management estimate of a 100bcfe 2P reserve base. This was now adjusted to the 89bcfe 2P reserves independently audited by GCA. The c 10% decrease in reserves compared to management’s estimate was offset by rolling forward the discount date and updating 2019–20 production and capital expenditures guidance in Egypt and Morocco.

Our updated valuation includes the South Disouq development and drill-ready gas prospects targeting c 275bcf of mean unrisked prospective resource in Egypt. In Morocco, we include our estimates of current discovered resource and we also include Lalla Mimouna discoveries and 12 planned appraisal/development wells in our valuation, targeting 15bcf. Nine of these wells are included in our core valuation, as risks are only around individual wells meeting the minimum threshold for commerciality – we include these at a 75% chance of success for nine of these wells. The remaining three riskier Lalla Mimouna wells step out of SDX’s core area and we assume a 30% chance of geological success.

As a result, our RENAV moves from 50.3p/share to 53.9p/share (+7%), with our core value standing at 49.3p/share. We note that our valuation has a significant core value component at 90% of our RENAV, and only 10% attributed to exploration and appraisal. This is materially different from the current share price of 25.8p/share. As can be seen in Exhibit 7, based on the current share price, the market is not pricing in all of SDX’s producing assets, nor its risked prospective resource

We forecast year-end 2019 net cash of c $10.4m and, as of end September 2019, SDX’s European Bank for Reconstruction and Development (EBRD) loan facility of $10m remains undrawn. The amount available under the EBRD facility was recently reduced to $7.5m, in line with the facility’s amortisation schedule, and discussions are underway to extend and re-establish the $10m availability under the facility. Based on the capex projections that underpin our production forecasts and SDX’s committed exploration programme, the company is fully funded and we forecast positive free cash flow from 2020. We do not foresee the need for further equity capital at this stage, unless incremental growth capex, over and above our forecasts, is dedicated to new projects or acquisitions.