Hurricane Energy — Update 28 April 2016

On 18 April 2016, Hurricane Energy announced that it had conditionally raised £52.1m gross through the proposed issue of 347m new ordinary shares at 15p/share. The net proceeds of the fund-raise are earmarked for drilling a pilot well and a horizontal well on Lancaster in Q316 (Lancaster 7 Wells: £43.9m) and for general corporate purposes (£5.4m).

In our view, Hurricane’s 2016 well programme is well timed, taking advantage of high-spec rig availability at an attractive price. The company has not released the contracted day rate for the Transocean Spitsbergen, but we understand that costs reflect recent reductions seen in deepwater rig rates which are down by more than 60% since peak. While Hurricane’s fund-raise at 15p/share is dilutive to our NAV, we believe it is sensible of Hurricane to take advantage of current availability and low day rates in the high-spec, deepwater rig market.

The company’s 2016 well programme incorporates a pilot well and a horizontal sidetrack on Lancaster and is known as Lancaster 7 Wells. The three objectives of the Pilot Well are as follows:

On completion of pilot well operations, the well will be plugged and abandoned and a horizontal well will be drilled and tested from the same borehole. The horizontal will be flow tested to clean up the well and look to replicate the results of the 2014 flow test. A longer duration shut-in and pressure build-up test than 2014 should provide further information on reservoir quality and continuity away from the wellbore.

A successful outcome from the 2016 well programme has the potential to materially de-risk EPS development, potentially providing Hurricane with more favourable terms for an EPS and/or full field farm-down. Importantly, we should see more certainty on the size of recoverable resource for the EPS phase of development, giving us greater confidence in the mid-case volumetrics that drive our valuation.

The Transocean Spitsbergen is a 2009 Aker H-6e semi-sub with harsh environment, ultra-deepwater capability currently ready stacked in Norway, according to RigLogix. We understand that Hurricane’s’ rig contract remains contingent on completion of the fund-raising and is available to commence work in Q316. Hurricane has not released details on cost contingency or risk-sharing arrangements with Transocean; well AFE stands at £43.9m.

Hurricane believe that the results of Lancaster 7 Wells should allow it to make a final investment decision to progress Lancaster’s EPS development phase. EPS is planned for first oil in 2019, which should provide long-term production data to de-risk and optimise full field development and provide shareholders with an acceptable risked return on capital.

EPS or development of Lancaster will involve recompleting and tying back two horizontal wells (recompletion of wells drilled in 2014 and 2016) to a leased FPSO. The minimal facility FPSO, which is limited to oil separation, produced water clean-up and fuel gas power systems. Tanker offloading will be required as there is no alternative export infrastructure. Total cost from the end of 2016 through to first oil is estimated by Hurricane at $240m excluding letters of credit.

Ours EPS production profile is based on two wells producing at start-up with an IP rate of 8mb/d. We assume per well EUR in the EPS phase is inline with average full field development EUR as per Hurricane's 2013 CPR. There is potential upside to this assumption as the EPS phase development focuses on the monetisation of oil within mapped closure as successfully tested by well 205/21a-6 in 2014. We view our assumption as conservative and expect to update post the Lancaster 7 wells programme.

We model first oil in line with company guidance in H119, giving an unrisked, forward-looking IRR (gross basis) of 48% based on our oil price deck, which assumes Brent long-term at 70$/bbl (real). We note that delivery of first oil in 2019 will be dependent on EPS FPSO and modification yard availability.

Full field development (FFD) of Lancaster is aimed at recovering remaining oil from Lancaster’s mapped structural closure, in addition to oil from basement reservoir and Victory sands below mapped closure. We currently model 36mmbbl recovery in the EPS phase and 164mmbbl through FFD. Hurricane’s 2013 CPR splits Lancaster volume between above and below mapped closure (61mmbbl and 139mmbbl respectively).

Our FFD development largely follows assumptions made in the company’s 2013 CPR, adjusted for the latest cost information and improved per well flow rates after Hurricane’s success at well 205/21a-6 in 2014. Our base case assumes a purchased FPSO development delivering first oil in 2024, with peak production of c 70mb/d as shown in the production profile below.

Our unrisked forward-looking IRR of a combined EPS and FFD development of Lancaster on a gross basis and at an Edison (70$/bbl real long term Brent) price deck, is estimated at 41%.

Hurricane is funded through the 2016 well programme, although further funds will be required to progress Lancaster through to EPS and FFD. We assume Hurricane’s net capex through to EPS and FFD first oil is funded via farm-down and an FFD reserve-based lending (RBL) facility (we assume $250m net RBL in our base case). Based on our forecasts, we expect the company to require more funds in 2017. Our financial forecasts assume £9.3m of net debt at year-end 2017. Taking a view on asset dilution through farm-out, our analysis assumes a farminee will require a 25% forward-looking, post-carry IRR to invest. On this basis, we believe that Hurricane will need to farm down a 58% equity interest in Lancaster i to fund both EPS and FFD. This dilution is reflected in the working interests we apply in our NAV, with Hurricane retaining a 42% working interest in both EPS and FFD.

Our RENAV moves from 45p/share to 34p/share to reflect the issue of new shares, macro and asset-level updates. Despite this RENAV downgrade, we continue to see more than 149% upside from the current share price and believe there is potential for our RENAV to increase over the course of 2016 as EPS development is de-risked through the Lancaster 7 Wells programme.

Key changes to our last published model include:

Our RENAV remains highly sensitive to long-term oil price assumptions, with a post farm-down NAV break-even at c 50$/bbl Brent. At higher oil prices, our RENAV is several times the current share price, as shown in Exhibit 7 below.

At this stage, we do not include value from other discoveries and prospects as there is no clarity on when appraisal/exploration wells will be drilled and/or funded. This blue-sky exploration/appraisal portfolio is potentially worth a further 12p/share on our estimates. We have not conducted detailed dilution analysis for this portfolio of assets and as such may be overestimating the commercial chance of success.