Hurricane Energy — Update 12 July 2016

Hurricane is planning to drill two wells on Lancaster in Q316 with a view to obtaining sufficient data to be able to make a final investment decision on the EPS phase of the development by H117. The wells will consist of an inclined pilot hole, 205/21a-7, followed by a horizontal sidetrack, 205/21a-7z.

The pilot hole will be drilled off the crest of the structure and is designed to reach total depth in the water leg. To ensure this is achieved, the well will be drilled to around 100m below the deepest point at which the presence of oil has been established to date in Lancaster (ie 1,781m based on oil cuttings in the 205/21a-4 well). The key objective of the well will be to confirm the oil water contact (OWC), which would then allow the current resource range of 62-456mmboe to be refined. Further objectives are to evaluate the properties of the basement aquifer and to refine the company’s understanding of the overlying Victory sandstone (formerly known as the Commodore sandstone).

Hurricane is planning to acquire a comprehensive set of data in the pilot well. Advance gas chromatography, logging while drilling (LWD) and a full suite of wireline logs will be taken across the Victory sandstone and fractured basement. In addition, an open-hole DST will be carried out over the entire fractured basement section of the well and will include production logging (PLT) and downhole fluid sampling.

The volumes of hydrocarbons trapped in fractured basement reservoirs can exceed the volume that is trapped in the mapped structural closure. For Lancaster, the recoverable volume in structural closure is 61mmbbls, based on a spill point depth of 1,380m true vertical depth subsea (TVDss), and this is the volume that will be targeted in the EPS. If this low case is confirmed by the EPS, then no further development would take place. However, if the OWC is established to be consistent with or deeper than the 2C case of 1,597m TVDss, Hurricane believes that a continuous oil column can be assumed across the reservoir based on current reservoir simulations incorporating results from the 205/21a-6 well. This would positively affect the resource range, as shown in Exhibit 3. The 2C OWC is currently based on oil recovered from a drilling swab and MDT analysis from the 205/21a-4 well, while the 3C case of 437mmbbls is based on oil recorded to 1,781m TVDss in the 205/21a-4 well in post-well analysis.

The ability of the pilot well to determine the OWC is therefore crucial to the future development concept for Lancaster. In addition, the extensive data gathering should allow more certainty around the water saturation in the reservoir, which will assist in establishing the extent and continuity of the aquifer.

After data gathering of the pilot well has been completed, it will be abandoned and the top hole section used for the horizontal sidetrack. 205/21a-7z will be drilled at a similar depth to the existing 205/21a-6 well and around 140m above the shallowest estimated OWC. The well will have a 1km horizontal section and is expected to intersect 13 fault zones. It will be positioned close enough to 205/21a-6 to monitor interference between the wells during the EPS, while remaining far enough away to allow for reservoir drainage. Data gathering will be similar to that in the pilot hole, although wireline logging and PLT cannot be taken in a horizontal section. Once the drilling and testing programme is completed on the two Lancaster 7 wells, the company plans to move rapidly into FEED, with FID by the end of H117 and first oil by H119.

A successful outcome from Hurricane’s 2016 well programme has the potential to materially de-risk EPS development, providing greater certainty on the overall Lancaster resource, as well as volumes recoverable under a two-well EPS.

Our conservative EPS asset valuation stands at 12p/share, with potential to rise to 18p/share if higher per-well recovery is proven (Hurricane base case). Hurricane’s capital markets day (CMD) pointed to slightly lower fixed opex than we had estimated in our standalone EPS valuation. Adjusting our estimates to reflect company guidance and including the translational effect of a stronger dollar increases our risked EPS asset valuation from 8p/share to 12p/share and Hurricane RENAV from 34p/share to 41p/share.

We note that our EPS valuation remains on the basis of volumes recoverable in structural closure at EUR of 36mmbbls (in line with a per-well EUR of 18mmbbl as per RPS Energy’s CPR for full field development). Recent well simulation work being carried out by Hurricane and confirmed by a third party suggests upside to our EUR assumptions, with producers showing no immediate decline and an extended plateau response – an additional 10mmbbls recovered per well compared to RPS’s 2013 CPR assumptions.

Hurricane expects to test well productivity through the open-hole drill stem test (DST) of the planned horizontal well and to see if the flow rates of 205/21a-6 can be replicated. We see a further 6p/share upside to our EPS valuation if Hurricane can firm-up recoverable volumes in line with a company base case estimate of 53mmbbl.

The profiles below help visualise the difference in predicted production between RPS CPR assumptions and more recent well simulation work. If Hurricane can prove up its model of a limited well decline for the first five to seven years of production, there is c 10mmbbls of incremental oil recovery predicted per well, which should lead to better full field development economics driven by a lower well count.

We model first oil in line with company guidance in H119, giving an unrisked, forward-looking IRR (gross basis) of 59% 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 depend on EPS FPSO and modification yard availability, successful execution and costs in line with company estimates.

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 46%.

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 £3.9m 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 55% equity interest in Lancaster to fund both EPS and FFD. This dilution is reflected in the working interests we apply in our NAV, with Hurricane retaining a 45% working interest in both EPS and FFD.

Other forms of funding being considered for the EPS phase of development include export credit finance available to fund yard costs, which we understand make up the bulk of pre-EPS first oil capex.

We make a modest change to our valuation at this stage and expect a further update post the Lancaster 7 wells programme. As a result of lower anticipated EPS development costs, as set out at Hurricane’s CMD, we see better returns and net NPV for Lancaster EPS development. Our net risked NPV/share for Lancaster EPS rises from 8p/share to 12p/share as result (0.5p/share of this increase is driven by a foreign exchange translation impact as we move from $1.45/£ to $1.4/£).

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 9 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 13p/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.