Hurricane Energy — Update 15 December 2015

Hurricane is continuing to focus on achieving first oil from its 207mmboe Lancaster field, West of Shetland. The fractured basement field was granted oil field status by the UK Oil and Gas Authority (OGA) in September 2015, representing a first step towards the submission of the Lancaster early production system (EPS) field development plan (FDP). Meanwhile, the recent subdivision of its P1368 licence into four subareas will provide greater flexibility in progressing farm-down options for the field.

However, the award of two further West of Shetland blocks in the 28th Offshore Licensing Round highlights that Hurricane holds material basement prospectivity beyond Lancaster. Here we look in more detail at the nearby analogous prospects Lincoln and Warwick, which sit within tie-back distance of the planned Lancaster EPS. Background information on fractured basement reservoirs and a discussion of Lancaster can be found in our initiation note published in June 2015.

In the 28th Offshore Licensing Round Second Tranche announced in July 2015, Hurricane was awarded two blocks West of Shetland, 204/30b and 205/26d (licence P2294 in Exhibit 1). The blocks contain the western extension of the Lincoln prospect from Block 205/26b/Licence P1368S, together with the Warwick prospect. Both are considered similar to Lancaster and offer relatively low-risk near-field exploration potential, which the company is currently looking to prioritise once the Lancaster EPS is successfully implemented.

In addition, the OGA announced in November 2015 that it had approved a subdivision of the original licence P1368 into four subareas:

The subdivision will simplify the potential farm out of the assets, since it provides the flexibility to farm down the discoveries and prospects separately as required.

Lincoln is an undrilled prospect sitting around midway between Lancaster to the north-east and the Premier development Solan to the south-west. The reservoir in Lincoln sits 500m deeper than in neighbouring Lancaster, but otherwise appears to be similar with a highly faulted basement reservoir identified on 3D seismic. The prospect is estimated to contain P50 prospective resources of 150mmbbls in Block 205/26b, but is also believed to extend into the recently awarded Block 204/30b, where potential resources have yet to be quantified.

Evidence for the presence of oil in Lincoln comes from the 205/26-1 well drilled by BP in 1975 (Exhibit 2). The well was drilled on the down-dip flank to the south of Lincoln and found oil in the sandstones immediately above the basement and traces of oil in the short section of basement drilled in the well. In addition, oil samples were found in core recovered from 2,078m supporting Hurricane’s model of oil below structural closure, assessed in the 2013 CPR as sitting between 1,780m and 1,820m. Oil is possible below structural closure in basement reservoirs as the oil backfills down through the fracture network and cannot then escape through the non-permeable rock. Hurricane calls this the ‘jellyfish model’ (Exhibit 3).

Below structural closure, the CPR assumes that oil could extend down to 2,135m. Using these contacts, the 150mmbbls in Lincoln are estimated to be distributed between 66mmbbls within structural closure and 84mmbbls below. The company sees the deliverability of the basement reservoir as the key issue for the prospect. The prospect’s proximity to Lancaster suggests that there could be fluid communication between the two, though this would have to be confirmed by drilling.

Hurricane is keen to drill an exploration well in Lincoln as early as possible. The company has identified a well location and hopes to drill here based on the results of appraisal drilling at Lancaster. The OGA has granted a two-year extension to the requirement to drill a well on Lincoln to 31 December 2019.

Like Lincoln, Warwick is geologically similar to Lancaster, with significant faulting present based on seismic interpretation. The prospect exhibits a similar topographical relief to Lincoln, and lies closer to the main Faroe-Shetland source kitchen to the north. Sitting in the recently awarded 204/30b and 205/26d blocks, the prospect is at a less advanced stage than Lincoln, and Hurricane is working to map the faults and prepare a volumetric assessment prior to identifying a drill location. The timing of an exploration well here is also aligned with progress on the Lancaster EPS.

Warwick and the Lincoln extension are the latest additions to the Hurricane portfolio, which includes the following additional assets:

Pending confirmation of any drilling activity and in keeping with our initiation note, we base our valuation on the Lancaster proposed development that Hurricane is seeking a farm-in partner to help fund. We have adjusted our previous valuation for oil price, retaining a long-term $80/bbl real Brent assumption, but with a reduction in short-term forecasts that drops 2019 (first year of Lancaster production) assumed Brent from $88.3/bbl to $84.6/bbl. From 2020 our oil price assumptions remain unchanged from our initiation note. We continue to apply a 12% discount rate for our NPV calculations.

As Hurricane is seeking to fund Lancaster through a farm-out, we reflect our valuation on a post-farm-out basis. We assume the farm-in partner will seek a minimum return and adjust its carry and retained interest as appropriate; assuming Hurricane needs a full carry we estimate that the farm-in partner will seek a 20% IRR, giving it a 66% interest with Hurricane retaining a 34% interest.

We continue to assume that Hurricane will start its initial Early Production System (EPS) in late 2018, although any significant delays to the ongoing farm-out process over 2016 could delay this. With no changes to schedule and only modest macroeconomic adjustments, our reference case valuation (Exhibit 7) is largely unchanged at 47p/share (previously 45p/share).

Our reference case assumes a purchased FPSO. This increases to 57p/share in the event that the company leases a FPSO for the development (Exhibit 8).

For the remaining exploration/appraisal portfolio, we estimate an additional 19p/share could be added to our valuation once Hurricane confirms funding and drilling commitments for these prospects/discoveries (Exhibit 9). However, we stress that these do not form part of our current valuation until wells are funded and planned to be drilled in the next 12-18 months.

Once Hurricane completes its initial assessment of the 28th Offshore Licensing Round acreage, this upside valuation will also include the additional volume potential in Block 204/30b (the Lincoln extension) and in Block 205/26d (the Warwick prospect).

Hurricane exited H115 with £12.4m of cash, down from £15.9m at end 2014. The reduction, split £1.9m cash from operations, ie cash G&A, and £1.5 capex, is slightly above the £5m pa burn rate we had previously assumed and, assuming this trajectory, would fund the company through to end 2016. We do not believe that the current cash position to be a problem with Lancaster farm-out discussions likely to be at an advanced stage, although this will clearly start to become an issue if such a deal is not secured in H116.

We present our financial forecasts in Exhibit 10. Readers should note that in keeping with our standard research principles, we show Lancaster currently being fully debt funded. In practice, we expect Lancaster to be funded through the ongoing farm-out process so these forecasts should be considered as illustrative only.