Rockhopper Exploration — Operator confident in 2018 Sea Lion Phase 1 FID

Premier Oil reported FY17 results on 8 March 2018, highlighting the progress the company has made in restoring balance sheet strength. This included a combination of refinancing existing facilities, successful execution of the Catcher development and consequent enhanced organic cash generation and non-core asset disposals. Looking ahead, Premier Oil expects leverage to fall to c 2.5x net debt/EBITDAX by end Q119, enabling management to direct cash flow towards high-return growth projects in addition to debt reduction.

The largest project in Premier Oil’s current development portfolio is Sea Lion, with potential Phase 1 net production of 50kboed, and a Premier estimated post-tax net leveraged NPV10 of c $1bn at a $65/bbl oil price. Funding for the project is expected to be split into three component parts: vendor financing (c $375m), export credit/bank finance (c $750m) and upstream partner equity (c $375m).

Below we highlight key elements of Premier Oil’s FY17 annual results presentation/conference call, which give us increased confidence in the potential development of Sea Lion Phase 1:

Premier expects to finalise project funding during 2018 ahead of FID towards the end of 2018 and with first oil in 2022. We continue to assume a 2023 first oil for Phase 1 of the development, just over four years after project sanction. This is a slightly longer development timeline than Catcher, which was sanctioned by Premier Oil in June 2014 and delivered first oil in December 2017.

We see confirmation of vendor financing and senior debt as important enablers of the project that we feel will further de-risk Sea Lion Phase 1 from a market perspective. In this note, we have increased our commercial chance of success for Sea Lion Phase 1 from a modest 20% to 40%, although we see potential for further de-risking in the coming months as financing is secured. This upgrade also includes the impact of rolling forward the date at which we discount cash flows to start 2018, modified capex phasing and is partly offset by a currency mark-to-market with our £/US$ rate changing from 1.3 to 1.4.

Our total Rockhopper RENAV rises from 44.2p/share to 62.9p/share (+42%) as a result and we provide a valuation sensitivity analysis to Sea Lion’s chance of success in Exhibit 5 below.

We note that Premier Oil’s net Sea Lion Phase 1 valuation, which Premier management estimates at $1bn using a $65/bbl oil price assumption, includes the cost carry of RKH’s share of capex to first oil and is calculated on a leveraged basis with a 10% cost of equity. Key differences between our valuation of Sea Lion and Premier Oil’s are highlighted below:

Our updated valuation assumes a 40% commercial chance of success for Sea Lion Phase 1. We expect further de-risking as Premier secures debt funding and reaches project FID. As it stands, we estimate that the market is assuming a c 20% chance of success for Sea Lion Phase 1 and minimal value for future phases of development.

The economics of Sea Lion remain sensitive to our underlying oil price assumption and cost of capital, as shown in Exhibit 9. A $5/bbl reduction in our long-term oil price assumption (from $70/bbl Brent to $65/bbl) has a 19% negative impact on our RKH RENAV. Premier Oil estimates that the company’s net economics are break-even at c $45/bbl.

Funding risk: key risks are around the Sea Lion partner group’s ability to secure vendor, senior debt and equity financing for the Phase 1 development, as discussed earlier in this note.

Oil price risk: the bulk of RKH’s value is dependent on long-term prices, although near-term cash flows are reliant on near-term realisations in Italy and Egypt.

Fiscal regime change: the FIG is unlikely to increase the fiscal take in the foreseeable future, especially given the current outlook for oil prices. Indeed, given the delays in getting project sanction, it is in everyone’s interest to incentivise first oil as soon as possible. A renegotiation of terms is therefore possible, but we are not assuming it.

Reservoir risk: Sea Lion has been extensively appraised, so reservoir distribution here is understood and the waxy nature of the Sea Lion crude known. Similar appraisal and analysis will be required at the Isobel-Elaine complex.

Argentina: relations between Argentina and the UK have thawed in recent years. In September 2016, the UK and Argentinean governments agreed to work together to remove “restrictive measures around the oil and gas industry, shipping and fishing affecting the Falkland Islands”. A second commercial flight to the Falklands is expected later this year, which requires UK and Argentinean support. We hope that a path to normalisation of diplomatic relations continues.

Payment and repatriation risk from Egypt: Egyptian production can be paid in a combination of Egyptian pounds and US dollars, and we believe that it is materially easier to be paid in Egyptian pounds (although to date RKH has only accepted US dollars, paid directly into its UK bank accounts).

Rockhopper presents an end-December 2017 unaudited $51m in cash and no debt. We expect this to fall to just over $35.7m by year end FY18 (assuming a c $3m receivable unwind) as the company funds pre-sanction activity for Sea Lion, including corporate G&A as well as $3m for Abu Sennan and the Raya-1X well in Egypt.

Current cash is clearly not enough to fund development of Sea Lion, but existing farm-out agreements with PMO will enable RKH to progress to Sea Lion first oil, based on the partner group’s estimated $1.5bn gross capex bill. Existing agreements call for a $337m development carry on Phase 1, with a similar-sized carry on further phases. Given the debt-biased financing structure outlined by PMO, the carry net to RKH of the $375m equity finance for Phase 1 pre-first oil would only be $150m. We would not be surprised to see an evolution of the existing farm-out agreement.

RKH recently provided an update on the company’s Greater Mediterranean assets, reporting improved production from Abu Sennan, strong realisations and confirmation of a four-well drilling programme in 2018. The company’s Egyptian receivables position is significantly reduced ($4.5m outstanding) and historical liabilities to Beach Energy have been satisfied, meaning RKH will now benefit from 100% of payments from the Egyptian General Petroleum Corporation (EGPC) relating to its net interest. Cash flows from the company’s Egyptian asset base are expected to cover operational costs, G&A and contribute to maintenance capex going forward. Company financials are largely driven by the company’s producing Greater Mediterranean assets and the continued investment in Sea Lion.

Abu Sennan: producing slightly ahead of management expectations following workovers in H217 at 880kboed net. Following JV approval, the company is to drill one exploration well (Prospect S), two development wells and a water injection programme at Al Jahraa in 2018. The focus remains on replacing reserves and maintaining production, with the potential to materially increase recovery factor over time. (Abu Sennan accounts for 2p/share of our NAV.) Net capex for the assets is estimated at $3m in 2018.

El Qa’a Plain: the Raya-1X commitment well is to be drilled in 2018, targeting a relatively high COS, but small (1-2mmbo) prospect close to existing discoveries. Net capex is estimated at less than $1m.

Italy: Guendalina continues to perform to forecasts (290kboed in 2017). However, the Civita gas field incurred downtime in February 2018 due to a pipeline depressurisation event, which is to be remedied. RKH continues to look at divesting its non-core Italian assets, including Civita (currently just 0.3p/share of our NAV), to Cabot Energy.