Rockhopper Exploration — Parties committed to complete Sea Lion deal

During 2019 Rockhopper achieved revenue of $10.3m from its Greater Mediterranean assets while progressing its Sea Lion project in the Falkland Islands. In January 2020, Rockhopper and Premier Oil announced that an HoT had been signed with Navitas Petroleum to farm in for a 30% interest in the Sea Lion project. The entry of an additional partner into the joint venture brings further industry validation and improves the likelihood of securing project financing for Phase 1 of the Sea Lion development. Rockhopper is now fully funded from the start of 2020 through to completion of Phase 1 of the project, which will develop 250mmbbls of gross resources. In addition, a contingent consideration of up to $48m is payable to Rockhopper by Premier Oil and Navitas for future phases of development in the North Falkland Basin. Finalisation of the sale and purchase agreement is expected during summer 2020.

Progress on the preliminary information memorandum (PIM), submitted by the Sea Lion joint venture in August 2019 and a key milestone for final investment decision (FID) for Sea Lion, was held up as a result of the UK general election, and is now expected to move forward. Progress is contingent on Premier completing its corporate actions (North Sea M&A/equity raise) and a recovery in the oil prices.

In January 2020, Premier also announced a series of significant North Sea M&A deals, which would materially strengthen its balance sheet and further support Sea Lion project financing discussions. Had oil prices stayed at 2019 levels, the additional cash flow would have accelerated the company’s debt reduction, increasing the likelihood that project finance could be secured for Sea Lion Phase 1. However, the coronavirus outbreak and the Russia/Saudi Arabia oil price war led to an unprecedented decrease in oil prices and a decrease of c 70% in Premier’s market cap.

Notwithstanding the current external headwinds Rockhopper is facing, it announced that good progress was made during Q120 to convert the HoT into fully documented agreements, and that despite the current oil price environment, all parties remain committed to finalising the Navitas farm-in agreement, with completion subject to agreed consents and approvals. Sale of the Egyptian assets, together with the HoT signed with Premier and Navitas, leave the company in a relatively stable financial position with unaudited cash resources of $21.9m as at 1 April 2020, no debt and limited exposure to future development costs (excluding licence fees, taxes, costs incurred prior to 1 January 2020 and project wind-down costs) at Sea Lion.

In March 2017, Rockhopper started international arbitration proceedings against the Republic of Italy in relation to the Ombrina Mare field it acquired from Mediterranean Oil & Gas. Rockhopper believes it has strong prospects of recovering ‘significant monetary damages’ based on lost profits as a result of the Republic of Italy’s breaches of the Energy Charter Treaty. We estimate that these will be recoverable at c $20m on a risked basis in our valuation using a simplified approach, which assumes a 50% chance of recovering the associated acquisition costs. We have not carried out a loss of profits calculation, but press reports suggest it could be materially higher, with the claim running up to €275m plus interest. Clearly, there is material upside to our valuation in the event of a damages award to Rockhopper. Indicatively, a $50m award to Rockhopper net of costs would be worth up to 8.5p/share to equity holders. On 26 June 2019, the tribunal rejected Italy’s request for suspension of the arbitration and its intra-EU jurisdictional objections. Rockhopper expects a final outcome and potential damages award in the coming months.

We value Rockhopper’s asset base using a conventional risked net asset value (NAV) approach, based on a risked valuation for proven reserves, and contingent and prospective resources. Key assumptions in our valuation include estimates of production profiles, asset development costs and operational costs, in addition to realised commodity prices and costs of capital. We use publicly available sources for key assumptions, including company guidance.

We have updated our forecasts and NAV to reflect Rockhopper’s FY19 results, together with the impact of the coronavirus and Russia/Saudi Arabia oil price war, in our pricing assumptions. Our risked valuation has decreased to 24.4p/share. The main change in our modelling includes our long-term Brent assumption. We have revised down our long-term oil price expectation of $70/bbl Brent from 2022 to reflect current oil price volatility. We present three scenarios with Brent in 2020 at $40/bbl in our low case scenario, $50/bbl in our mid-case scenario and $60/bbl in our high case scenario, inflated at 2.5% per year, resulting in 2022 prices of $42.0/bbl, $52.5/bbl and $63.0/bbl respectively. Given the current oil price volatility, we will continue to monitor market conditions closely and may revisit these assumptions in due course. The NAV table below, in Exhibit 1, provides a breakdown of our valuation by asset.

Rockhopper currently trades at 7.4p/share relative to our risked valuation of 24.4p/share. Although an increase in the share price was observed following the deal announcement, it has been completely erased by the impact of the coronavirus on energy markets in combination with the Russia/ Saudi Arabia price war in early March 2020. The current share price suggests an implied chance of success of between 20% and 30% for Phase 1 at $50/bbl or c 50% at $40/bbl. We believe the project is more likely to proceed than not, now reinforced by the Navitas deal, hence our 55% commercial chance of success for Phase 1. However, recent global events will most likely affect timings, especially around closing funding and financing agreements for the Sea Lion joint venture, and consequently a final investment decision.

If the current oil price environment persists, we also expect to see significant cost deflation which will improve the project economics and valuation of Sea Lion Phase 1 development. In the table below we provide a sensitivity to the impact of capex on Sea Lion Phase 1.

Rockhopper ended FY19 with c $17m of cash on the balance sheet and no debt, in line with our estimates, and announced unaudited cash resources of $21.9m as at 1 April 2020. With the disposal of Abu Sennan, our forecast Italian asset capex and SG&A are covered for the coming years at $5m in 2020 and $4m in 2021. This represents a c 30% cost reduction versus 2019, in line with company guidance as a response to the coronavirus pandemic and market developments. As a consequence of the Navitas farm-in, Rockhopper is fully funded through to Sea Lion Phase 1 project completion given the newly agreed interest-free loan from Navitas and Premier (excluding licence fees, taxes, costs incurred prior to 1 January 2020 and project wind down costs at Sea Lion). We are accounting for this partnership loan in the company’s balance sheet. However, we do not believe Rockhopper will need to access any additional funding for Sea Lion Phase 1 development. Project funding for the joint venture is expected to be split into vendor financing, export credit/bank finance and upstream partner equity.