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Research: Energy & Resources
Hurricane’s technical committee has concluded that there is a reasonable probability that the oil water contact (OWC) in the Lancaster field is shallower than the range of OWCs estimated in the 2017 competent person’s report (CPR) by RPS Energy. As a result, the company believes there is a risk that the estimated reserves for the Lancaster early production system (EPS) and the contingent resources across the West of Shetland portfolio will be materially downgraded. Given the range of outcomes which could emerge from the technical review, and less than a month to the interim results on 11 September 2020, we believe suspending our valuation is a prudent move until there is further clarity on reserves, resources and remedial actions being considered to mitigate potential reserve downgrades.
Written by
Hurricane Energy |
Resource downgrade warning |
Technical and |
Oil & gas |
18 August 2020 |
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Hurricane Energy is a research client of Edison Investment Research Limited |
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Hurricane’s technical committee has concluded that there is a reasonable probability that the oil water contact (OWC) in the Lancaster field is shallower than the range of OWCs estimated in the 2017 competent person’s report (CPR) by RPS Energy. As a result, the company believes there is a risk that the estimated reserves for the Lancaster early production system (EPS) and the contingent resources across the West of Shetland portfolio will be materially downgraded. Given the range of outcomes which could emerge from the technical review, and less than a month to the interim results on 11 September 2020, we believe suspending our valuation is a prudent move until there is further clarity on reserves, resources and remedial actions being considered to mitigate potential reserve downgrades.
Year end |
Revenue |
EBITDA |
Operating cash flow($m) |
Capex* |
Net debt/(cash) ($m) |
12/18 |
0.0 |
(12.6) |
(4.4) |
(209.9) |
99.5 |
12/19 |
170.3 |
(11.7) |
112.2 |
(55.4) |
38.2 |
Note: *Capex is net of carried investment by Spirit Energy
Shallower OWCs driving lower volumes
In June 2020, Hurricane established a technical committee to carry out a root-and-branch review of its geological and reservoir models, including consideration of a shallower OWC given the higher than expected water production seen in the EPS. The work carried out by the committee to date indicates a reasonable probability that the Lancaster OWC is shallower than the range of OWCs previously estimated, and as such there is a risk of a material downgrade to the Lancaster EPS reserves and to the portfolio contingent resources. Given Hurricane is indicating the OWC is potentially shallower than the range of OWCs previously estimated, Edison anticipates that recoverable volumes from the EPS, on a ‘do-nothing basis’ could be lower than original 1P reserves of 28mmbbl.
Production decline without intervention
The potential reserves downgrade indicates that Lancaster EPS production will likely decline from the current level of c 17,000bod without technical intervention. However, Hurricane is looking at production enhancement options to mitigate potential declines. Prior to the most recent shutdown, both wells were producing since the electrical submersible pumps (ESPs) were commissioned in July 2020.
Valuation and forecasts suspended until interims
Our valuation has been suspended until we can review our forecasts and valuation after the company provides its updated reserves and resources and/or conclusions from the ongoing technical review. We expect that our core NAV could be significantly reduced from our previous estimate of 13.6p/share. Our previous RENAV of 37.1p/share could also potentially be downgraded, especially if the shallower OWC leads to downgrades of contingent resources across the wider West of Shetland portfolio. We note that Hurricane may be able to mitigate some of the impact of this downgrade through remedial actions currently being considered.
Technical review highlights shallower OWC
Hurricane’s technical committee was set up in June 2020 to review the full range of possible geological and reservoir models for the Lancaster field, including to investigate the possibility of a shallower OWC given that water production from the Lancaster wells had been higher than expected from existing production forecasts.
The review is ongoing and has yet to be completed, but at this stage it has become reasonably probable to the committee that the OWC is likely to be shallower than the range of OWCs outlined in the 2017 CPR. The company is now indicating that there is a risk of a material downgrade to the Lancaster EPS reserves and to the contingent resources across the entire West of Shetland portfolio. This assessment does not include any production enhancement options currently under evaluation to mitigate the potential production decline. Hurricane expects to complete the technical review by its interim results, which are due on 11 September 2020.
The Aoka Mizu also underwent a controlled shutdown on 2 August 2020 to undergo inspection, which highlighted the need for repairs.
Lancaster EPS: Volume lower than 1P
A shallower OWC could result in substantially lower volumes than outlined in the 1P case for the Lancaster EPS (the 2017 CPR estimated 2P reserves of 37.3mmbbl and 1P reserves of 28.1mmbbl). In the absence of further technical details from the company at this stage, it is not possible for us to estimate what this volume will be.
We have previously noted that the most recently reported flowing bottomhole pressure seen in the Lancaster EPS (at the 2020 capital markets day) is around 50psi lower than modelled pre start-up for the low case, giving an indication that the reservoir was not responding as originally forecast.
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Exhibit 1: Lancaster flowing bottomhole pressure |
Exhibit 2: Pre Lancaster start-up bottomhole pressure model |
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Source: Hurricane Energy |
Source: Hurricane Energy |
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Exhibit 1: Lancaster flowing bottomhole pressure |
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Source: Hurricane Energy |
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Exhibit 2: Pre Lancaster start-up bottomhole pressure model |
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Source: Hurricane Energy |
Without any further interventions, the EPS production will, in our view, likely not remain at the current rate of 17,000bod, and will decline as water influx increases. We note that this drop off in production rate is likely to reduce cash flow from our previous estimates and potentially limit the capital available to carry out any technical interventions that the company identifies to enhance production.
In our previous note we outlined a number of remedial options to bring the 205/21a-7z well back into production. Hurricane has since commissioned the ESPs in both wells and, prior to the recent shutdown, the 7z well was producing using an ESP at a rate of c 5,000bod and a water-cut of 53%, while the 205/21a-6 well was flowing naturally at c 12,000bod and a water cut of c 12%. We note that the six well sits around 20m higher than the 7z well, so that water influx here can be expected to lag behind that seen in 7z (assuming that water production could be coming from the aquifer rather than being ‘perched water’ as had initially been assumed).
Valuation
Given the uncertainty surrounding the exact extent of the material downgrade to the Lancaster EPS reserves and to the portfolio contingent resources, we are suspending our valuations (both core NAV and RENAV) until we learn more from the technical review. This will include both assessing production declines and reduced reserves and resources, and also the potential impact of any production enhancement options currently under evaluation.
We expect our Lancaster EPS core NAV could be substantially lower than our last published estimate of 13.6p/share, as we expect EPS total recoverable volumes (absent any production enhancement options) could be below the original 1P case. Furthermore, costs on a per barrel basis will likely increase from our previous estimates as a substantial portion of the Lancaster costs were fixed in nature. Given that the EPS was delivering 18.6p/share within our core NAV of 13.6/share, the downgrade to our core NAV is likely to be substantial.
The impact on our wider RENAV, which also includes both the Lancaster full field development and a portion of the Greater Warwick Area development, is equally uncertain. If Hurricane concludes that a shallower OWC will materially reduce the contingent resources across its wider West of Shetland portfolio then this would also have a significant impact on our RENAV, which we previously estimated at 37.1p/share.
Investors should note that while we expect material reserves and resources downgrades, this does not take into account the potential production enhancement options currently being evaluated. We anticipate learning more about these options along with the conclusions from the review carried out by the technical committee by the company’s interim results on 11 September 2020.
Financials
In our previous note in June 2020 we assessed the ability for Hurricane to cover the Lancaster EPS residual capex, its exploration & appraisal (E&A) commitment wells and repay its $230m convertible bond principal repayment in 24 July 2022 out of cash reserves and EPS cash flows of $183m. We concluded that the company had a modest $43m of headroom to achieve this based on base case EPS assumptions.
Consistent with our approach on valuation, we are suspending forecasts until we learn more about the conclusions of the technical review. However, if EPS cash flows are potentially substantially lower than previously thought through to the end of 2022, it is possible we will conclude that the company may not have sufficient cash reserves to pay the bond principal as previously thought.
This would necessitate the company to either refinance this bond or secure additional sources of finance, which could well be a reasonable approach (many oil and gas companies operate in this manner). Ultimately Hurricane’s financing options will be predicated on the technical options available to the company following the technical committee review and any potential production enhancement measures being considered.
Exhibit 3: Financial summary
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$m |
|
2017 |
2018 |
2019 |
Year end 31 December |
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|
IFRS |
IFRS |
IFRS |
PROFIT & LOSS |
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Revenue |
|
|
0.0 |
0.0 |
170.3 |
Operating Expenses |
(14.6) |
(12.7) |
(118.9) |
||
EBITDA |
|
|
(14.6) |
(12.6) |
(11.7) |
Operating Profit (before amort. and except.) |
|
(14.6) |
(12.7) |
51.4 |
|
Exploration expenses |
(10.4) |
0.0 |
(66.5) |
||
Exceptionals |
10.4 |
(42.4) |
34.7 |
||
Other |
0.0 |
0.0 |
0.0 |
||
Operating Profit |
(14.6) |
(55.0) |
19.7 |
||
Net Interest |
7.6 |
(5.9) |
(21.5) |
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Profit Before Tax (norm) |
|
|
(7.0) |
(18.5) |
30.0 |
Profit Before Tax (FRS 3) |
|
|
(7.0) |
(60.9) |
(1.8) |
Tax |
0.0 |
0.0 |
60.5 |
||
Profit After Tax (norm) |
(7.0) |
(18.5) |
90.5 |
||
Profit After Tax (FRS 3) |
(7.0) |
(60.9) |
58.7 |
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Average Number of Shares Outstanding (m) |
1,583.8 |
1,959.6 |
1,978.5 |
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EPS - normalised (c) |
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|
(0.4) |
(2.2) |
(2.5) |
EPS - normalised and fully diluted (c) |
|
(0.4) |
(2.2) |
0.3 |
|
EPS - (IFRS) (c) |
|
|
(0.4) |
(3.1) |
3.0 |
Dividend per share (p) |
0.0 |
0.0 |
0.0 |
||
Gross Margin (%) |
NA |
NA |
30.2 |
||
EBITDA Margin (%) |
NA |
NA |
-6.9 |
||
Operating Margin (before GW and except.) (%) |
NA |
NA |
30.2 |
||
BALANCE SHEET |
|||||
Fixed Assets |
|
|
587.9 |
884.2 |
932.5 |
Intangible Assets |
126.4 |
131.5 |
75.9 |
||
Tangible Assets |
445.3 |
728.2 |
796.2 |
||
Investments |
16.3 |
24.5 |
60.5 |
||
Current Assets |
|
|
350.1 |
106.0 |
228.7 |
Stocks |
1.4 |
4.6 |
9.9 |
||
Debtors |
4.7 |
2.6 |
50.4 |
||
Cash |
343.9 |
98.9 |
168.4 |
||
Other |
0.0 |
0.0 |
0.0 |
||
Current Liabilities |
|
|
(28.8) |
(55.1) |
(94.4) |
Creditors |
(28.8) |
(55.1) |
(94.4) |
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Short term borrowings |
0.0 |
0.0 |
0.0 |
||
Long Term Liabilities |
|
|
(226.7) |
(307.0) |
(375.8) |
Long term borrowings |
(191.1) |
(198.4) |
(206.6) |
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Other long term liabilities |
(35.6) |
(108.7) |
(169.2) |
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Net Assets |
|
|
682.5 |
628.1 |
691.1 |
CASH FLOW |
|||||
Operating Cash Flow |
|
|
(8.1) |
(4.4) |
112.2 |
Cash tax paid |
0.0 |
0.0 |
0.0 |
||
Capex |
(265.7) |
(209.9) |
(55.4) |
||
Acquisitions/disposals |
0.0 |
0.0 |
0.0 |
||
Financing |
322.3 |
163.4 |
13.1 |
||
Dividends |
0.0 |
0.0 |
0.0 |
||
Net Cash Flow |
48.5 |
(50.9) |
69.8 |
||
Opening net debt/(cash) |
|
|
(98.6) |
(152.8) |
99.5 |
HP finance leases initiated |
0.0 |
0.0 |
0.0 |
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Other |
5.7 |
(201.4) |
(8.6) |
||
Closing net debt/(cash) |
|
|
(152.8) |
99.5 |
38.2 |
Source: Hurricane Energy accounts
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Research: TMT
EQS delivered a good first half performance, boosted by companies’ needs to adapt their communications strategies to the impact of the COVID-19 pandemic. Revenue guidance for the year has been tilted to the higher end of the previous range and EBITDA guidance lifted by €0.5m to $4.0–5.0m. We have lifted our forecast from €3.5m to €4.1m, rising to €8.5m for FY21e as the scalability of the platform helps improve margins. With the group now over the peak investment in its cloud-based COCKPIT software, free cash flow is on a clear improving trend. The share price has recovered well from the market setback in March but remains on a discount to peers.