Rockhopper Exploration — Update 21 April 2016

The resurrection of the deal sees Rockhopper paying substantially less than was originally announced ($22m in cash and shares) in August 2015. As a result, the $/boe (2P+2C) figure has fallen from $4.5/boe to $2.7/boe. While the oil price has fallen, the asset is cash generative even at oil prices of $35/bbl (opex is $8/boe) and the deal provides better returns.

Our modelling of the asset in September 2015 indicated an IRR of 22% (on the then oil price assumptions of $60/bbl in 2016 and $70/bbl in 2017) while the new deal sees an IRR of 23%. We expect a payback in around three years.

Rockhopper will take on the receivables value of Beach Energy, passing on the receivables paid until the sum of $8.6m is paid. Alternatively, Beach can elect to receive 25% of the outstanding amount one year after completion in full and final settlement. We believe that the receivables have built (from $3m in August 2015 to $8.6m in January) as a result of Egypt de-prioritising payments given the sale of the asset. We would expect this to start to rebalance after the close of the deal.

Metrics

As seen below, the implied $/2P boe is very competitive vs past deals – this is not surprising given the collapse in the oil price.

In December 2010, Beach (22%) and partners started a six-well exploration programme on the Abu Sennan in the Western Desert, Egypt. The first well (GPZZ-4) encountered hydrocarbons and was appraised and tested, and followed by three discoveries, flowing oil, gas and condensate at a combined rate of 12mboe/d (gross).

Development leases over the discoveries were granted in 2012, and the fields started production in February 2013, delivering Beach a total of 130mbbls in the year. A further three exploration/
appraisal wells and one development well were drilled. Two had hydrocarbon shows. In August 2013, the operator (Kuwait Energy) estimated gross 2P of 18.5mmbbls and 142bcf in the Kharita formation only. In total, 20 wells have been drilled, with 16 successful.

Gross production was 663mbbls (and 61mbbls net entitlement) for the year ended June 2014. Gross 2P reserves were estimated at 13.1mmbbls and 21.2bcf. For the half year ended 31 December 2014, production increased by 66% to 50mbbls, while production increased further by June 2015 as a gas pipeline from the El Salmiya field was commissioned. At the time of the first acquisition announcement in August 2015, Rockhopper gave estimates of future production, which we have assumed in our modelling. However, we note that the fields suffer from relatively high decline rates, so will require in-fill wells (gross costs of around $5m per well) to keep production at current levels.

The 2P and 2C resources given by Rockhopper are 3.5mmboe (across four fields), suggesting a 2P+2C reserve life of 12.8 years (assuming an average 2016 production of 4.4mboe/d).

In 2015, Rockhopper pointed to substantial prospectivity in the licence – in excess of 100mmboe (gross) across a number of prospects – this is still the case. We do not believe that all of these will be drilled, and would expect that if initial wells planned are unsuccessful, no further wells will be drilled. At the moment, we do not know which will be drilled, but one could assume that the company will initially focus on those in the exploration areas (as opposed to the production areas) given the desire to convert the exploration areas into production areas. Of the leads/prospects in exploration areas (identified in 2015 but not yet in 2016), the top two contain 32mmboe, and the top four contain around 65mmboe, still substantial volumes. Some changes may have been made since 2015, but we would imagine that the top targets could be of similar size.

We assume that Rockhopper’s interest in the acquisition is predominantly in Abu Sennan. While the El Qa’a Plain is a larger acreage position (and Rockhopper will hold a larger WI at 25%), exploration is currently not valued by the market (or much by industry) and so we would see this entirely as an option (albeit one that will require some limited expenditure).

Further, we note that a partner in the block (Petroceltic, 37.5%) is in examinership in Ireland and may not be able to fund its portion of any wells (although we believe it may have ample Egyptian currency working capital, the group-level financial situation is poor). How this affects the block’s exploration activities is therefore uncertain, we think. Should Petroceltic default on this well, there is the possibility that Rockhopper will increase its working interest, and therefore net exposure to the well (costs and net risked value). If the PCI stake is apportioned according to current working interest, RKH’s interest may increase to 40%. We estimate current net drilling costs at $2-2.5m for the committed exploration well in 2016/17 (assuming WI of 25%).

Rockhopper indicates prospect sizes of potentially 50-100mmbbls in fault assisted traps, although the leads and prospects will benefit from the 2D/3D seismic being processed. We expect to more fully model the financial impact once this is better known. For now, we include the exploration costs in 2017 financials, but explicitly do not value any benefit from this drilling (even on a risked basis).

We make a number of changes, including remodelling of the Sea Lion Phase 2 to 300mmbls (in line with PMO disclosure). We also make the broad assumption that these volumes are split equally between PL04 and PL32, although we note that as no guidance has been released about this split it is subject to revision over time. We assume first oil in 2021 (Phase 1) and 2025 (Phase 2).

As a result, our valuation increases. Our NAV increases to 90p/share, with RENAV moving to 103p/share. We have valued the producing assets at Abu Sennan at NPV12 of $15m, or 2.3p/share. We do not formally include the acquisition in NAV yet – we will wait until the deal closes. However, we do include the numbers in our financial forecasts to give investors an idea of the cash flow implications. Further value for exploration/appraisal will be given once the deal closes and the timing of drilling and size of targets are known. We note that the producing assets are valued at $4.4/boe in our modelling, well above the purchase metrics.

Rockhopper remains well capitalised, with $110m of cash at the end of 2015 (excluding $2m of restricted cash). The Beach Energy acquisition is an example of where a well-funded, patient buyer can make returns above the costs of capital in this low environment. With pro rata volumes (post-closing) of 1,500-1,800boe/d, the acquisition should provide valuable cash flows to offset G&A going forwards, as well as exposure to upside from appraisal/exploration.

As the service costs fall, the committed carry from Premier covers more and more of the capital required pre-first oil at Sea Lion, reducing the requirement for Rockhopper to seek more expensive financing from either the debt facility or external funding.